Court confirms creditor protection for life insurance

The Michigan Court of Appeals has issued a decision confirming that all elements of a life insurance policy, including the cash value of a whole life or universal life policy, are exempt from levy by a judgment creditor.

The plaintiff sued the defendant - for what is not disclosed - and recovered a judgment in the amount of $2.5 million. Plaintiff sought a writ of garnishment seeking to have the Prudential Insurance Company turn over the cash value of a policy that had been sold to the defendant. Defendant objected to the request.

MCL 500.2207 protects life insurance policies from claims of this nature by creditors. But the plaintiff argued that this section was intended to protect only the death benefit that is payable to the beneficiaries named by the insured, money that the insured himself does not own and can not reach while he is still alive. The cash value, the plaintiff argued, is fully available to the insured and can be taken out by him at any time, although this would reduce the total amount payable under the policy to the beneficiary after the insured is gone.

The Court of Appeals rejected that argument, ruling that the intent of the Legislature was to protect the entirety of the policy. One important point that it noted was that the cash value, if untouched during the insured's lifetime, will add to the recovery by the beneficiary. Conversely, allowing a creditor to attach the cash value would diminish the amount ultimately received by the beneficiary.

DC Mex Holdings v Affordable Land, LLC, decided July 25, 2017

Inherited IRAs not protected

The U.S. Supreme Court has ruled, in the case of Clark v. Rameker, that inherited IRAs cannot be protected in a bankruptcy filing. As a result, IRAs that have been inherited from a deceased worker (the "participant") are available as assets to pay creditors.

The opinion for a unanimous court, written by Justice Sotomayor, focuses on key differences between IRAs owned by the participant and inherited IRAs:

"Inherited IRAs do not operate like ordinary IRAs. Un­like with a traditional or Roth IRA, an individual may withdraw funds from an inherited IRA at any time, with­out paying a tax penalty. §72(t)(2)(A)(ii). Indeed, the owner of an inherited IRA not only may but must with­draw its funds: The owner must either withdraw the entire balance in the account within five years of the original owner’s death or take minimum distributions on an annual basis. . . And unlike with a traditional or Roth IRA, the owner of an inherited IRA may never make con­tributions to the account. 26 U. S. C. §219(d)(4)."

The code, she noted, does not define the term "retirement funds." Considering the ordinary meaning of the term (a Scalia-like endeavor, it would seem), it would mean funds set aside for the owner's retirement. Disregarding a particular owner's subjective intention, and focusing on the objective characteristics, she noted three factors:

"Three legal characteristics of inherited IRAs lead us to conclude that funds held in such accounts are not objec­tively set aside for the purpose of retirement. First, the holder of an inherited IRA may never invest additional money in the account. . .  

"Second, holders of inherited IRAs are required to with­ draw money from such accounts, no matter how many years they may be from retirement. . .  

"Finally, the holder of an inherited IRA may withdraw the entire balance of the account at any time—and for any purpose—without penalty. . . "

IRAs that are owned by the participant continue to be protected to the extent provided by Federal or state law. (Both must be considered under the Bankruptcy Code.) In Michigan, that law is MCL 600.5451-1-k. Qualified retirement plans, including 401-k plans, are exempted under MCL 600.5451-1-l and under provisions of Federal law.

Debts of the decedent

At Bankrate.com, Steve Bucci answers a "debt advisor" question from a reader who had accumulated some $35,000 of gambling debts. The reader's father took out $35,000 in "unsecured loans" - i.e., cash advances on credit cards - and had begun paying off those advances, apparently with money from the son. The father then died unexpectedly. The reader's mother knew nothing about the loan arrangement.

The father left no assets and no will. The reader's concern is that the credit card companies would try to collect on the debts from his mother, who does have assets. He wonders if he should "continue to pay on these debts". This suggests that it was the reader, not the father, who had been making the payments on the credit card accounts.

Bucci's answer includes these points:

• If the parents are residents of a community property state - Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin - then the mother would have a responsibility to follow up on these debts.
• If they live elsewhere, then she has no legal responsibility for the debt.
• She may still feel a moral obligation to make good on the debt.
• She needs to know about the arrangement, because she is likely to be contacted by the creditors, and is likely to be give false information suggesting that she has a legal obligation to continue to pay on the accounts.
• Both of them should consult with counsel regarding their rights and obligations.

He recommends that "the executor of the estate" make contact with the creditors, explain that the debtor has died, and provide a copy of the death certificate. He overlooks the fact that the father died with no will and no assets. There will not be an estate or an executor (in Michigan, a "personal representative"). But the advice is sound. Any family member can make the contact and provide the certificate.

When a debtor dies, the following applies in Michigan:

• Any debt which is secured (car loans, mortgages) must still be repaid. If it is not repaid, the property securing the debt can be seized and sold.
• Any debt which is unsecured must be repaid from the probate assets of the deceased, or from his trust assets.
• If there are no such assets, then the creditor will not be able to collect.

"Probate assets" refers to any property that was owned by the debtor, in his own name, without any other person as co-owner. If the debtor dies without any probate assets, or without assets passing to others under a trust, then the creditors are out of luck. The death benefits of life insurance policies, money passing under an IRA or other form of pension to a designated beneficiary, or property passing by virtue of joint ownership are not subject to the claims of the creditors of the decedent. The sole possible exception would arise if it can be shown that the decedent took steps to defraud his creditors by moving personal assets into some form of ownership that would not have to respond to his actual and known debts.

More:

• Is my family responsible for my debts? at the AARP web site
• Debt After Death: Banks Chase Down Mourners - CNN
• The Michigan statute governing payment of life insurance benefits - MCL 500.2207 - makes special provision for certain beneficiaries, but not for others.