Whether you are the owner of a life insurance policy yourself or are the beneficiary of someone else’s policy, it is a good idea to understand what happens at the end of the policy’s lifespan — when the policy owner dies and the insurance company sends the death benefit to the named beneficiary.
Understanding life insurance payouts
One of the most important elements of the life insurance application process is the designation of a primary beneficiary or beneficiaries. This can be a single person or multiple persons, or it can be an entity such as a charitable organization.
You may also designate a contingent beneficiary. This person or entity is a secondary recipient of your policy payout. If your primary beneficiary dies before you do, the contingent beneficiary would receive your death benefit.
If you have a term life insurance policy, the coverage lasts for a certain length of time — such as 10, 20 or 30 years — and features a simple payout of the death benefit amount if you pass away during the policy’s lifespan.
The payout for a permanent life insurance policy, such as whole life, is a bit more complicated.
A whole life policy also includes a savings component that you can draw from during your life. Be aware that any money you borrow from your insurance policy will be subtracted from your death benefit. If you have a $500,000 whole life policy and you borrowed $100,000 to start a business, your beneficiary will only receive $400,000 unless you pay back the loan into the policy.
Types of life insurance payouts
There are several ways a beneficiary can receive the death benefit from a life insurance policy. The most common is the lump sum payment. As the name indicates, this is a single payment, usually in the form of a check, that is given to the beneficiary once the amount has been approved by the insurer. That single payment would be for the entire amount of the death benefit, minus any outstanding loan amounts, if applicable.
The beneficiary may also be able to choose an installment payment of the death benefit, usually in the form of an annuity. An annuity is the periodic payment of a sum of money over an extended period of time. Some beneficiaries prefer annuities as a way of receiving a continuing income for a longer period of time.
A third option allows the insurer to function like a bank account, holding on to the death benefit until it’s needed. The insurer would issue a checkbook to the beneficiary, so they could draw on the money as needed.
The life insurance payout process
The life insurance payout process is not complicated, but it does require the beneficiary to make some financial decisions and handle some paperwork. Here is what you need to do:
File the claim
As soon as possible after the policyholder’s death, contact the insurance company to find out their procedure for filing a claim. You will likely have to submit a certified copy of the death certificate and complete additional paperwork, such as a claim form. Although there is no deadline for filing a claim, it is wise to handle this as soon as possible. Your state will have laws that indicate how long the insurer can review your file — often 30 to 60 days.
If you file the claim properly and provide all the necessary documents, you will typically receive the death benefit payout of a life insurance policy within a month. However, there are rare circumstances in which delays might occur.
Policies are contestable by the company for the first two years they are in effect, so if the policyholder purchased the policy recently, the insurer may have questions, as life insurance claims on new policies can be a warning sign of fraud. If the death was by suicide, benefits might be denied if there was a suicide clause in the contract.
If the policyholder was murdered, there may be a delay as the insurance company works with police to ensure that the beneficiary was not involved in the crime. If the policyholder lied on the application or was killed while committing a crime, the insurer may also delay the death benefit payment. In any of these cases, expect to wait up to a year for issues to be resolved.
Once everything is approved, you must decide how you would like to receive your payout. The lump sum payout option is by far the most common. Since there are no restrictions on what the money can be used for, a lump sum may help you achieve financial goals such as:
- Paying off a mortgage
- Saving for college tuition
- Paying down consumer debt
- Saving for retirement
- Creating an emergency fund
Depending on your financial situation and how comfortable you feel handling the ramifications of the death benefit payout, it may be prudent to contact a financial advisor to discuss the tax consequences and financial options available to you.
Frequently asked questions
How much life insurance do I need?
That depends on what you hope to accomplish with your policy. Consider your long- and short-term debts, including mortgage debt, and your family’s monthly expenses. Many financial experts recommend an amount of life insurance equal to 5-15 times your annual salary.
What is the difference between term life insurance and whole life insurance?
Term insurance, as the name suggests, lasts for a specific term of time. It’s a simpler form of insurance than whole life, and the beneficiary will only receive the death benefit if the insured passes away during the specified policy term. Whole life insurance lasts for your entire life, as long as you pay your premiums. It’s more expensive than term insurance, but in addition to the death benefit, it features a savings component that allows you to borrow from your policy after a specified amount of time has passed.
Is it better to take a lump sum payment or spread it out over time?
That depends on your circumstances. If you have considerable debt you would like to pay off quickly, a lump sum might be best. If you are more concerned about having money to support your family over time, you may prefer an annuity. If you are uncertain, a good financial expert can help you weigh the pros and cons of each option.