Can life insurance be used to pay off debt?

Your life insurance policy may include ways to access funds before your death.

Key points

• You can access a death benefit from a term life insurance policy sooner if you have a terminal diagnosis.
• To borrow against the cash value of a whole life insurance policy, you will have to 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 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 alive. Depending on the circumstances, you may be able to. Many life insurance policies have a feature that allows access to some or all of the value before death.

How to cash out 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 fixed term (the term), and if you die during the term, the insurer will pay the death benefit to your beneficiaries. If the term ends and you’re still alive, you get nothing. These policies are attractive because term life insurance premiums are generally much lower than whole life insurance premiums for the same death benefit. You get a financial safety net for a relatively low cost.

There is, however, a time when you may be able to access your death benefit sooner. If your policy has an Accelerated Death Benefit Rider (also known as a Terminal Illness Benefit Rider or Living Benefit Rider) and you are diagnosed with a terminal illness, you can access a portion of your benefit of death before your death. You can use the money to reduce your debts, cover your final arrangements or pay any other expense you choose.

Early access to your death benefit may affect your taxes, as well as eligibility for Medicaid and Social Security benefits.

How to cash in a permanent life insurance policy

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

One option is to redeem the policy. This means you get the full cash value, but give up your life insurance. Some policies allow partial surrender. This means that you keep the policy, but when you die, your heirs receive a lesser death benefit.

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

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

The downside of borrowing against your cash value is that you will pay interest on the amount you borrow, as well as origination fees and other fees charged by the insurer. Make sure the cost of this loan is lower than the cost of your current debt, otherwise it might not be worth using this strategy to pay off your debt. If you die before repaying 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 your debts?

This is a personal question that only you can answer. Life insurance is a gift for the people you care about, but it can also be a financial tool you can take advantage of while you’re still alive. Exploiting it can mean there is less for your beneficiaries. But while it makes sense to leverage your life insurance to pay off more expensive debts, it could put you in better financial shape now.