You purchased a life insurance policy as a way to provide your loved ones with financial security when you pass away. While your policy can help your surviving loved ones that are listed as beneficiaries, like most people, you probably aren’t aware of the fact that your policy can also benefit your creditors.
If you have a lot of debt and you are wondering if your creditors can go after your benefits, it’s important to find out if your policy – and more importantly, your beneficiaries – will be protected from creditors, and if so, whether or not there are limitations to those protections.
It Depends on Where You Live
If you do have outstanding debts after you pass away, there is a chance that creditors will be able to go after the benefits of your life insurance policy in order to pay off your debts; however, that’s not always the case. Whether or not your life insurance will be garnished for debt depends on the state you live in. Ideally, you will avoid debt, but you may still need life insurance.
For example, in some states, life insurance is protected from creditors; in other words, creditors cannot garnish the benefits of your policy to pay for your outstanding debts. But, some states only offer limited protection for life insurance. For instance, in the state of Texas, a life insurance policy’s cash value and death benefit are completely protected from creditors, meaning that the policy cannot be garnished for debts. In the state of Florida, on the other hand, only the cash value of a life insurance policy is protected and cannot be garnished for debt, as long as the person who is insured is still living; however, after the insured passes away, the benefits of the policy are no longer protected by the state. That means that creditors are able to garnish the benefits of the policy and take the money they are owed before the beneficiaries listed on the policy will receive their payout.
Cash Value and Term Life Insurance Policies
With cash value life insurance policies, like whole life, premiums will be deposited into a separate account, known as a cash account, after expenses, such as the cost of your insurance, are deducted. Typically, an annual charge will also be applied.
Generally, with a cash value policy, there is a minimum amount of dividends; usually between 2 and 4 percent. You are allowed to borrow or withdraw money from your policy; however, the amount that you withdraw may be taxed. The major disadvantage of a cash value policy is that you may not be able to afford the annual premium, and if that happens, you may have to cancel your coverage. In this case, when you do pass away, your beneficiaries will only receive the value of your life insurance policy; they will not receive the amount that you paid into the policy.
Term life insurance policies are another option. As the name suggests, this type of policy will only last for a predetermined amount of time; 20 or 30 years, for example. However, while the amount of time that the policy lasts is limited, the amount you will be required to pay on the monthly premiums are less expensive than the amount you will have to pay on cash value life insurance policies, such as whole-life.
Are Life Insurance Policies Ever Susceptible to Creditors?
While the state that you reside in does determine how protected your life insurance policy is from creditors, there are other instances that can make these policies more susceptible to creditors. For instance, if any beneficiaries of a life insurance policy are still living when the insured passes away and they have co-signed loans with you, creditors can file a lawsuit against the beneficiaries in order to receive the amount that is owed for the outstanding debts from the payouts of your policy. If any of the listed beneficiaries didn’t co-sign any loans with you, but you have loans that are outstanding, your beneficiaries may have to use the payouts from your policy in order to cover the outstanding debt. They may also have to use some of the payouts to pay for any taxes that have been placed on your estate.
If you have named your estate as the beneficiary of your life insurance, or if the beneficiary you have named has passed away, your life insurance payouts are particularly vulnerable to creditors. For example, there is a chance that the assets listed in your estate will need to be liquidated in order to pay off any outstanding debts, which could include your life insurance. If this happens, any living beneficiaries will only receive a payout from your policy after your debts have been paid off.
Protecting Your Life Insurance from Creditors
In order to find out how you can protect your life insurance – and your named beneficiaries – from creditors, speak to your insurance agency. There may be ways to successful ensure that the payout from your policy will not be used to pay off debt.