Your ability to keep insurance proceeds in a Chapter 7 bankruptcy depends on a number of 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 the extent to which you can protect (exempt) insurance proceeds, so where you live is important, too.
Read on for more information about how to determine whether you can keep insurance proceeds in a Chapter 7 bankruptcy.
When you file for Chapter 7 bankruptcy, everything that 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 of 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.
You can learn more about how bankruptcy exemptions work in Bankruptcy Exemptions.
For insurance proceeds that you get because of an accident, there are two issues: when the accident occurred, and whether a bankruptcy exemption covers the proceeds.
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.
Keep in mind that the date of the accident is the key date—not the payment of the insurance proceeds. Only insurance proceeds attributable to an accident that occurred before your Chapter 7 filing are potentially part of your bankruptcy estate.
You can keep insurance proceeds payable to you only up to the amount that your state's exemption laws allow (or the federal exemption, if your state allows for 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.
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:
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 be available to protect these proceeds, as well.
A few other points to keep in mind:
For a broad explanation of exemptions, read Bankruptcy Exemptions: An Overview.