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Can a life insurance policy be used to pay debt?

Don't miss these facts...
  • Life insurance pays a set amount to a named beneficiary at an insured’s death
  • A named beneficiary may use the death proceeds of a life insurance policy for any purpose he or she wishes, including the payment of a debt
  • Debts are one of the main reasons people buy life insurance
  • A beneficiary can shield life insurance proceed from creditors
  • A beneficiary can use life insurance proceeds to pay creditors as quickly or as slowly as needed
The concept of life insurance is a modern phenomenon in its present form. There are indications of life insurance and similar ideas as far back in time as the Greeks and Romans when payments were made to the families of fallen soldiers.

The current concept is much different in that it applies to a much larger population on a broader base of application.

In short, life insurance pays a set amount of money to a named beneficiary when an insured person dies. This is done by contract and is a very common and stable occurrence.

In rare cases when falsehoods are placed on the insurance application, the claim is denied, if the falsehood changes material statements that would have affected the insurability of the deceased.

In the large majority of situations, however, the death benefit is awarded to the beneficiary.

The miracle part of the equation is the exceedingly small amount is paid to the insurance company compared to the death benefit, especially in earlier years.

Learn more about life insurance below and make sure to use our free comparison tool above!

Who can life insurance proceeds be paid to?

adobestock_113202604-1600x1600Life insurance proceeds are paid to a named beneficiary or the estate of the insured if there is no named beneficiary, or to the estate of the insured if the estate is named as the beneficiary.

The proceeds at death are paid directly to the named beneficiary who can use the proceeds for any purpose that is desired.

There are no restrictions on how the money can be used unless placed there by the insured while the insured was still alive.

For example, it could be stipulated that the proceeds be paid to the beneficiary under settlement options, which would simply change the frequency of payments, but not to whom the proceeds would be paid.

Can Life Insurance Proceeds Be Used To Pay Off Debt?

One of the prime reasons people purchase life insurance is to pay off a debt if the insured dies. A major debt that people want to resolve if they die is their mortgage on their home.

A breadwinner of a family usually desires to leave home free and clear to the family if he or she should die prematurely.

If both spouses work, it is common practice to cover both husband and wife in some manner so the mortgage can be either partially retired or fully paid off if someone dies.

Other debts such as car loans, installment loans, credit cards, and other similar debt are usually covered by some form of life insurance.

Money is included in life insurance planning to cover burial expenses and any taxes due at death, which is a form of debt. There is nothing wrong, nor is it illegal to plan to cover debt when a person dies with life insurance.

Estate Planning

adobestock_87355456-1600x1600If an individual has assets enough to need more formal planning to pass assets on to relatives, it is likely there will be further debts in this process.

In addition to all of the normal debts people desire to cover with life insurance, there may also be added attorney’s fees, administrative fees, and executor fees to be absolved.

Life insurance is the perfect vehicle to cover debt because it creates the solution at the exact time that it is needed.

As soon as the person who owes the debt dies, the exact amount of money that is needed becomes immediately available.

Protect Your Life Insurance Proceeds From Creditors

Most states have provisions that protect life insurance proceeds from creditors. It is fairly easy to earmark how much life insurance some receives after the fact, and the states would simply allow that amount to be exempt from attachment by creditors.

While there have been situations where creditors have attached life insurance proceeds, they usually have little success because of different statutes in states that prohibit that.

However, when life insurance is put into the bank, it can be construed that the money loses its identity as life insurance, thus becoming fair game.

This practice can be defended against by using life insurance settlement options.

Settlement options simply offer options as to how the beneficiary is paid. Instead of receiving a lump sum of money, the beneficiary can choose to receive it as an income of various amounts and lengths, or leave it on deposit with interest, and draw it out as needed.

Life Insurance Trusts

adobestock_128127524-1600x1600A life insurance trust is an Inter Vivos or a living trust. A living trust gives the power of the insured to move assets into the trust before death which keeps the property from going through probate.

That is the same with life insurance, and then the trust controls the distribution of the life insurance proceeds at death. This would make it impossible for creditors to get at the money.

The primary reason for a living trust is to make the transfer of property at the death of an individual easier than going through the probate process. This is a perfectly legal method of transferring assets at death.

Debt could still be paid from the proceeds of the trust but in such a manner of the choosing of the trustee, or by instructions of the deceased person, given before his or her death.

The Responsibility of Debt

It is morally responsible in a civilized society for people to pay their debts and not seek to escape their payment.

Life insurance provides that means to pay debts if they still exist at our debts. It is also prudent to pay the life insurance to a named beneficiary to pay the debt at their discretion.

However, it is possible to name the creditor directly as beneficiary.

This is frequently done with mortgage insurance when a person purchases the mortgage life insurance at the time they take out the insurance with the lender.

The lender works through a credit life insurance company in order to set this up.

Credit card companies have similar arrangements where a death benefit can be created and paid directly to the credit card company to satisfy the debt.

In Conclusion

adobestock_17688255-1600x1600Life insurance proceeds are paid directly to a named beneficiary at the death of the insured.

The money, once received by the beneficiary may be used for any purpose the beneficiary desires, including the payment of a debt.

The beneficiary can pay in stages, all at once, or in any manner that he or she chooses.

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