When a person receives the death benefit of a life insurance policy, it is normally non-contestable unless there was doubt as to whether the policyholder named beneficiaries in a sound mental state. However, this would have to be proven in a court of law. If someone owes you money, you may be able to sue a person with a life insurance policy in force (or someone who has just received death benefit proceeds), though you wouldn't normally be suing them directly for the proceeds.
Life insurance might be protected from creditors in some states, but is not necessarily protected. You may sue another individual in court and obtain the proceeds in a life insurance policy if the policy has a cash value associated with it, and the court finds that this would be primarily how the judgment would be satisfied. This process involves suing an individual while the policy is still in force. You generally cannot sue an individual for the death benefit proceeds unless the beneficiary is part of the case. If you are suing someone who has just received a death benefit, you may sue that person and receive money from them, which may include part or all of a death benefit settlement.
Life insurance death benefits are protected in most cases from creditors because the death benefit is for the benefit of the policyholder's beneficiary, and is normally not an asset of the policyholder directly. Cash value policies, however, may have limited protections associated with them. Suing and receiving proceeds of a cash value policy will necessarily reduce the death benefit by an amount equal to the amount withdrawn or borrowed from the policy to pay the claim, but a policy may not be forcibly reassigned as part of a judgment.
The benefit for you is that you may sue someone and receive the money that is owed to you if the individual owns a cash value policy. While states differ in protections, states like South Carolina only exempt $4,000 of cash value in life insurance policies. The chances of you recovering money owed to you is high if you can prove your case and the individual has more than the exemption amount in their policy. This is because the life insurance policy may be a fixed life insurance contract with guaranteed cash value. This guaranteed cash value ensures that the money will be there if you win your case and you'll have the best opportunity to collect on it.
You must be aware of your states laws concerning exemption amounts for life insurance. For example, Florida generally exempts all of the proceeds of life insurance from creditors. You won't receive any money from a debtor in this state (from a life insurance policy). Also consider whether your debtor might file for bankruptcy. If your debtor files for Chapter 13, you may receive some, but not all, of the money owed to you and the court might allow the debtor to keep his policy.
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007