Can Life Insurance Be Used to Pay Off Debt?

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

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

How to cash out a term life insurance policy

Term life insurance has no cash value. The way it works is you pay a monthly premium for a set amount of time (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 typically much lower than whole life insurance premiums for the same death benefit. You get a financial safety net for a comparatively low cost.

There is, however, a time when you might be able to access 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 access a portion of your death benefit before you die. You can use the money to reduce debt, cover your final arrangements, or pay any other expense of your choice.

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

How to cash out 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 option of tapping into it.

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

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

Another option you might have is to borrow against your cash value. In this case, you're not actually withdrawing your cash. You're taking a secured loan from the insurer, using your cash value as collateral. One perk is that you will typically qualify for this loan automatically. No credit check is required.

The downside to borrowing against your cash value is you'll pay interest on the amount you borrow, plus any origination fees and other fees the insurer charges. Be sure the cost of this loan is lower than the cost of your current debt, or it might not be worthwhile to use this strategy to pay down your debt. If you die before repaying the loan, your heirs will get 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 people you care about, but it can also be a financial tool you can leverage while you're still living. Tapping into it can mean there is less for your beneficiaries. But if it makes sense to leverage your life insurance to pay off more costly debt, doing so could put you in better financial shape now.