The process of becoming disabled in the middle of one’s career is often financially costly as well as personally devastating. The approval process for long-term disability insurance (LTD) benefits can also be lengthy, leading to a situation in which individuals who leave work due to disability experience a period with no income, followed by income replacement benefits that account for only a fraction of their former wages. Unsurprisingly, it is common to see questions about long-term disability benefits in bankruptcy proceedings. Many individuals wonder what disability income protection bankruptcy offers, and how to report their LTD benefits in bankruptcy filings. You may also wonder about a bankruptcy impact on long-term disability income in your situation. Some of the answers will depend on where you live, as many states establish exemptions for certain types of income. States also handle the rights of creditors somewhat differently. With these caveats in mind, there are still some general principles that may help you understand what to expect.
What Is Bankruptcy?
Bankruptcy is a legal process by which debtors who have no realistic expectation of being able to meet their financial obligations to creditors declare their insolvency and ask assistance from the civil courts in making arrangements to discharge their debts. When successful, debtors may be able to establish new terms for paying off all of their debts, or they may be able to have some portions of their debts forgiven in exchange for the liquidation of their assets to cover others. Usually these arrangements take place through a process of court-managed compromise negotiations with creditors, such that each creditor is able to receive at least a portion of the debt originally owed.
Both individuals and businesses may file for bankruptcy, a fact which may have particular importance for people who owned their own businesses prior to becoming disabled. For these individuals, questions about the disability income protection bankruptcy offers can be especially complicated if their business structure does not protect personal assets from business debts. Typically, however, businesses vs. individuals file for different types of bankruptcy under distinct chapters of the United States Bankruptcy Code.
Types of Bankruptcy
Individuals most often file under Chapter 7 or Chapter 13 of the Bankruptcy Code. The chapter under which an individual declares bankruptcy will determine the standards set for the case, the scope of relief available, and to some extent the assets that may receive a degree of protection. The types and amounts of the debts themselves can also play a role in determining how a bankruptcy plays out. For individuals concerned about a bankruptcy impact on long-term disability benefits, how the benefits are paid out and whether there is at any point a lump-sum distribution, such as for “back pay,” can be important considerations.
Bankruptcy Impact on Long-Term Disability: Chapter 13
Chapter 13 of the Bankruptcy Code covers a version of bankruptcy sometimes called “reorganization” bankruptcy. This may put many people in mind of the Chapter 11 bankruptcy more often filed by businesses, but in general Chapter 13 allows individuals to establish a court-managed plan for paying off their creditors over a period of time, often three to five years. Chapter 13 offers much greater protection of the debtor’s existing assets than does Chapter 7, but it can also mean a substantial bankruptcy impact on long-term disability, as courts will normally include LTD benefits in bankruptcy filing as part of the income an individual has available to put toward a repayment plan.
Chapter 13 bankruptcy may be an option you choose to pursue if you have substantial assets you wish to protect, such as a lump-sum long-term disability settlement or a home that is already debt-free. This form of bankruptcy may also be the only type available to you if you do not meet the means testing requirements for bankruptcy under Chapter 7.
Disability Income Protection: Bankruptcy Under Chapter 7
Under Chapter 7 bankruptcy, a court will order the sale of your assets to pay off debts. A trustee will oversee the sale and the tendering of proceeds to the various creditors. Because Chapter 7 sells off available assets to raise money to repay debts, it is often called “liquidation” bankruptcy. This form of bankruptcy generally is not available to individuals who have significant financial assets already in hand, as the expectation is that they would need to put whatever money they have toward their outstanding debts before seeking assistance from the courts.
Chapter 7 bankruptcy tends to be resolved more swiftly than the payoff periods for Chapter 13, and in many cases the disability income protection bankruptcy under Chapter 7 affords for ongoing LTD benefit payments can be significant, since once the liquidation period is over an individual’s debts are generally considered resolved, although their credit rating may suffer for many years to come. The risks to long-term disability benefits in bankruptcy are substantial for individuals who have accepted lump-sum settlements of their longterm disability claims, whether the bankruptcy proceedings are managed under Chapter 13 or Chapter 7.
Types of Debt in Bankruptcy
One of the few true consensus positions in contemporary American life is that medical care is too expensive. Unfortunately, despite general agreement on the nature of the problem, no comparable unity has yet emerged concerning a solution. These factors have led to a situation in which medical debt has for several years been a leading cause of bankruptcy among middle class households. Other causes may include the collapse of a business in which an individual has invested significant portions of their own money, and on whose subsequent revenue generation the entrepreneur has relied.
Regardless of the dominant cause of debt for an individual and their household, there are a few predictable types of debt that many people do carry. Some of these types of debt are more susceptible to resolution through bankruptcy than others.
Credit Card Debt
Many American households carry at least some measure of credit card debt. The amount can vary widely, depending on the overall spending limit and the consistency with which the cardholder was in the habit of paying off his or her balance before the series of financial misfortunes that led to a declaration of bankruptcy in their particular case. The number of cards, and in some instances whether any of these cards may be held jointly between spouses, can also be factors.
Auto Loans
Very few Americans have the ready capital to pay for a motor vehicle up-front, in cash. Even those who have the resources may be hesitant to empty their savings accounts to cover a single purchase. Consequently, most personal vehicles are “financed,” with the dealer paid by the bank or credit union that holds the loan and the vehicle itself serving as collateral in case of default.
Home Mortgages
Home mortgages work in much the same manner as auto loans, but they are generally financed over a much longer period. Complicated legal questions can arise over the sale of a home that is still under mortgage, but many people receiving long-term disability benefits have to navigate these questions as part of an overall strategy for “downsizing,” making lifestyle changes to reduce their household expenses after leaving the workforce.
What Kinds of Debt Cannot Be Forgiven in Bankruptcy?
There are a few kinds of debt that are rarely, if ever, forgiven during bankruptcy proceedings, even under Chapter 7 proceedings. These types of debt usually center on obligations to the state and federal governments, often in the form of unpaid taxes, but there are exceptions.
Student Loan Debt
Most types of consumer debt held by private lenders are susceptible to bankruptcy resolution, but student loans form an exception to this general rule and cannot normally be forgiven. Individuals receiving LTD benefits in bankruptcy filing under own-occupation disability policies designed to protect them against loss of income when they are no longer able to perform the work necessary for their chosen careers may be especially susceptible to high rates of student loan debt because these own-occupation policies are disproportionately selected by people in career paths that demand a significant investment of time and money in their professional training.
Often these individuals will have student loans not just from college, but from graduate school, and it is not unusual for their student loan debt to match or even surpass the total value of a home. When the home itself is also under mortgage, the total debt can easily range into the millions, even when an individual’s pre-disability income may never have reached six figures. The amount of that pre-disability income, the percentage of income replaced by LTD benefits, and the structure of the individual’s student loan repayment plan can all be important considerations in determining the impact of student loan debt on long-term disability benefits in bankruptcy proceedings.
Child Support
Almost no circumstance will remove debt from the arrears owed for child support, and parents managing LTD benefits in bankruptcy filings should not expect their bankruptcy to constitute an exception. The logic that courts usually follow is that all parents are equally responsible for contributing to their children’s welfare, regardless of whether the parents are married and regardless of any parent’s financial circumstances.
Child Support and Parental Income
That said, courts also acknowledge that not all parents have the same resources. Parents with high-earning jobs do not have a greater personal responsibility to care for their children than do parents in minimum wage positions, but they do typically have more money with which to provide financial advantages. Parents managing their long-term disability benefits in bankruptcy proceedings understandably often have very limited resources to offer their children.
Child Support Calculations and LTD Benefits in Bankruptcy Court
Standard child support calculations generally aim to devote a percentage of a parent’s income to the support of his or her children, often on a monthly schedule. If parental income changes, filing for a modification of child support obligations may be appropriate. A bankruptcy court may not absolve you of those obligations, but a family court can and in many cases will recalculate and adjust the amount you owe going forward, based on your updated income information. Family courts will also frequently work with parents who have recently become disabled, and those navigating bankruptcy impact on long-term disability income, to establish a plan for catching up on their past due child support payments.
Unpaid Taxes
Bankruptcy will not typically eliminate personal debt due to unpaid individual income taxes. Just as the Internal Revenue Service (IRS) can usually garnish an individual’s income from any source, even Social Security Disability Insurance (SSDI) payments, in most cases the agency can also exempt any amounts you owe them from debt forgiveness under Chapter 7 of the Bankruptcy Code. Chapter 13 usually requires negotiated repayments of most types of debts, and so debts due to unpaid taxes may offer less of a distinction for individuals navigating bankruptcy impact on long-term disability under Chapter 13 filings.
The somewhat more encouraging news, for many individuals wondering how much disability income protection bankruptcy truly offers, is that in some cases it may be possible to work with the IRS directly to establish a repayment plan that allows the disabled person to pay off their tax debt in installments that can be more manageable than a lump sum demand. Depending on how your long-term disability premiums were handled, as well, the LTD benefits themselves may sometimes be exempt from new income tax assessments. Given the stakes, you may find it helpful to speak with an attorney who can go through all the details of your individual situation and offer you tailored advice.
Long-Term Disability Benefits in Bankruptcy: Preparing for the Road Ahead
The disability income protection bankruptcy affords will depend partly on the types of debts you carry heading into bankruptcy, and the amounts of those debts relative to your assets. The assets themselves will also help to determine which type of bankruptcy is advisable and available in a given situation. The handling of LTD benefits in bankruptcy filing may be affected by state exemptions, as well as by the federal exemptions for taxes, unpaid child support, and in most cases student loans. The cumulative bankruptcy impact on long-term disability in your particular case will be structured by whether you are approved for bankruptcy under Chapter 13 vs. Chapter 7. Long-term disability benefits in bankruptcy are not normally seized outright as monthly payments come in, but they will typically be counted as part of your income available for paying debts. Working with a trusted accountant to ensure your financial records are organized and up-to-date may be helpful, and you may also wish to consult with an attorney regarding strategies for protecting your long-term disability benefits in bankruptcy proceedings.
