Restructuring your finances can have some side effects.
“Bankruptcy, Michael, is nature’s do-over.”
- “Money.” The Office, season 4, Episode 7.
Filing for bankruptcy sounds scary, right? Like it’s not just me? It’s so scary that people have to debunk commonly held myths about the very concept. So today, we wanted to discuss something you may not have thought readily about—does bankruptcy affect life insurance?
It’s a fair question. Bankruptcy is about managing your debts. But how exactly does bankruptcy affect your life insurance policy? And can it have an effect on your ability to apply for coverage? Read on to find out—*whispers* it’s not as bad as it sounds.
- What is bankruptcy?
- Who declares bankruptcy?
- Effects of bankruptcy
- Bankruptcy and life insurance policies
- What’s next for bankruptcy and life insurance?
What is bankruptcy?
In simple terms, bankruptcy is a court process where individuals and businesses can tackle their debts and repay their creditors. How does this happen? Depends on the type of bankruptcy you’re filing for. When it comes to individuals and businesses, the most common types are Chapter 7 and Chapter 13 filings.
Some differences between the two chapters are eligibility requirements, timeframe and the ways the debts are managed. For example, Chapter 7 filings usually liquidate some of your property and can take approx. six months to discharge the debt. Chapter 13, meanwhile, offers a repayment plan and requires those filing to stick with the plan for three to five years.
Who declares bankruptcy?
Other than certain paper company managers declaring it in the office, plenty of people declare bankruptcy. People declare bankruptcy when they have far more debts than money to cover them. For example, in 2020, filers owed $148 billion and had total assets of $47 billion.
And statistically speaking, it’s usually low-income people who file for bankruptcy either due to things like divorce, severe illness, or job loss. The median income of people who file for Chapter 7 and Chapter 13 bankruptcies can range from $30,000 to the low $40,000s.
Comparison of assets owned vs amount owed by bankruptcy filers
Effects of bankruptcy
Bankruptcy laws were written to give people a second chance when it comes to finances. But that doesn’t mean there won’t be effects felt once you file. Let's say you file for Chapter 7 bankruptcy. That filing will appear on your credit reports and affects your scores for the next 10 years. Chapter 13 filings affect your scores for seven years. Having your credit affected means that efforts to secure loans and mortgages could be affected. Plus, it’s public record. So employers will see the filings when you apply for a job as well.
That’s not to mention the immediate costs. The amount it takes depends on the type of bankruptcy, your individual case, and where you live. But for a Chapter 7 filing, the average total could be $1,788 in total. That’s the filing fee plus any attorney fees you may encounter.
Bankruptcy and life insurance policies
If you’re a beneficiary and you file for bankruptcy, can life insurance be garnished? Well, it can. Typically people who receive a life insurance payout don’t file for bankruptcy because, well, they have money to address their debts. However, in the event you may still need to file, there are some things to note.
You’ll have to file the proceeds with your paperwork. Bankruptcy trustees actually ask you if you expect any money to come to you in the future, so they’re looking out for funds. You may be able to keep the payout if you receive a bankruptcy exemption, but cash assets are less easy to protect. So life insurance proceeds during Chapter 13 or Chapter 7 filings can be taken to cover those debts.
Filing for bankruptcy can affect life insurance applications as well. According to our underwriting team, insurers will generally deny coverage for folks who have filed but haven’t had their bankruptcy discharged yet. Even after the discharge, insurers will typically see the bankruptcy as a “red flag” that can help lower your class rating. A lower class rating could mean higher monthly costs. But, again, that’s part of the underwriting process, which takes a whole host of factors into account.
What’s next for bankruptcy and life insurance?
If you have a life insurance policy but are thinking of filing for bankruptcy, there are steps to take that might help. Preparing your documents, talking with attorneys, and credit counseling are just a couple of initial steps to re-organizing your finances. And there are things to consider when trying to protect your policy. And the same can be said for protecting any life insurance payout you may receive. So the best first step is just getting educated and finding the right answers. The first step is always the most important.