Jan. 2, 2007

If I file for bankruptcy, will the creditors take the accumulated cash in my whole life insurance policy?

Cathy, Nevada

Dear Cathy,

Bankruptcy is one of the few situations when state law supersedes federal law, so while there are provisions in federal law that can protect certain types of property from creditors in bankruptcy cases, each state may have its own rules as to whether the federal rules are applicable.

According to John Rao, a staff attorney with the National Consumer Law Center, federal law allows a person filing bankruptcy to "exempt" up to $8,625 of accumulated cash value from the assets that creditors can claim. Furthermore, if you don't have or don't need the full exemption for real estate, you may also be able to protect another $8,000 of cash value from your creditors.

However, according to Mark Segal of Segal & McMahan, a Nevada attorney familiar with bankruptcy law and member of the National Association of Consumer Bankruptcy Attorneys, Nevada's rules are somewhat different.

In Nevada, the exemption of life insurance cash value from bankruptcy proceedings depends on how much you pay for the policy, says Segal. If your annual premiums are less than $1,000, all of your cash value is exempt, but if you pay more than $1,000 per year for your policy, your creditors will have the right to claim part of the cash value.

For policies with more than $1,000 annual premium, you will need to divide 1,000 by your annual premium to determine how much of your cash value you can exempt from your bankruptcy. For example, says Segal, if you pay $2,000 per year for your life insurance, you would only be able to exempt ½ of your cash value ($1,000 exemption ÷ $2,000 annual premium = ½).

That does not necessarily mean that your creditors will take the cash value. According to Segal, most creditors will allow you to "buy back" or reimburse them for the portion of the cash value that is not exempt so that you will not need to alter your life insurance policy.

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Disclaimer: We are journalists, not financial planners or insurance brokers. Nothing we say should be interpreted as a recommendation to buy or sell any insurance product, or to provide other financial or legal advice.