How life insurance payouts work
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Life insurance policies are designed to provide financial support to your family members after you pass away. The money can also be used to pay for your end-of-life expenses, funeral costs and final medical bills. However, you might be wondering how your loved ones will obtain the money from your policy after you die. In this article, we’ll explain how life insurance payouts work, the different types of payouts and how to claim the money.
What is a life insurance payout?
After your death, your designated beneficiaries receive the money from your policy in a payout called the death benefit. You choose the death benefit amount when you purchase a policy, and as long as you continue to pay the premiums, your beneficiaries are guaranteed that money when you die (with a few exceptions).
However, your beneficiaries don’t automatically receive a check for the death benefit when you die. First, they need to file a claim with the insurance company so they can confirm your death. They also have to choose how they want to receive the payout.
Almost all life insurance payouts are tax-free, and when your beneficiaries receive the payout, they can use the money however they choose. Some policies, like whole life insurance, tend to have a higher payout, which can be used as income. For policies that offer less coverage, like final expense life insurance, the payout is typically used for things like funeral expenses.
Who receives life insurance payouts?
Your beneficiaries are the primary people who receive life insurance payouts. When you buy life insurance, you select who you want to be your beneficiaries. Most people choose a spouse or child, but you can also designate a charity, organization or funeral home as the beneficiary. Only the beneficiary is entitled to the death benefit payout after you die.
As the policyholder, there is only one circumstance in which you can use the money from your death benefit while you’re still alive. If you have an accelerated death benefit rider, it allows you to use some or all of the money to pay for end-of-life expenses if you are diagnosed with a qualifying terminal illness. But if you take out the money early, your beneficiaries will receive a lower payout when you die.
How to claim the payout
After your death, your beneficiaries can file a claim and receive the death benefit. Here’s a brief overview of the claim process:
- Contact the insurance company: The first step is to contact the insurance company. The beneficiary will be asked to provide a copy of the death certificate and verify their identity. An agent will provide some paperwork to fill out before the claim can be processed.
- Understand the contestability period: Life insurance companies have a contestability period, which means if the policyholder dies within the first two years, they have the right to review the policy and check for misrepresentations. If the policyholder is found to have lied on their application, it’s possible that the insurance company could deny the death benefit.
- Wait for approval: After the death certificate and paperwork are submitted, the insurance company will review the information and either approve or deny the claim. This can take anywhere from a few weeks to a few months depending on the company and other circumstances.
- Choose the payout type: Once the claim is approved, the beneficiary can choose how they want to receive the death benefit.
Life insurance payout types
Life insurance beneficiaries can choose how they receive the payout. There are advantages and drawbacks to each method, so it’s important to weigh the benefits before making a selection.
The most common way to receive a life insurance payout is in a one-time, tax-free lump sum. The insurance company writes a check for the full amount and sends it to the beneficiary to use however they want.
The other option is to receive the money in installments overtime. You can choose the amount you want to receive every month, and use it like regular income. Keep in mind that if you want to receive more than the monthly installment, you may have to pay a penalty.
|Lump sum||Immediate access to the full death benefit|
Can use the money to cover end-of-life and funeral expenses
|Money doesn’t earn interest overtime|
|Installments||Can use the money as supplemental monthly income for life|
Money earns interest overtime
|You’ll likely incur a penalty if you take out more than the allotted monthly amount|
How taxes affect payouts
One of the biggest perks of a life insurance death benefit is that the money is almost always tax-free. The same is true for cash value payouts. According to the IRS, life insurance payouts aren’t included in your gross income, and therefore, you don’t have to report the money on your tax return. So if you choose to receive a death benefit in a lump sum, you get to keep the full payout.
The only exception is when the death benefit earns interest, which is the case when you receive the money in installments. If you choose to receive the payout in installments, you will need to report the interest received on your taxes.
- When a life insurance policyholder dies, their beneficiaries receive the payout (death benefit).
- The payout can be used for anything, but extra income and end-of-life costs are the most common uses.
- Beneficiaries can choose to receive the payout in a lump sum, or in installments over time.
If you’re the beneficiary of someone’s life insurance policy, it’s important to understand how the payout process works. Remember that you don’t receive the death benefit automatically, and you need to file a claim with the insurance company to start the process. You also get to choose how you want to receive the money—either in a one-time payment, or multiple installments—which both have considerations to keep in mind.