Sometimes, issues that you’ve just skimmed over burst forth in bunches, demanding attention.
Lately, that issue in my bankruptcy cases has been insurance.
Because its treatment varies so, we need to be asking more pointed questions of clients about both insurance policies and the debtor as beneficiary.
Unmatured life insurance
Starting with exemptions, §522(d)(7) makes an unmatured life insurance policy exempt without limit.
So, the insurance element of a policy owned by the debtor is exempt whether it insures the life of the debtor or someone else.
Life insurance cash value exempt
The loan value, or accrued dividend, on a life insurance policy is exempt up to $8000. §522(d)(8).
But here come qualifiers: the policy has to be owned by the debtor. And it has to insure the life of the debtor or someone on whom the debtor is dependent.
If the client has insurance with cash value on a business partner, a parent, or their kids, it doesn’t fall into this exemption category.
Means test deducts term insurance on breadwinner
For means test purposes, the premium on life insurance is an allowable deduction from current monthly income.
But again, it must be term insurance (don’t want any disguised saving going on here) and it must insure the life of the debtor.
That may leave a gap if the debtor is dependent, or the debtor’s household is dependent, on the wages of a non debtor spouse.
Insurance proceeds exemption
A different set of rules apply if the death of the insured preceded the bankruptcy filing and we’re dealing with death benefits.
The income stream from a life insurance policy is exempt if the debtor was the dependent of the decedent on the date of death. §522(d)(11)(C).
But, the exemption is limited to the amount necessary for support for the debtor and the dependents of the debtor.
This, of course, opens the nasty issue of what is “necessary for support”: is it beans and rice, or beefsteak?
When debtor is the beneficiary
If a death has occured prepetition and the debtor is the beneficiary, you look to exemption law as discussed above.
We’re fond of saying that bankruptcy deals with a snapshot of the debtor’s assets on the date of filing bankruptcy.
But that glosses over the exceptions to the rule: the bankruptcy estate includes inheritances (used loosely); marital settlement agreements; and life insurance benefits to which the debtor becomes entitled within 180 days of filing. That’s §541(a)(5).
Insurance proceeds payable directly to the debtor on account of a death in that 180 day window become assets of the estate, subject to the exemptions we’ve already examined. To the extent the debtor knows he’s a beneficiary, there may be a planning opportunity here to divert insurance proceeds from the financially troubled client.
We’ve looked at exemptions from the perspective of the federal bankruptcy exemptions. If those exemptions aren’t available in your state, you need to search out the treatment of both the policy and any proceeds provided in state law.
Twice recently, my clients have owned key man insurance on a former business partner. In my cases, the business was defunct. If operating, perhaps there is an argument that the debtor was indirectly dependent on the partner, or there wouldn’t have been a need for the insurance.
A current client acquired, at the suggestion of his financial advisor, expensive life insurance on his children. I’m not seeing any exemption possibilities there other than the grubstake exemption.
Then, finally, a client was the beneficiary of his mother’s life insurance, which was payable to him for the purpose of providing a culturally traditional funeral. Sorry, said the bankruptcy trustee: if it’s payable to you, it’s grist for your creditors.
As Arthur Conan Doyle has Sherlock say: These are much deeper waters than I had thought.
Image courtesy of Flickr and Andercismo