Carrying debt is one of the main reasons to buy a life insurance policy — your dependents can use the proceeds to pay off any debt they have, including a mortgage, student loans, or other personal loans. If you have any debt when you die, in most cases, your creditors won’t be able to take the death benefit from your beneficiaries.
But if the list of beneficiaries on your policy isn’t up-to-date by the time you pass away, or you have co-signed loans with your beneficiaries, creditors may have a right to claim the funds before they can receive the money. Here’s how to make sure your policy pays out as intended and financially protects your loved ones.
Can creditors go after my life insurance benefit?
When your life insurance company pays your death claim, the money will go directly from the insurer to your beneficiary. It won’t pass through your estate at all, so any creditors you have won’t have any legal claim to the money.
Insurance regulations also prevent creditors from taking the life insurance death benefit from your beneficiaries. This is true even if you have outstanding debts. Only the people listed in your policy can receive a payout. The life insurance company won’t pay out to an unlisted creditor.
However, if the death benefit becomes part of your estate, the creditors can make a valid claim to the money. This can happen in the following scenarios:
If all of your beneficiaries die before you and you never name new ones.
If you list your estate as a beneficiary on your policy.
After you die, your estate may go through probate court — a legal process that determines where your assets go, including the death benefit from your policy if you didn’t name any beneficiaries. If you have debt, it will be paid before your loved ones get their share of any remaining life insurance death benefit.
Regulations protect your beneficiaries from your creditors, but there are no regulations that shield your beneficiaries from their own debts. Once they receive the death benefit it becomes part of their assets, which can be seized if they’re past due on their own loans.
How to protect your life insurance from creditors
There are a few guidelines that can guarantee your loved ones get the protection you planned for.
Be specific when naming beneficiaries. Listing your beneficiaries by name and their relationship to you is the best way to make sure the payout for your policy goes to the right person. If available, you should also provide their date of birth and Social Security number.
Don’t list your estate as a beneficiary. Naming your estate exposes the death benefit to creditors and ties the money up in legal proceedings.
Keep your beneficiaries updated. If none of your beneficiaries can accept the death benefit, the payout goes through probate. Update your policy during major life events, like a divorce, marriage, or death in the family to ensure that your policy pays out as you intend.
Name a contingent beneficiary. A secondary beneficiary can accept the death benefit if none of your primary beneficiaries are able to, which will save the money from going through probate.
→ Learn more about who you should never name as your life insurance beneficiary
What types of debt can become a part of your estate?
Not all debt will remain with your estate when you die. Federal student loans and some private student loans are forgiven when you pass away. Most private loans, however, can be recouped from your assets. Any debt that was co-signed or in a shared account becomes the responsibility of the people you leave behind.
Who takes on your debt?
Even though a creditor can’t take the death benefit from your beneficiaries, your family can still become responsible for your loans. This is why it’s important to buy enough life insurance coverage to protect not only your income but also any debts that will remain after you die.
This is especially true for married couples in community property states. In community property states, all assets are shared with your spouse once you’re married. After you die, your spouse will be responsible for any debts you took on during the marriage, even if they didn’t co-sign the loan.
Nine states have community property state laws in place:
Arizona
California
Idaho
Louisiana
Nevada
New Mexico
Texas
Washington
Wisconsin
Learn more about life insurance and financial planning
Frequently asked questions
Are life insurance policies protected from creditors?
Yes, most of the time. The payout will go directly to your beneficiary and any creditors you owe money to will not be able to take the payout from them.
However, creditors can go after a life insurance payout if it becomes part of your estate, which happens if you name your estate as beneficiary or if all of your beneficiaries die before you.
Are your beneficiaries responsible for your debt when you die?
Not necessarily. When you die, some types of debt — like student loans — go away, but most private loans will stay with your estate. And while your beneficiary legally may not have to pay off lingering debt, whoever you name as your beneficiary is probably also the person who will be responsible for managing your estate when you’re gone.
How do you protect your life insurance proceeds from creditors?
Make sure the beneficiaries listed on your policy are always up-to-date. Otherwise, the money will be paid out to your estate when you die. If that happens, the money from the payout will go through probate court and creditors will be able to claim the money.
