Asset Protection when facing bankruptcy can be viewed as a difficult task. There are some things that can be done to protect assets if there is no asset protection plan already in place. While this method discussed below will not solve all problems, it is a way for clients to protect some assets and leave insurance benefits to the family instead of sending money to the pockets of creditors.
Asset Protection and Bankruptcy: Bankruptcy Code and Life Insurance Can Provide Asset Protection
Asset protection is a major concern, especially among those who have considerable wealth. In addition to traditional asset protection planning methods such as an irrevocable trust, it is also possible to use the Bankruptcy Code in combination with life insurance to create an asset that is protected.
Most people know of another individual that has had to file for bankruptcy. The following information can be beneficial if you or someone you know is facing bankruptcy and has not done any irrevocable trust asset protection. It is possible to protect and retain many assets from the bankruptcy creditors.
Asset Protection Going into Bankruptcy
When an individual is going into bankruptcy, they usually have the mindset that all liquid wealth they have will be lost in the bankruptcy and will then be divided among various creditors. Without the right asset protection planning, this is often what happens. However, the bankruptcy laws will allow an individual to retain $10,775 of any life insurance contract that has not matured. The policy must be owned by the debtor and the debtor or their dependents must be insured by the policy. This is under bankruptcy law §522(d)(8).
There are some unique opportunities for clients to protect their assets by using the bankruptcy law in combination with no-cash value policies.
An Example of Bankruptcy Asset Protection
For example Mr. Brown, age 51, who realizes his creditors will soon be closing in and will force him to file for bankruptcy. He has debts that are more significant than his assets; he has not created an irrevocable trust to hold his biggest assets, and will soon have no choice but to file for bankruptcy to clear him from the growing debt. We shall assume that he has $45,000 of liquid wealth in a bank or brokerage account. Under the current bankruptcy laws, Mr. Brown could take $25,000 and pay a premium payment into a no cash value UL policy that has a guaranteed death benefit. For this example, we will say the death benefit is $350,000.
The question now is what will be the cash surrender value of that policy in one year from now? It will definitely be less than $10,775. This means that $45,000 that would have been handed over to creditors will instead end up providing a guaranteed $350,000 life insurance policy that will become an asset to the family for their entire life.
This may not be the best solution when it comes to bankruptcy and asset protection issues, but it would be better to give the money to the family as a lifetime benefit instead of turning it over to the creditors.
Is Life Insurance for Asset Protection during Bankruptcy Fraudulent Conveyance?
One question many clients will ask is if this act is in violation of fraudulent conveyance laws. The answer is no. To begin with, it is not a conveyance at all, so it should not be deemed a fraudulent conveyance. The individual that is transferring the money from a certain bank account into a life insurance policy is not transferring any ownership. In addition, that same individual who had the money in the bank will also be the owner of the life insurance policy.
It may be confusing as to how this could be fair and it seems to contradict the rights of the creditor. Many creditors will see it in this manner, however, there are many cases in which the bankruptcy trustee has unsuccessfully argued that the use of life insurance as an asset protection tool for pre-bankruptcy will place creditors at a disadvantage by defeating the chances of the creditor getting the amount that is owed to them. Due to these arguments, the courts have been forced to weigh the debtor’s rights versus the rights of the creditors. So far, the advantage goes to the debtors.