Can Life Insurance Proceeds be Taken by Creditors?

July 17, 2020

Key Takeaways:

  • In most cases, life insurance proceeds are exempt from creditors
  • Proceeds may not be exempt if your spouse is your beneficiary and you co-signed certain types of loans
  • Once your beneficiary receives your life insurance death benefit, those funds could be claimed by creditors seeking money they owe (depending on state regulations)

If you have debt, you may be wondering whether creditors could claim your life insurance proceeds after you die. In most cases, life insurance proceeds will pass exempt from the insured person's creditors, but there are a couple of exceptions.

Understanding beneficiary designations

When you take out a life insurance policy, you should name at least one beneficiary. A beneficiary is a person or organization who will receive the death benefit of your life insurance coverage should you die while the policy is still in force.  Keep in mind that you can name more than one person as the primary beneficiary. If you do so, you should indicate whether each beneficiary should receive an equal share of the life insurance death benefit, or whether they should receive different percentages.

You can also name one or more contingent beneficiaries. The contingent beneficiary would inherit policy proceeds if the first-named beneficiaries do not survive you or choose to disclaim their share of the proceeds.

The insurance company is contractually obligated to pay the policy's proceeds to the person, or people, you named. Those proceeds become the property of the beneficiaries when you die. This means they avoid probate court proceedings. It also generally means that those proceeds are not available to your creditors.

What if your estate is the beneficiary of your life insurance policy?

If you didn’t select any beneficiaries, the proceeds of your life insurance policy will then be payable to your estate if you pass away while your coverage is in force. While beneficiaries are not responsible for your debts, your estate is. So, naming your estate as the beneficiary - either outright or by default - will make funds available to pay valid debts (subject to certain protections under your state's laws.) Sometimes, this is done intentionally, to ensure funds will flow through the estate to pay off debts.

When your spouse is your beneficiary

Another exception to the general rule is that life insurance proceeds may not be exempt from creditors if they are payable to your spouse, or if they are payable to someone else with whom you had joint financial obligations.

State laws govern to what extent married people are responsible for their spouse's debts. If you were co-signers on a mortgage loan, credit card, personal loan, or other financial obligation, then your policy proceeds may be reachable to satisfy those debts.

Life insurance proceeds are not exempt from the beneficiaries' creditors

Finally, even though life insurance policy proceeds may be exempt from being used to pay your creditors when you die, that doesn't mean they are exempt from the reach of your beneficiaries' creditors. When you pass away, your policy proceeds contractually become the assets of the beneficiaries you designated.

As soon as your beneficiaries have a right to receive those proceeds, they are fair game for anyone to whom they owe money unless an exception applies in your state.

Symmetry Financial Group can help you create a financial legacy with life insurance

People often purchase life insurance with the goal of making the death benefit available to pay their debts after they die. In most cases, the funds are not required to be paid to creditors.

Keep in mind that there can be state-specific nuances to the above scenarios, so when in doubt, talk to a licensed insurance agent at Symmetry and/or an estate planning attorney to confirm how your state's laws may impact your beneficiaries' right to receive policy proceeds free from the claims of creditors.

To learn more about how life insurance can help you protect your loved ones while creating a financial legacy, request a free quote today and we’ll help you build a plan that fits your budget and goals.


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