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Individuals, both single and married, buy life insurance with the intention of helping their family or their loved ones if and when tragedy strikes. While not the only purpose, but the primary purpose of buying life insurance is to give yourself peace of mind in knowing that life insurance will help in a financial sense. Unfortunately, what you might not know is that the benefits that you have been paying for to become life insurance proceeds for your beneficiaries could wind up in the hands of your creditors if you do not structure your policy properly. Start comparing life insurance now by using our FREE tool above!
It is possible that your creditors could attempt to take the proceeds of your life insurance after your death. While it is a possibility, it is also possible to protect your policy and your beneficiaries from creditors who want the money that they are due. Protection starts with your estate planning and how your life insurance designates beneficiaries or entities that you have established. If you would like to avoid some of the common and costly mistakes that can take away from the proceeds your beneficiaries will receive after your death, read on and get valuable information that you need to make smart decisions.
Do life insurance beneficiaries have to pay descendent’s creditors?
You never really think about how life insurance proceeds must be used until you are a named beneficiary on a policy. While it is not something that comes to mind when you are comparing policies or when you are applying for coverage, it is something that you should know about to avoid some serious issues for your loved ones who are to receive proceeds following your death.
You will be happy to hear that designated beneficiaries will receive the claims payout directly as long as they are named directly on the contract. As a named beneficiary, you do not have to worry about the funds going to probate and this protects the payout from creditors. Since the proceeds will not pass through probate as part of the descendant’s estate, the money that the named heirs receive will not be required to pay the final bills. Sometimes this poses problems when property is involved. These are problems that should be considered before you choose not to pay off outstanding debt.
Situations Where Creditors Can Attempt to Intercept Payouts
Unfortunately, not all scenarios are quite as simple. While having a named beneficiary can protect the proceeds in most scenarios, there is a possibility that certain creditors can collect life insurance proceeds even when there are designated heirs who are entitled to the payout. You should know about all of the situations where a creditor can intercept a life insurance payout and then learn about ways to prevent this from happening as you are estate planning. Here are some of the scenarios where proceeds may be up for grabs to creditors:
- No Beneficiary is Named
When no individual or trust is designated as a beneficiary, it is said that the estate will become the beneficiary. Naming an estate as a beneficiary can become a huge problem when there are creditors that are entitled to money. According to probate law, creditors are entitled to make claims against an estate for at least 2 to 6 months following their death.
Since the life insurance funds must pass through probate and become part of the estate, the creditors can make claim to those funds to cover debt.
Money and other assets are used to pay the debt first, but the life insurance proceeds are not protected because no beneficiary was named. Since the proceeds went to the estate, the creditors are entitled to make their claims and collect. This includes claims for credit card debt, mortgage debt, medical debt, and tax debt. In this scenario, it is possible to inherit debt when you are the executor of an estate.
- Beneficiaries Are Deceased At Time of Death
When you select beneficiaries, the selections are made with the assumption that the individuals will outlive you. If the person or people that you have named are deceased at your time of death, this can pose some serious problems when it is time to payout. The problems it creates will benefit your creditors but not necessarily your new heirs. This is why updating your insurance on a regular basis is so important.
When no living beneficiary is listed, the proceeds will become part of the estate and will go through probate much like when no beneficiary was listed at all. It is treated the same exact way even though you had taken the time to structure your policy to avoid problems. The only way to ensure that a deceased beneficiary will not lead to proceeds ending up in the hands of your creditors is to list contingent beneficiaries. These are the people who should receive payout only if the others are no longer living.
- Cash Value Policies
Listing a beneficiary will not always protect the proceeds. In some states, the value of cash value life insurance will only have limited protection. In Florida, for example, the value is protected while the policyholder is living but not when they die. The state law allows the creditors to take from the value of the permanent insurance before it is passed to beneficiaries. You should review the laws surrounding cash value insurance so that you know if it vulnerable to claims from creditors.
- There is Joint Debt
If the donor of the life insurance proceeds passes away, but they had entered into a loan as a co-signor with the beneficiary, the creditor will have the right to collect to pay off the balance of the joint debt. The reason for this is because the beneficiary has an interest in the loan and the other party of the loan is deceased. This creates too much risk to the creditor for them to keep the loan on the books.
- Judgement Against Beneficiary
It is not only the debt of the deceased that you need to be concerned about. It is possible that life insurers can go after the life insurance money that you have received as a designated beneficiary when you are the borrower. Creditors you have already entered into a contract with cannot collect if the contract was before the life insurance payout was issued. If, however, you receive the payout and then you borrow money that you default on, the creditor can file a judgement and ask for a lien to be placed on the insurance money. This is why beneficiaries need to borrow responsibly.
How to Prevent Creditors From Making Claims Against Life Proceeds
Estate planning can be extremely complicated. Since so many complications can arise, you must consult with a professional when you are not yourself an expert. One thing that experts will teach you is how you can make life insurance proceeds untouchable to creditors and how to reduce tax liabilities so that your loved ones will get the biggest inheritance possible. Here are some of the ways that you can structure your insurance so that debt does not eat it up:
- Setup a Revocable Living Trust
Setting up a living trust can help make it so that creditors cannot make claim to the money. This is because the assets in the trust can bypass probate and this is when the claims can be made. Since there is no probate, the creditors have no entitlement. Having a living trust will also help you write instructions on how the money can be used, designate minor heirs, and avoid delays associated with probate.
- Setup an Irrevocable Trust
You also have the option to set up an irrevocable trust so that the IRS cannot seize proceeds if your loved one owed taxes. This is a good option when you are sure who you want the trustee to be as there is typically no flexibility for amendments or modifications. Since there are not modifications allowed, it offers the best asset protection. The funds in the trust no longer belong to the grantor so that means that creditors, the government, Medicaid, and even bitter divorcing spouses cannot make claims against the trust.
- Pay off Debts
There is always the option to pay off all of the debts so that no creditors will have the ability to make legitimate claims against your estate. By doing this, the inheritance cannot be diminished because of outstanding debt.
No one wants to buy a form of financial protection just for that protection to go to a greedy creditor instead of the intended beneficiary. Since it is a possibility, you must be sure that you are dedicated to your estate planning as you are buying life insurance. If you have gotten great advice, it is time to buy coverage and structure it. Use an online rate comparison tool to compare the premiums and then start the application process with everything that you know in mind. Start comparing life insurance plans now by entering your zip code in our FREE tool below!