Improper Ownership Of Life Insurance Policy Is Windfall For Creditor...

I saw another example of how sloppy financial and estate planning causes problems in bankruptcy. In this instance, a man took out a $100,000 life insurance policy on his own life. The man died at a time when he and his wife had substantial amounts of  credit card debt. The wife wanted to file bankruptcy. I explained to the  that the life insurance proceeds would be part of her bankruptcy estate if she were the insurance beneficiary.  I suggested that she collect the life insurance, but that she avoid filing bankruptcy. She could use some of the life insurance to negotiate some debt at a discount and find ways to spend or protect the balance of funds from creditors.

When I looked at the insurance policy I saw that the husband neglected to name his wife, or anyone else, as a beneficiary. Therefore, the life insurance proceeds would not be payable to his wife, but would be part of the husband’s estate. The husband’s estate would have to file a probate proceeding to administer the insurance. During the probate the credit card companies could file claims against the estate and the insurance proceeds. The insurance proceeds are still part the wife’s bankruptcy estate because she is her husband’s heir under his will.

There is no way for the wife and her family to escape the credit cards in this situation. In effect, the credit card companies are the primary beneficiary of the husband’s insurance policy.

There is a way for people to properly plan to avoid forfeiting life insurance to creditors. If the husband had created an “insurance trust” he could have protected all the insurance benefits from his creditors and his wife’s creditors. A typical insurance trust maintains life insurance death benefits in a protective trust after death. The trust provides for payments to the family beneficiaries for their needs, but the trust agreement specifically prohibits payments of death benefits to creditors. The insurance trust is created before the insured buys the life insurance policy, and the trustee fo the insurance trust is named as the policy owner.