Many of our clients come to us in financial hardship because they can’t work due to illness or injury. It’s our job to help them claim their total and permanent disability (“TPD”) and income protection benefits and get them out of financial hardship. However, sometimes a client’s financial situation is so dire that they must consider bankruptcy.
Therefore, we are often asked whether superannuation money and/or disability insurance benefits are available for distribution amongst creditors in the event of bankruptcy.
The general rule in bankruptcy is that all of your assets vest in the trustee in bankruptcy and are available for distribution amongst the creditors (even assets obtained after bankruptcy, can be made available). However, there are some exceptions to this general rule which are set out in section 116 of the Bankruptcy Act 1966.
What are the exceptions to this rule?
Any superannuation money (your employer contributions and any contributions you have made yourself), which is in a regulated superannuation fund on the day of bankruptcy is not available to creditors in bankruptcy. This means that money which is held in the superannuation fund is protected from creditors.
Importantly, any superannuation money which is withdrawn from the superannuation fund before the day you enter bankruptcy will be available for distribution.
These benefits are treated differently in bankruptcy depending on whether the benefits are held in the superannuation fund or are held by you personally. Also, as a general rule, TPD benefits paid due to personal injury are not divisible. More specifically:
If a TPD benefit is provided via a superannuation fund account, the relevant insurer will usually pay your TPD benefit into your superannuation account.
You must then make a separate application to withdraw the TPD benefit money from the superannuation account. Any superannuation TPD benefit which is paid into a superannuation account is protected in bankruptcy in the same way that ordinary superannuation money is protected.
This means that, after bankruptcy, you can withdraw your superannuation TPD benefit from your superannuation account and it will not be available for distribution amongst your creditors.
As mentioned before, if you withdraw your TPD benefit from your super account and then declare bankruptcy, those monies will be made available to your creditors.
TPD insurance benefits which are not held in a superannuation fund (for example you have approached a private insurance company directly or via a financial advisor and purchased a policy in your own name) are treated differently.
Traditionally these benefits have been thought to be available to creditors, however, a 2016 court decision supports that these TPD insurance benefits may not be available provided they relate to a personal injury (rather than an illness).
Income Protection benefits
As with TPD insurance benefits, income protection benefits are most likely treated differently depending on whether they are owned via superannuation or directly:
Superannuation based income protection benefits are not likely available for distribution amongst creditors in bankruptcy if they relate to a personal injury or provided they are considered to be a temporary payment due to injury or illness.
Non-Superannuation based income protection benefits are not likely available for distribution amongst creditors if they are paid due to a personal injury. They may, however, be divisible if they relate to an illness.
A trauma insurance benefit paid because of a physical injury is not likely divisible amongst creditors.
If you receive a death benefit directly from a superannuation account, it is likely to be considered an interest in a registered superannuation account and not divisible amongst your creditors in bankruptcy.
But if the superannuation fund pays the death benefit, and any remaining fund balance, into the deceased estate which is then distributed to you (as a beneficiary to the estate), it is likely available to your creditors.
The Bankruptcy Act also exempts the right of a bankrupt to recover damages or compensation for personal injury or wrong done to them or a family member (s116(2)(g)).
As set out above, there is legal authority that this extends to insurance policies outside superannuation if they are for "personal injury", at least in the context of court action for damages which was commenced before the bankruptcy (Berryman v Zurich Australia Ltd).
However, there is still some doubt whether a claim for life insurance benefits (pure risk death, TPD, income protection, trauma or terminal illness) is a claim for insurance contract benefits and not a compensation or damages claim.
It is therefore important to first seek the written approval of the trustee-in-bankruptcy before you lodge a claim or start (or continue) a court case.
As you can see the rules relating to the availability of disability benefits are complex. To add to this complexity, they change over time.
In each case consideration needs to be given to all the relevant details of the payment to consider if the payment is:
- superannuation based or not;
- for a personal injury or illness; and/or
- paid directly from a superannuation account or via an estate.
If you are unwell and your financial circumstances are forcing you to consider bankruptcy, not only should you consider investigating what disability entitlements are available to you, you should also consider the treatment of any benefit in the event of bankruptcy.
Lastly, if you are in bankruptcy, it is always important to first seek the written approval of the trustee-in-bankruptcy before you lodge a claim or start (or continue) a court case.
If you would like more advice on the matters outlined in this article, please get in touch directly with today’s blog writer, superannuation and insurance lawyer Tom Cobban.
Melbourne: 03 9448 8048
Brisbane: 07 3013 4300
Anywhere else in Australia: 03 9448 8048
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The article is accurate at the time of publication, but the information is subject to change and professional, up to date advice should be sought.