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Estate and Elder Law

Creditor Protection & Life Insurance

Evaluation of creditor risk and the development of a strategy for acquiring creditor protected assets is an essential element of every good estate plan.  In an effort to provide financial security for a loved one upon death, certain creditor protection benefits exist for life insurance policies.  New York's statutory scheme is complex and the creditor protections afforded to life insurance policies are in large measure dependent on the identities of the policy's owner, beneficiary, and insured.  Generally speaking, New York's protection against creditors extends to the death benefit, cash surrender value, and available loan value of life insurance policies.  For example, pursuant to New York's Insurance Law Section 3212(b)(1), an insurance policy that the debtor owns on his life for the benefit of his wife is exempt from the debtor's creditors.  Also, when the owner of the policy is a life insurance trust (frequently utilized to avoid estate taxes), the creditors of the creator of the trust cannot reach the policy. 

The exemption statute is for the protection of the beneficiary and not the debtor.  In protecting the beneficiary, creditors of the owner cannot force the owner to surrender the policy or borrow against the policy to the detriment of the third party beneficiary.  See In re Jacobs, 264 B.R. 274 (Bankr. W.D.N.Y. 2001).  However, it is important to note that loans actually taken by the debtor-policy owner are not protected under the statute because the debtor has full control and disposal of the proceeds.  See Tanges v. Schonbrun, 196 N.Y.S.2d 381 (Nassau County Supreme 1959).  Additionally, protection from creditors under New York's Insurance Law Section 3212(e) does not exist when funds are contributed to a life insurance policy with the actual intent to defraud existing creditors as provided under New York's Debtor and Creditor Law. 

Subject to the exceptions and limitations discussed above, making contributions to life insurance can offer excellent creditor protection.  It is important to keep in mind that these protections are not always absolute, other limitations may apply in bankruptcy, and once funds are withdrawn from these protected assets, they become accessible to creditors.

David R. Schoenhaar is an associate at Ruskin Moscou Faltischek where he is a member of the firm's Trust & Estates Department.