If you’re a smart consumer (and since you’re here reading an insurance article on your own time, you must be), you want to know everything about the product you’re considering before you sign on the dotted line.
Life insurance is a big deal, but what sets it apart from other important financial decisions is that you will not be around to experience the benefit of your policy.
Nonetheless, it’s a good idea to learn about how the claims process works, and how death benefits may be paid out.
What is a life insurance payout?
Let’s go back to the basics. Life insurance is a contractual agreement between a life insurance company and a policyholder (hey, that’s you!). In the simplest form of this agreement, the insurer pledges to pay a specific amount of money to those named as beneficiaries if the insured dies while the policy is in force. In exchange, policyholders agree to pay life insurance premiums for the duration of the policy or while they are alive. Your premium is often split into monthly, quarterly, or annual payments.
Though losing someone is never easy, life insurance can offer tax-advantaged financial relief for your loved ones should you pass away. The people who you designate to receive your life insurance payout are called your beneficiaries and the payout your beneficiaries receive, also known as a death benefit, is generally received income-tax free.
Who gets your life insurance payout?
If you’re unsure who to name as your beneficiary and are considering making your loved ones draw straws, we’ve got you. Save your straws for milkshakes or determining who has to wash the dishes.
When you purchase a life insurance policy, you will then name your beneficiary or (wait for it) beneficiaries (plural). You can name a single primary beneficiary or multiple beneficiaries. These are the people who you select to receive a death benefit upon your passing – typically a spouse, children, family members, or even a close friend.
Additionally, you may want to select a contingent beneficiary, a person or entity that gets the insurance payout if the primary beneficiary is deceased. Primary and contingent beneficiaries can be people or entities like a trust or a non-profit organization.
Remember to talk to your beneficiaries
Information is power in the insurance world. Your insurer will want the contact information of each beneficiary you name, as well as their social security numbers. On your end, it is a smart idea to make sure the people you select as beneficiaries are aware they will receive your life insurance payout. If you take a minute to email these folks the name and contact information of your insurance company, and your policy number, it can save them heaps of stress in the future.
Life insurance beneficiaries: navigating the life insurance claim process
Losing someone you love is a heart-wrenching experience – and in addition to navigating grief, there will be realities to face and bills to be paid. As a life insurance beneficiary, it is important to note that life insurance companies don’t automatically dole out payments upon a policyholder’s death. In most cases, the beneficiary must file a life insurance claim, also called a death claim, to receive the insurance payout.
How does a life insurance policy work after someone dies? Let’s start with the four main steps of the death claim process:
1. Gather the necessary documents
There are no tight deadlines or time limits when it comes to filing a death claim. When beneficiaries are ready to file, their first step should be gathering the necessary documents including:
- The policy document . If beneficiaries can’t find this document, your insurance agent may be able to help. This document lists policy type, coverage amount, and policy owner information.
- A claimant’s statement. Each beneficiary will need to submit what is called a claimant’s statement and is also referred to as a claim form. A claim form typically includes the beneficiary’s contact information and their preferred method of receiving the death benefit payment. For individuals, this is a straightforward process, but if the beneficiary is an entity and not a person, a certificate of Power of Attorney may be required.
- A death certificate. The insurance company will need a certified copy of the policyholder’s death certificate with a raised seal issued by the state. In most cases, this can be obtained from a funeral home or mortuary. Otherwise, much like birth certificates, a death certificate can be ordered from a county or state vital records office.
2. Get in touch with the insurer
As soon as beneficiaries gather all the necessary documents, the next step is notifying the insurance agent of the policyholder’s death and submitting the claim form. The contact information should be on the policy document and can also be found on the insurer’s company website. Life insurance companies will give beneficiaries instructions on how to submit the required documents and ask for any additional information they might need to process the death claim.
3. Wait for the insurer to process the claim
In the words of Harry Potter and Hermione, and now we wait . In some cases, insurers will send beneficiaries a payout within a few days, but the process can take up to sixty days or longer.
During this time, the insurance agent will review the death claim and the documentation submitted. They’re making sure the policy is active, that there was no lapse in payment, and that the coverage term has not expired. Once the insurance institute has crossed all the t’s, dotted all the i’s, and approved the death claim, payment will be submitted to beneficiaries via the method selected in the claimant’s statement.
4. Decide how you’d like your life insurance payments distributed
If you assumed that life insurance payouts were a one-and-done situation where the beneficiary receives a single check, you’re not wrong. A lump-sum payment is one of the payout options, but there are a few other ways beneficiaries can receive a death benefit.
- Installment payments, otherwise known as a systematic withdrawal, occur when a beneficiary elects to receive a certain percentage of the payout in timely installments. For example, your beneficiary may opt to be paid 10% of the death benefit annually over ten years. A lot of times people go with this incremental payout option because the unpaid amount usually earns interest (though any interest earned is usually taxable).
- Annuities are lifetime income payouts, which means the beneficiary receives a guaranteed permanent life payment for the rest of their lives. If this option is selected, the insurance company calculates the payment amount using the beneficiary’s age at the time of the claim. If your beneficiary chooses a set annuity period, they will also select a beneficiary of their own. If they die before the annuity period ends, their selected beneficiary will receive the remaining death benefit from your policy. If your beneficiary passes away without this set timeframe, any remaining death benefit would go back to the insurance company.
- Retained asset accounts are offered by some insurance companies as a payout option. If selected, your beneficiary’s payout would be placed in an interest yielding account. They would have full access to this account, which is guaranteed by the insurance company even if the amount exceeds the $250,000 FDIC limit. The initial death benefit remains tax-free, but any interest earned is taxable.
- Lump-sum payments , as previously mentioned, are a life insurance payout option. If selected, the insurance company will issue your beneficiary a one-time lump sum payout of the entire death benefit. Policies offered by Bestow, for example, would pay a death benefit in this way.
What is the best thing to do with a life insurance payout?
When you sit down with your beneficiaries, consider sharing with them your motivation for purchasing life insurance coverage. Though you won’t have any say in what they do with the payout after you are gone, it might be helpful for your loved ones to know your intention.
There are no rules or right ways to spend a death benefit because each person’s financial situation is unique.
Here are some of the most common ways life insurance payouts are used:
- To pay off debt. This might look like paying off a mortgage or completely clearing out high-interest rate credit card debt.
- To invest. Life insurance payouts can provide a unique opportunity to invest. If your beneficiary doesn’t need the money to survive, they might consider buying stock or investing in a mutual fund. In these cases, consulting with a financial advisor first is a good idea.
- To save for your children’s education. If your beneficiary is your spouse or the guardian of your children, they may want to set the money aside for college tuition or even invest it in a college savings account to offer some long term support for their education.
- To hire a financial planner. Understandably, a beneficiary may not be certain of the best way to handle a large sum of money, especially after a recent loss. In this case, hiring a financial planner to analyze their finances and advise them on the best path is a great plan.
Apply to get life insurance coverage today
Life insurance payouts should not be shrouded in mystery. You want to know your loved ones are more financially prepared for the future if you pass away. Life insurance is one tool that can help you achieve some peace of mind.
Bestow offers term life insurance coverage of up to $1.5 million, and our application process is simple, straightforward, and only takes a few minutes to complete. If you like what you see, you can apply online without a medical exam.
Bestow does not give tax or legal advice. The information provided is not intended to offer any tax, legal or financial advice. It is always a good idea to consult your tax, legal and financial advisors regarding your specific situation.