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Using Life Insurance to Pay Off Debt
You may have heard about using life insurance to pay off debt – but what does that mean? There are two possible ways to look at this issue: using it to pay off your own debt, or leaving a death benefit your loved ones can use to pay off debt after you’re gone. We’ll go over what you need to know about both aspects.
Using Life Insurance to Pay Off Debt in Your Lifetime
Yes, you can use life insurance to help pay off your debt – but only if you buy the right type of coverage now. There are two main types of coverage: term life and permanent life insurance.
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Term life: covers you for a specific period of time
Permanent life: covers you for the rest of your life, no matter when you pass away
Only permanent life policies come with cash value. Cash value is like a savings account attached to your policy. It’s funded with a portion of every payment you make, plus interest paid by your insurer.
You can access that cash value in multiple ways:
- Policy loans. This is a private loan between you and your insurer, letting you borrow against your cash value. It does not appear on your credit report. Like any loan, you will owe interest on the amount you borrow. If you don’t pay it back, the insurer will deduct what you owe from the death benefit before it pays out to your loved ones.
- Partial withdrawals. If you don’t like the idea of a loan, you can withdraw a portion of your cash value. Instead of interest, however, you will probably have to pay a withdrawal fee. It’s likely to be less than the interest on a loan, however, so this may end up being the less expensive option.
- Full withdrawals (when you cancel your policy). If you decide you don’t need your policy, you should always take the proper steps to cancel it – which means working through your insurer. If you have cash value at the time you cancel, you are entitled to a payout of that money, minus any outstanding loan balance and surrender (cancellation) fee.
Cash value is the best method for using life insurance to pay off debt in your lifetime – there are no restrictions on what you can with the money. It’s yours to use as you see fit.
Want some in-person advice on using life insurance to pay off debt? We’re here to help! Call us at (800) 521-7873 and ask our licensed agents any questions you have. Or click the button below to start with a free term life quote.
Tips and Considerations
Cash value is a great financial resource – use it wisely! Here are a few tips and considerations:
- Cash value takes awhile to build up. It’s funded over time and isn’t going to be an instant source of cash as soon as you buy a policy. If you’re thinking of using life insurance to pay off debt in the first few years of your policy, it’s not going to be a viable solution. You just won’t have enough cash value yet. On the other hand, if you’ve had your policy for a decade or longer, there’s likely enough there to use to pay down a credit card, car payment, or make a lump sum payment toward your mortgage.
- Different policy types accrue cash value in different ways. If you’re buying a policy just for the cash value benefits, pay close attention to the accrual method of the policy you choose. For example, whole life policies offer a flat, guaranteed rate of interest. If you can lock in a high rate of interest, this policy type is ideal for steady, dependable returns. But if you prefer to take a more active role, variable universal life lets you invest your cash value in a selection of market offerings. Stocks and ETFs are common options, depending on your insurer. The catch here is that just as you can earn cash value faster with good choices, a poor investment choice can cause you to lose cash value.
- Policy loans let you earn more interest than withdrawals. If you’re debating between the two main methods to pull cash value, consider this. If you take a policy loan, yes, you owe interest – but it will be offset by the amount of interest you continue to earn on that cash value. Since you’re not actually removing any cash (just borrowing against it), the full dollar value is still in place and earning interest. With a withdrawal, money actually is leaving your account. Less money in your account means you’ll earn less interest going forward.
Want some in-person advice on choosing a life insurance policy? We’re here to help! Call us at (800) 521-7873 and ask our licensed agents any questions you have. Or click the button below to start with a free term life quote.
Using Life Insurance to Pay Off Debt After You’re Gone
Of course, the most common reason to buy life insurance is to provide for your loved ones after you’re gone. That includes paying for any debt you leave behind. There are no restrictions on what they can use that money for. They can pay the rent, buy groceries, pay off your credit card, buy a car, or even pay off the mortgage. Every penny of that policy goes to your loved ones, too. Once they file a claim, it will be paid out 100% income-tax-free.
The only cases where the death benefit isn’t income-tax free is if you overfunded your policy in the first seven years and the IRS changed its status. As long as you make your payments in the requested amount (without overpaying), you and your beneficiaries are fine.
Want some in-person advice on using life insurance to pay off debt? We’re here to help! Call us at (800) 521-7873 and ask our licensed agents any questions you have. Or click the button below to start with a free term life quote.
Tips and Considerations
Life insurance is the best way to ensure your loved ones have a financial cushion after you’re gone. Here are a few tips and considerations as you’re shopping for a policy:- Cost of term versus permanent policies. As mentioned above, only permanent life policies have cash value. But if you’re not worried about cash value and just want to leave cash for your loved ones, a term policy is the most affordable way to do it. Term life always costs less than a permanent policy of the same face value.
- Choosing the right face amount. How much coverage should you buy? It can be a tough question – but we’re here to help. Call us at (800) 521-7873 for customized help, or check out our post here, with tips and strategies to help you do a rough estimate yourself. As a very basic rule of thumb, you can also use 10 times your annual salary as a starting point.
- Keeping your beneficiaries updated. When you buy your policy, you’ll be able to choose primary and contingent beneficiaries, along with the percentage of the death benefit each should receive. Contingent beneficiaries would only get their portion if your primary beneficiaries are deceased. It’s important to keep all your beneficiary designations updated as changes happen in your life: marriage, divorce, new kids, and other family events may change who you want the death benefit to go to. It’s up to you to refile your beneficiary designations whenever you want to add or remove someone.
Want some in-person advice on using life insurance to pay off debt? We’re here to help! Call us at (800) 521-7873 and ask our licensed agents any questions you have. Or click the button below to start with a free term life quote.
