Can I Keep Insurance Proceeds in Chapter 7 Bankruptcy?

Your ability to keep insurance proceeds in a Chapter 7 bankruptcy depends on several factors. Why you received the money is important because different restrictions apply to accident and life insurance proceeds. Also, state and federal law ultimately determines how much you can protect or "exempt" insurance proceeds, so where you live is important, too.

Read on for more information about determining whether you can keep insurance proceeds in a Chapter 7 bankruptcy using bankruptcy exemptions.

How Bankruptcy Exemptions Protect Property

When you file for Chapter 7 bankruptcy, everything you own is potentially property of your bankruptcy estate. That doesn't mean that you'll lose everything, however.

Each state has exemption laws that allow you to protect specific assets. Some states allow you to choose between state exemptions and federal exemptions, depending on which set will work best for you.

Many people can exempt all their property in Chapter 7 bankruptcy—but not always. The Chapter 7 trustee can sell or liquidate nonexempt assets to pay creditors. In most cases, you won't be able to exempt unnecessary luxury goods, such as a flashy car or boat.

Accident Insurance Proceeds

Two issues determine whether insurance proceeds are protected in bankruptcy: when the accident occurred and whether a bankruptcy exemption covers the proceeds.

The Accident Date

You'll be able to keep insurance proceeds due to a personal injury that occurs after your Chapter 7 filing. You can keep insurance proceeds resulting from a post-bankruptcy accident regardless of whether they're exempt. They won't be part of the estate.

By contrast, if you're injured in an accident that occurs before you file for Chapter 7, any insurance proceeds payable to you are likely property of your bankruptcy estate. You'll need to take the next step of figuring out if they are exempt to determine if you'll get to keep them.

Remember that the accident date is the key date—not the payment of the insurance proceeds. Only insurance proceeds attributable to an accident before your Chapter 7 filing are potentially part of your bankruptcy estate.

Exemptions for Accident Insurance Proceeds

You can keep insurance proceeds payable to you only up to the amount your state's exemption laws allow (or the federal exemption, if your state allows it). Some states have generous exemptions for insurance proceeds received in a wrongful death or personal injury case. Other states' exemption laws are more restrictive.

You might also be able to exempt additional proceeds by using a state or federal wildcard exemption—an exemption that allows you to protect any property of your choosing.

Life Insurance Proceeds

The law is somewhat different concerning life insurance. Life insurance proceeds are likely property of your bankruptcy estate if you're entitled to them as the result of a death that occurred:

• before you filed for Chapter 7, or
• within six months after you filed for Chapter 7.

State law will determine the amount of the life insurance proceeds exemption you'll get to claim or if you can use the federal exemptions. Again, a wildcard exemption might also be available to protect these proceeds.

Other Life Insurance Proceeds Considerations

A few other points to keep in mind:

• Disclosure. You must include any claim to insurance proceeds as an asset in your bankruptcy schedules. Failure to disclose your right to payment of insurance proceeds can result in sanctions by the bankruptcy court. The court could dismiss your Chapter 7 case or deny you a discharge for failure to disclose assets.
• Trustee's right to handle claim. If you haven't reached a settlement before you file Chapter 7, the trustee might take over handling any pending litigation. Generally, a trustee will take an active role in pending litigation only if there are likely insurance proceeds you aren't entitled to claim as exempt.
• Court approval of settlements. Settlements of insurance claims after you file Chapter 7 require bankruptcy court approval. The court will approve a proposed settlement if it's entered into in good faith and is in the best interests of your bankruptcy estate. Ordinarily, your bankruptcy estate will not have an interest in a proposed settlement unless the amount exceeds any applicable exemptions. In that situation, creditors would be entitled to receive any amount over and above the exemption amount.