If you have debts, you may be wondering whether your 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.
When you take out a life insurance policy, you should name at least one beneficiary . That's the person or organization to whom policy proceeds will be paid should you die while the policy is still in force. But keep in mind that you may also name more than one person as the primary beneficiary. If you do so, you should indicate whether each named 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, to inherit 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 such named beneficiaries when you die. This means they avoid probate court proceedings. It also generally means that those proceeds are not available to your creditors.
If you have not named beneficiaries of your policy, proceeds will then be payable to your estate. While individuals named as 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.
Another exception to the general rule is that life insurance proceeds may not be exempt from the reach of your 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 those policy proceeds may be reachable to satisfy those debts.
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. As stated above, once you die, those 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.
People often purchase life insurance with the intention of making the proceeds available to pay valid debts after they die. In most cases though, the funds are not required to be paid to creditors. It is important to note that there can be state-specific nuances to the above scenarios, so when in doubt, talk to an insurance professional 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 your creditors.
To learn more about how life insurance can help you protect your loved ones while creating a financial legacy, contact us today.