The ins and outs of bankruptcy

The ins and outs of bankruptcy

Thousands of Australians are declared bankrupt every year so what happens to their assets including superannuation and life insurance? Jeff Scott investigates.

Many Australian families experience financial stress around this time of year. After Christmas, all Santa has left behind is often a pile of bills.

In extreme situations, people who can’t pay their bills are forced to declare bankruptcy.

Last financial year, 31,859 Australians entered into personal administrations under the Bankruptcy Act; a significant improvement from the record 36,5391 people in 2009-2010. This does not include corporate insolvencies.

Once a person is declared bankrupt, any assets that are not subject to an exclusion sit with the trustee of the estate of the bankrupt2. Bankruptcy typically lasts for three years3.

The below items are exempt and can be retained:
  • Certain household furniture and personal effects4
  • Motor vehicles valued at less than $7,900 (indexed each financial year)5
  • Tools of trade used to earn an income valued at less than $3,750 (indexed each financial year)6
  • Regulated superannuation as defined in the Superannuation Industry (Supervision) Act 19937
  • Assets held in trust for others8
  • Life insurance payments for the bankrupt and their spouse9
  • Compensation payments arising from personal injury10
  • Income under $57,239 (if no dependants) to $77,845.04 (more than four dependants), with any excess being contributed at $0.50 for every dollar earned (as at 20 September 2018)11 

Implications for life insurance

Life insurance policies are not property divisible amongst the creditors of a bankrupt.

Similarly, any benefits received by a bankrupt, their spouse, or defacto partner are not divisible amongst the creditors of the bankrupt12. Originally, this provision was interpreted to apply only to whole of life, endowment or term policies that provided death cover, along with TPD or trauma riders, until a case in Western Australia extended this exemption to standalone disability cover13.

If an undischarged bankrupt receives income protection benefits under a life insurance policy, such benefits are exempt up to the above income thresholds. This exemption is an aggregate amount from all income sources14

Implications for superannuation

Like life insurance policies, superannuation assets are not property divisible amongst the creditors of a bankrupt, and any income or pension payments are also not divisible amongst the creditors15.

In a recent court case, this provision was extended to include payments to dependent beneficiaries from the superannuation fund, where the beneficiary was bankrupt16.

Where an undischarged bankrupt receives pension income from a superannuation fund, those benefits are exempt up to the income thresholds. This exemption is an aggregate amount from all income sources17.  

Under the Bankruptcy Act, there are rules that prohibit individuals from making payments to their superannuation fund solely for the purpose of avoiding creditors, and under these circumstances, individuals may be required to roll back the contributions18. These excess contributions would be divisible by creditors.

Jeff Scott is Head of Product Strategy and Technical Support at ClearView.
1 Australian Government - Australian Financial Security Authority, 2018. Personal Insolvency Statistics.
2 s58(1)(a) Bankruptcy Act 1966
3 s149 Bankruptcy Act 1966
4 s116(2)(b) Bankruptcy Act 1966; Reg 6.03 Bankruptcy Regulations 1996
5 s116(2)(ca) Bankruptcy Act 1966; Reg 6.03B(3)&(4) Bankruptcy Regulations 1996; Release Date 31 October 2018.
6 s116(2)(c)(i) Bankruptcy Act 1966; Reg 6.03B(1)&(2) Regulations 1996; Release Date 31 October 2018.
7 s116(2)(d)(iii) Bankruptcy Act 1966
8 s116(2)(a) Bankruptcy Act 1966
9 s116(2)(d)(i)&(ii) Bankruptcy Act 1966
10 s116(2)(g)(i)&(ii) Bankruptcy Act 1966
11 s139K Bankruptcy Act 1966; Release Date 31 October 2018.
12 s116(2)(d)(i)&(ii) Bankruptcy Act 1966
13 Berryman v Zurich Australia Ltd [2016] WASC 196 (1 July 2016); s116(2)(g) Bankruptcy Act 1966; s60(4) Bankruptcy Act 1966.
14 s139L Bankruptcy Act 1966; s139P Bankruptcy Act 1966; s139S Bankruptcy Act 1966
15 s116(2)(d)(iii)&(iv) Bankruptcy Act 1966; s 128B Bankruptcy Act 1966; 128C Bankruptcy Act 1966; 139ZU Bankruptcy Act 1966
16 Morris (Bankrupt) v Morris (Bankrupt) [2016] FCA 846.
17 s139L Bankruptcy Act 1966
18 s128C Bankruptcy Act 1966