Life Insurance and Bankruptcy

Does bankruptcy affect life insurance policies?

Life insurance proceeds after bankruptcy, inside or outside of super, may not be affected by bankruptcy, which means that creditors may not gain a rightful access to the funds. Life insurance payments can only be claimed by the rightful nominated beneficiaries, no matter what the circumstances are.

How does the the bankruptcy act treat assets?

Any assets that come into your possession in these circumstances is divisible by your creditors

  • When you declare for bankruptcy or after you declare for bankruptcy
  • Before you are cleared of bankruptcy

Click here for the excerpt from the Bankruptcy Act

Under the Bankruptcy Act 1966 section 116 (1), it's stated that:

All property that belonged to, or was entrusted to a bankrupt when he/she has been declared a bankrupt, or has been acquired or is acquired by him or her,
Or has been transferred to him or her, after he or she has declared bankruptcy and before his or her clearance, is property divisible amongst the creditors of the bankrupt.

Is life insurance is exempt from the bankruptcy act?

Act's subsection 1 does not extend to life insurance policies and the proceeds, even if the definition 'property' would normally be applicable to them. This exemption applies to life insurance policies held inside or outside superannuation.

Source: Commonwealth Consolidated Acts - Bankruptcy Act 1966 Section 116

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Life insurance exemptions from bankruptcy

1. Life insurance policies held inside superannuation

The Bankruptcy Act 1966 section 116 (2) excludes your life insurance policies and payments, within the meaning of the Superannuation Industry (Supervision) Act 1993 (SIS Act) if the bankrupt has ownership of:

  • A regulated superannuation fund; or
  • An approved deposit fund; or
  • A superannuation scheme from the public sector (that has exemption); and
    • The payment from such fund has been received by the bankrupt on or after the date of the declaration of bankruptcy; or
    • If the bankrupt has funds that accumulated in a Retirement Savings Account (RSA); and
    • The payment from the RSA has been received by the bankrupt just on or after the date in which bankruptcy has been declared, as long as the payment is not a pension or annuity within the meaning of the Retirement Savings Accounts Act 1997.

2. Life insurance policies held outside superannuation

As for ordinary life policies, the Bankruptcy Act section 116 (2) also applies the following exemption from section 116 (1) of:

  • Policies of life assurance or endowment assurance in respect of the life of the bankrupt of the spouse or de facto partner of the bankrupt;
  • The proceeds of such policies received on or after he/she has been declared a bankrupt.

Source: Commonwealth Consolidated Acts - Bankruptcy Act 1966 Section 116

3. Other types of life insurance policies

Certain stand-alone policies such as total and permanent disability (TPD) cover, trauma cover and income protection cover are not considered as life insurance under the common law and are subject to the Act subsection 1.These exemptions of life insurance policies are based on the common law definition, not of the definition of the Life Insurance Act 1995. This means that a life policy under the Life Insurance Act may not necessarily be considered as a life insurance policy under common law and therefore, it is considered to be a property divisible amongst the bankrupt's creditors under the Bankruptcy Act section 116 (1).

At risk professionals may want to consider implementing a strategy by taking out these stand-alone policies with their spouses/de facto partners as the policyholder. This strategy, however, is not applicable to income protection cover, as it is considered to be income contributions to the bankrupt.

If the TPD and/or trauma cover are added benefits (riders) onto an existing term life insurance policy, then the proceeds will not be considered as property divisible by creditors of the bankrupt and only the nominated beneficiaries are entitled to the funds - policyholder, surviving joint owner, or policy holder's estate.

Did you know?

The word bankruptcy came from Italian Bancarotta, which means a broken bench and not a rotten one, as Italian Bancarotta might suggest - it's from Latin rumpere, to break. The bench was a literal one, however: it was the usual Italian word for a money dealer's table (and indeed is the origin of our bank for a financial institution and also for the sense of break in phrases like "He‟s gone broke").

Source: World Wide Words, 2013

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Richard Laycock

Richard is the senior insurance writer at finder.com.au and is on a mission to make insurance easier to understand.

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