What Happens To Life Insurance When I Declare Bankruptcy?

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As we review our client's assets when discussing bankruptcy there are three different questions, as Licensed Insolvency Trustees (LIT), that we get asked about life insurance:

1.    What if I have a term life policy on my own life?
2.    What if I own a Whole or Universal Life policy on my own life and there is cash value?
3.    What if I am the beneficiary of a life insurance policy on someone else’s life?

In evaluating your assets in a bankruptcy situation your Licensed Insolvency Trustee is determining if there is any equity or value in the asset that is potentially available to your creditors, subject to any exemptions under Provincial or Federal legislation for that type of asset.

Term Life Insurance

I like to compare term life insurance to car insurance where instead of insuring a vehicle you are insuring yourself.  It has a set monthly premium and has a set term – often 5, 10 or 20 years.  If you stop paying your monthly premiums before the end of the term the policy is cancelled, and that’s it.

Who wants to leave a gift for someone they love, only to have it lost to a bankruptcy filing?

Unless you actually die during the term, the policy has no value to you or your designated beneficiary – just like the insurance on your car.  Therefore, there is no value for your bankruptcy estate and your trustee will not ask you to pay anything for it.  If you should die during your bankruptcy, the policy will be paid out to your beneficiary and your trustee will have no right to the proceeds.

What About Whole Life or Universal Life Policies?

These two types of insurance are very similar - I won't discuss their differences here - but they are both considered to be "permanent" policies.  This means they are designed to last your entire lifetime and will not expire like term policies do.  Permanent policies often have a savings component to them and can accumulate cash value.  The cash value is the component of the policy that is relevant to your bankruptcy estate.

The cash value of a permanent policy is similar to any other type of investment asset and would become an asset that the LIT responsible for your bankruptcy must account for.  Under provincial legislation, however, the assets will be exempt from seizure by your trustee, as long as the designated beneficiary of your policy is either a spouse or common-law partner, parent, child, or grandchild.  Similar to term life insurance, if you should die during your bankruptcy, the policy will be paid out to your beneficiary and your trustee will have no right to the proceeds.

Being the Beneficiary of a Policy During Your Bankruptcy

If you are the beneficiary to someone else’s policy and they happen to pass away during your bankruptcy, the proceeds of that policy will be payable to your bankruptcy estate and you will not benefit from it (at least to the extent that your creditors are paid in full).  

If you are contemplating filing for bankruptcy and you think that person who has named you as their beneficiary has a risk of passing away during your bankruptcy, you may wish to have a discussion with that person.  What they wish to do with their policy is wholly their choice; who wants to leave a gift for someone they love, only to have it lost to a bankruptcy filing?  If they want to change the beneficiary to someone else, that is their decision to make. They will still have the option to re-instate you as beneficiary once your bankruptcy is complete.

Life insurance is an important issue for a lot of people, and most of us don't buy it motivated to invest but by the protection it can provide the people we love. Already in a vulnerable position, clients filing for bankruptcy care about what happens to their assets, a Licensed Insolvency Trustees understands these issues are deeply personal.