Bankruptcy and Life Insurance

Bankruptcy and life insurance. You might wonder what these two seemingly unrelated topics have in common. Plenty.

Bankruptcy isn’t just about getting rid of debt; it’s about restructuring your financial life.  As part of that process, you’ll examine what you earn and what you spend. For most of us, we spend more on things we shouldn’t and less on things we should.

Why is life insurance important?

Having an adequate amount of life insurance is the most important part of your estate plan, and it’s one of the most important parts of your overall financial plan. It’s as important as having a will, and more important than having a trust or other estate planning done.

If I die, will my spouse have enough?

I see married couples all the time who–together–make enough to do well financially. But if one income goes away, they’d be in trouble. If you died, would your spouse have enough to support himself or herself?  What about your children?  How would your spouse pay your mortgage? What about all the other expenses?  Even with a stay-at-home mom who–technically–doesn’t earn income, replacing her economic contribution to the household would cost a fortune.

10 times earnings…

The general rule–and this obviously doesn’t apply in all situations–is that you should have enough life insurance to replace ten times your earnings. For example, if you make $60,000 per year, you’d probably want a term life insurance policy with a death benefit of $600,000.  In the case of a stay-at-home mom, you’d be limited on what you could purchase, but don’t make the mistake of underestimating the economic value she contributes.

And then there’s the means test

If you need life insurance, get it prior to filing bankruptcy. You can count the monthly expenditure on the means test and the expense on schedule J (your expense schedule). That means the expense can help you regardless of whether you file Chapter 7 or Chapter 13. In Chapter 7, life insurance is viewed as a legitimate expense which weights against you having to file a Chapter 13 (or get your case dismissed for “abuse”).  In Chapter 13, the money you’d spend on life insurance would otherwise go to your unsecured creditors–think Visa and MasterCard in most instances.

As with buying a car before filing, let’s be clear: You do not buy life insurance to help you with the means test.  To do so would be considered bad faith and would be harmful to your case. But if you need life insurance, there’s nothing wrong with buying it–in fact, it’s the right thing to do. 

Filing bankruptcy is part of a complete financial makeover. And evaluating your life insurance needs is a very important part of the process.