Can creditors take my life insurance?

Creditors can only go after life insurance proceeds that pay out to your estate, but your beneficiaries are still liable for their own debts and debt they shared with you.

Headshot of Policygenius editor Nupur GambhirAmanda Shih author photo

By

Nupur Gambhir

Nupur Gambhir

Senior Editor & Licensed Life Insurance Expert

Nupur Gambhir is a licensed life, health, and disability insurance expert and a former senior editor at Policygenius. Her insurance expertise has been featured in Bloomberg News, Forbes Advisor, CNET, Fortune, Slate, Real Simple, Lifehacker, The Financial Gym, and the end-of-life planning service Cake.

&Amanda Shih

Amanda Shih

Editor & Licensed Life Insurance Expert

Amanda Shih is a licensed life, disability, and health insurance expert and a former editor at Policygenius, where she covered life insurance and disability insurance. Her expertise has appeared in Slate, Lifehacker, Little Spoon, and J.D. Power.

Updated|3 min read

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Debt accumulation is, unfortunately, a part of American life. Americans report spending 30% of their monthly income on paying down existing loans, [1] and the average household debt in the U.S. is $92,727. [2] 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 can't take the death benefit from your beneficiaries. But, cosigned loans and outdated beneficiary listings can put your life insurance money at risk. Here’s how to make sure your policy pays out as intended and financially protects your loved ones.

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Can creditors go after my life insurance benefit?

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 take the death benefit if it becomes part of your estate, which happens if:

  • All of your beneficiaries die before you and you never name new ones

  • You list your estate as a beneficiary 

Your estate goes through probate — a legal process that determines where your assets go — when you die. Lenders are entitled to those assets and can claim any life insurance money that becomes part of your estate before your loved ones get their share. If there's any money left after this process, it's distributed according to your will.

Regulations protect your beneficiaries from your creditors, but if they’re in debt, they're not 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 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. You can list beneficiaries by name and title (Jane Doe, spouse) or using broader terms (Current spouse). Listing someone by name and their relationship to you is always better because it leaves no room for confusion.

  • 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 so that your policy pays out as planned.

  • Name a contingent beneficiary. A secondary tier of beneficiaries can accept the death benefit if none of your primary beneficiaries can do so, saving the money from probate.

What types of debt can become a part of your estate?

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. Any debt that was cosigned 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 to cover not only your income but also any debts that can be passed on.

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. Nine states have community property laws in place: [3]

  • Arizona

  • California

  • Idaho

  • Louisiana

  • Nevada

  • New Mexico

  • Texas

  • Washington

  • Wisconsin

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. [4] The specifics vary by state, so consult a financial advisor if your parents are carrying debt.

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Can you use your life insurance policy to pay off debts?

Life insurance is meant to be 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, but you’ll lose life insurance protection and may pay taxes or penalties.

  • Collateral assignment: Some lenders let you use your life insurance as collateral for a loan. If you die before repaying, the creditor recoups its money from the death benefit and only the remainder goes to 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 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: Elderly or critically ill 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 pay high taxes and fees. 

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.

Frequently asked questions

Are life insurance policies protected from creditors?

Yes, most of the time. Creditors can go after life insurance if it becomes part of your estate, which happens if you name your estate as beneficiary or all of your beneficiaries die before you.

Are my beneficiaries responsible for your debt when you die?

It depends on the loan. Creditors can go after your assets for private loans and your loved ones are responsible for any debts you shared.

How do you protect your life insurance proceeds from creditors?

Make sure your beneficiaries stay updated so that the policy will never pay out to your estate and need to go through probate court.

References

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Policygenius uses external sources, including government data, industry studies, and reputable news organizations to supplement proprietary marketplace data and internal expertise. Learn more about how we use and vet external sources as part of our

editorial standards.
  1. Northwestern Mutual

    . "

    Planning & Progress Study 2021

    ." Accessed January 31, 2022.

  2. Experian

    . "

    Average U.S. Consumer Debt Reaches New Record in 2020

    ." Accessed January 31, 2022.

  3. IRS.gov

    . "

    Publication 555 (03/2020), Community Property

    ." Accessed January 31, 2022.

  4. Special Needs Alliance

    . "

    On Paper, Filial Support Laws Hold Adult Children Accountable

    ." Accessed January 31, 2022.

Authors

Senior Editor & Licensed Life Insurance Expert

Nupur Gambhir

Senior Editor & Licensed Life Insurance Expert

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Nupur Gambhir is a licensed life, health, and disability insurance expert and a former senior editor at Policygenius. Her insurance expertise has been featured in Bloomberg News, Forbes Advisor, CNET, Fortune, Slate, Real Simple, Lifehacker, The Financial Gym, and the end-of-life planning service Cake.

Editor & Licensed Life Insurance Expert

Amanda Shih

Editor & Licensed Life Insurance Expert

gray twitter icon linkgray linkedin icon link

Amanda Shih is a licensed life, disability, and health insurance expert and a former editor at Policygenius, where she covered life insurance and disability insurance. Her expertise has appeared in Slate, Lifehacker, Little Spoon, and J.D. Power.

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