In Part 2 of the articles series, "Is My Safe Money Safe?," I generally discuss the protection of life insurance and annuity values, IRAs/qualified plans assets and homes from personal creditors. In this column, I'll review some muddled laws in not only these 50 states, but also in the District of Columbia and Puerto Rico -- laws that safeguard the proceeds and avails of life insurance contracts. *(In my upcoming book on retirement income, there is more in-depth information on this timely subject. Use the article form to request a partial draft of Chapter 6, "Creditor Protection for Savings and Investments.")
To get started, let's look at a $500,000 policy that Harry owns on his life; it has a $100,000 cash value and is payable to his wife, Mary.
Question 1: Are Harry's cash values protected from his creditors?
Answer 1: In about nine "permissible beneficiary" states, Harry's cash values -- in the policy -- are fully protected simply because the beneficiary is his spouse. (A child, parent or dependent is normally a permissible beneficiary, too.) In 11 states, Harry would have complete shelter, since the policy itself is safeguarded. In another 11 or so states, full protection is granted merely because Harry is both the policyowner and the insured. (However, these states might not provide protection if Harry owned a policy on Mary -- a so-called cross-owned contract.) Seventeen to 18 states extend partial shelter up to a certain dollar limit, and in three states, there is absolutely no protection.
Note: We are analyzing whether a policyowner's cash values are protected from his or her own creditors. If so, there is no threat as long as money is in the policy.
Question 2: When Harry dies, are Mary's death proceeds protected from his creditors?
Answer 2: In 12 "permissible beneficiary" states, Mary's death benefits are sheltered from his creditors because she is his spouse. In 35 other states, her money is shielded merely because Harry is both policyowner and insured. (In these states, a policyowner/beneficiary of a cross-owned contract might not be protected from the insured's creditors.) In another five states, there is partial protection to a specified dollar limit.
Be aware: Clearly, a beneficiary has more death benefit protection when policyowner/insured are the same and the beneficiary is another party. For some reason, a number of states frown on arrangements where policyowner/beneficiary are the same and the insured is another party.
Note: We are analyzing whether a beneficiary's death benefits are protected from creditors of an insured. If so, the insured's creditors aren't a threat, as the money gets to a beneficiary's checking account.
Question 3: When Harry dies, are Mary's death proceeds protected from her creditors?
Answer 3: Here, we are looking past Harry's creditors, who may or may not be shut out at Harry's death. Fortunately, 22 states protect a beneficiary's proceeds from their creditors. And, sometimes those creditors include both current and future claimants.
The bottom line: Mary's insurance money could be safeguarded from Harry's creditors, her creditors, or both. It all depends on some complex state laws - likely in a state where she lives. And, many of these laws are 50, even 80-100 years old, and were drafted without any real knowledge of our business.
Question 4: Harry (or Mary) set up a settlement option plan for her at his death. Are the payments to Mary protected?
Answer 4: Virtually all states protect death benefits under arrangements that pay installments or annuitized incomes. These laws make sense. Money turned into a stream of payments belongs in the carrier's general fund, and is no longer available to clients or their beneficiaries. In exchange, a payee is entitled merely to the cash flow. To protect these payments, the program needs to include a spendthrift clause. This addendum will reflect that payments can't be attached prior to the carrier's release of the money.
Be aware: It's better if settlement plans are in place before the insured's death; our system gives improved protection when another person arranges something for heirs or beneficiaries. Also, spendthrift clauses probably don't assure shelter for cash flow after it gets to the payee.
Well, if that's not confusing enough, consider the following:
Question 5: After Harry's protected cash values and Mary's safeguarded death benefits or installment/annuity income reach the payee, is there ongoing protection from someone's creditors?
Answer 5: Here, the laws really get murky. My best answer is, "Maybe!"
When it comes to cash values, some states allow creditors to freely attach cash values no longer in the policy. Other states give shelter if non-exempt assets (money in a checking account -- or even investments acquired with these proceeds and avails) have paper trails back to the sheltered policy. Occasionally, these cash values are safe if there is a spouse, child, parent or beneficiary who might be dependent on the policyowner for support. It takes an interpretation of state law to get the right answers.
With death benefits, presume funds are shielded as they come under a beneficiary's control. Thereafter, any shelter may depend on whether the beneficiary is a dependent or can trace money back to the policy.
I wouldn't tell clients and prospects simply that, "The proceeds and avails of life insurance are protected from lawsuits, creditors and bankruptcy!" That can cause confusion. Instead, become well-informed on some tortured state laws, and who and what is sheltered from whom. Discuss local Revised Statutes, such as "Debtor/Collection" and "Life Insurance/Annuities" with an associate and lawyer friend. Your objective is to identify a series of laws, cases and legal impressions that can (a) shield funds in a policy, (b) protect lump sums in a carrier's general fund, and (c) safeguard insurer payments at point of release and receipt (and thereafter). Moreover, you'll want this money protected from everyone's creditors -- policyowner, insured and beneficiary.
If you master this topic, your clients and prospects will gain -- and you will, too.
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