How Does Life Insurance Help Me in Bankruptcy?
Updated: Feb 8
Life insurance can play an important role in bankruptcy, just as it can in life. Outside of bankruptcy, life insurance is a vital means of ensuring your loved ones are well-looked after should anything unfortunate befall you, but, in bankruptcy, life insurance plays an additional role of providing that same security to your loved ones while providing a sometimes necessary monthly expense that can sometimes significantly impact either your eligibility for a Chapter 7 bankruptcy or the size of your Plan payment in a Chapter 13 bankruptcy.
In a Chapter 7 bankruptcy, eligibility is determined, on one hand, by an income-based standard called the Means Test. This mechanism, introduced into the Bankruptcy Code in 2005 by financial industry lobbyists, looks at your household income (including all earners) and compares it to the median income for a household of that size in your state. If your household has a “below-median” income, you are eligible for Chapter 7 according to the Means Test (though, in reality, there are subtleties to the test that this quick explanation does not attempt to capture).
Additionally, however, there is an additional eligibility standard for Chapter 7 bankruptcy. This standard is a “good faith” standard that looks at your average monthly income and compares it to your average monthly expenses (as a household in both cases, not just as an individual). If there is “too much” money left over after those expenses are subtracted from that income, there is a possibility that the Trustees in your bankruptcy case may file a motion to have the case dismissed on the theory that you have money left over at the end of the month with which you might pay your creditors—even if you have passed the Means Test.
In such cases, every legitimate, honest monthly expense that cannot be objected to by the Trustees is of vital importance. Term life insurance with $0 present-day cash-value (benefit only to be paid out upon the demise of the policy holder) is a very useful expense to have on the list in such cases. (Note that whole life insurance, or cash-value life insurance from which the filing individual can draw funds at will at the time that the bankruptcy is filed, can be problematic as an asset requiring exemption or protection in Chapter 7 cases: this post does not address these issues.) Term life insurance is an expense that Trustees do not generally object to and will provide not only a reduction in monthly net income for “good faith” purposes but also will provide your family needed protection should anything unexpected occur.
In a Chapter 13 bankruptcy, this same monthly income vs. monthly expenses formula determines the amount of your Chapter 13 plan payment. Whatever is “left over” at that end of that average, hypothetical month described in the Bankruptcy Petition is the amount that is paid in the Chapter 13 plan on a monthly basis. Obviously, in this case, the term life insurance payment results in a lower Chapter 13 payment.
Some Chapter 13 Plans do require a minimum monthly payment to be made in order to be mathematically feasible and to meet certain criteria of the Bankruptcy Code, but a Chapter 13 bankruptcy is 3-5 years long and, though you are in bankruptcy and whatever the ramifications, life insurance remains a vital and responsible means of ensuring that a sudden tragedy does not result in long-term harm to your loved ones.
Guest Post by John M. Hilla, Michigan Bankruptcy Attorney