Can life insurance be used to pay off debt?

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Your life insurance policy may include ways to access the funds before you die.

Main points

  • If you have a terminal diagnosis, you can use the life term death benefit.
  • To borrow against the cash value on a whole life policy, you will pay fees and interest.

Life insurance is a great way to provide a financial safety net for your loved ones, especially if you are in debt. Thinking about paying off debt while you’re still alive is smart financial planning, and it’s a thoughtful gift for the people who would be left behind if something were to happen to you. If you’ve paid life insurance premiums, it’s natural to wonder if you can use that asset to reduce your debt now and ease some financial burdens while you’re still alive. Depending on the circumstances, you may be able to. Many life insurance policies have a feature that allows all or part of the value to be accessed before death.

How to cash in on a term life insurance policy

Term life insurance has no cash value. The way it works is that you pay a monthly premium for a set time (term), and if you die during the term, the insurer will pay the death benefit to your beneficiaries. If the term ends and you are still alive, you get nothing. These policies are attractive because life insurance premiums are usually much lower than life insurance premiums for the same death benefit. You get a financial safety net for a relatively low cost.

However, there is a time when you may be able to take advantage of your death benefit early. If your policy has an accelerated death benefit rider (also called a terminal illness benefit rider or living benefit rider) and you are diagnosed with a terminal illness, you can use part of the death benefit before you die. You can use the money to reduce debt, cover your final settlement, or pay any other expenses of your choosing.

Accessing your death benefit early can affect your taxes, as well as eligibility for Medicaid and Social Security benefits.

How to cash in on a permanent life insurance policy

Permanent life insurance accumulates cash value over time as you pay your premiums. Once you have a cash value, you have the ability to tap into it.

One option is to opt out of the policy. This means you get all of the cash value, but give up the life insurance. Some policies allow for a partial surrender. This means you keep the policy, but when you die, your heirs receive a smaller death benefit.

Surrendering your policy may affect your taxes if the value you receive is greater than the amount of premiums you paid.

Another option you may have is to borrow against your cash value. In this case, you are not withdrawing your money. You are getting a loan secured by the insurer, using your cash value as collateral. One benefit is that you will usually qualify for this loan automatically. No credit check required.

The downside of borrowing against your cash value is that you’ll pay interest on the amount you borrow, plus any origination fees and other fees the insurer charges. Make sure the cost of this loan is lower than the cost of your current debt, or it may not be worth using this strategy to pay off your debt. If you die before paying off the loan, your heirs will receive the full death benefit minus the amount you still owe.

A third option is to sell your permanent life insurance policy. In exchange for cash, the buyer becomes the beneficiary.

Should You Use Your Life Insurance To Pay Off Debt?

This is a personal question that only you can answer. Life insurance is a gift to the people you care about, but it can also be a financial tool you can use while you’re still living. Tapping into it could mean there’s less for your beneficiaries. But if it makes sense to use your life insurance to pay off the costliest debt, it could put you in a better financial position now.

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