Updated June 11, 2021|3 min read
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Debt accumulation is, unfortunately, a part of American life. Americans report spending 33% of their monthly income on paying down existing loans,  and the average household debt in the U.S. is $92,727.  Carrying debt is one of the main reasons to buy a life insurance policy—your dependents can use the proceeds to pay off what they owe.
In most cases, your creditors cannot take the death benefit from your beneficiaries. But, cosigned loans and outdated beneficiary designations can put the proceeds at risk. Here’s how to make sure your policy pays out as intended and financially protects your loved ones.
Creditors cannot take the death benefit from your beneficiaries if you have outstanding debts when you die
If the death benefit is paid out to your estate, it can be paid to creditors through a process called probate
List your dependents as your beneficiaries and keep your policy updated to protect the proceeds from lenders
Insurance regulations prevent creditors from taking the death benefit from your beneficiaries, even if you have outstanding debts. Only the people listed in your policy can receive a payout, so life insurance companies won’t pay out to an unlisted creditor.
But, creditors can seize the death benefit if it becomes part of your estate, which happens if:
All of your beneficiaries predecease you and you never name new ones
You list your estate as a beneficiary
Your estate and assets go through probate—legal proceedings that determine where your assets go—when you die. Lenders are entitled to those assets and can claim any life insurance proceeds that become part of your estate before your loved ones get their share. If, after this process, there is any death benefit left, it will be disbursed as stated in your will.
Note that regulations protect your beneficiaries from your creditors, but if they’re in debt, they may not be protected from their own lenders. Once they receive the death benefit, it becomes part of their assets, which can be seized if they’re past due on their own payments.
There are a few guidelines that can guarantee your loved ones get the protection you planned for.
Be as clear as possible when naming beneficiaries: You can designate beneficiaries by name and title (Jane Doe, spouse), or using broader terms (Current spouse). Being specific when naming is always better, because it leaves no room for ambiguity.
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 up to date: If none of your beneficiaries can accept the death benefit, the payout is subject to probate. Update the designations during major life events, like a divorce, marriage, or death in the family to keep your policy current.
Name a contingent beneficiary: Name a secondary tier of beneficiaries to accept the death benefit if none of your primary beneficiaries can do so.
Not all debts fall on the shoulders of loved ones—federal student loans and some private student loans are forgiven when you die. But most private loans can be recouped from your assets and any debt that was cosigned or in a shared account becomes the responsibility of the people you leave behind.
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 to cover not only your lost income but also any debts your loved ones might have to pay off.
Married couples in community property states—where all assets are shared with your spouse once you’re married—should be extra vigilant about this. After you die, your spouse is responsible for any debts you took on during the marriage. There are nine states that have community property laws in place: 
Some states with filial responsibility laws will hold you responsible for a parent’s debt. Thirty states and the District of Columbia currently have filial responsibility laws.  The specifics vary by state, so consult a financial professional if your parents are carrying debt.
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Life insurance is meant to be utilized as an income replacement for your dependents after you die. But, there are some policy options you can use to pay off loans while you’re alive. The tradeoff is that they can put your beneficiaries at a disadvantage.
Cash surrender: The cash value is an investment-like account included in most permanent life insurance policies. You can cash out your policy to access the cash value, but you’ll lose life insurance protection and may pay taxes or penalties.
Collateral assignment: Some lenders give you the option to use your life insurance as collateral for a loan. If you die before repaying, the creditor recoups its money from the death benefit and the remainder is split among your beneficiaries.
Credit life insurance: A type of decreasing term policy often tied to mortgages, credit life covers a specific loan and only benefits your creditor. You’ll need additional coverage to provide for your family.
Policy loan: Some insurers also allow you to take out a loan using your permanent policy as collateral. If you don’t repay your loan, it’s subtracted from the death benefit when you die.
Viatical settlement: Though it’s not recommended, older policy owners can sell their life insurance policy for cash. In addition to losing coverage, you’ll get a fraction of the death benefit in return and the transaction is subject to taxes and fees.
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Understanding how death benefits are distributed and how different policy options affect your coverage will help you provide maximum financial support to your loved ones. As long as you manage your beneficiary designations carefully, the proceeds from your policy will be safe from creditors.
Usually, no. Creditors can only take the death benefit if it becomes part of your estate, which happens if you name your estate as beneficiary or all of your beneficiaries predecease you.
Some debt is forgiven when you die, like federal student loans. Creditors can go after your assets for private loans, and your loved ones are responsible for any debts you share.
Regulations protect beneficiaries from your debts, but if they shared any debt with you or are behind on their own payments, creditors can come after the death benefit they receive.
Life insurance terminology doesn't have to be confusing. Here are definitions of the most common terms and phrases you'll find in a policy.
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