Everything you need to know about life insurance policy payouts

Purchasing a life insurance policy can give you peace of mind. That’s because you know it will provide money to help support your loved ones if something happens to you.

And if you are one of those loved ones, here’s what you need to know about how a life insurance policy payout works after the policy owner — a parent, a spouse, or someone else who might have named you as a beneficiary — passes away.

Figure out your beneficiary status

When someone buys a life insurance policy, they can choose two types of beneficiary:

• A primary beneficiary: This is the person(s) who will receive a payout from the policy when the policy owner dies.
• A contingent beneficiary: This is who will receive a policy payout if something happens to one of the primary beneficiaries.

If a policy owner names more than one primary or contingent beneficiary, they can spell out what percentage of the death benefit proceeds each will receive.

Pro tip: If you’re a policy owner, let your beneficiaries know that you’ve chosen them to receive a payout when you die.

If you are a possible beneficiary, check with your loved ones to find out whether they’ve named you a sole beneficiary, one of many beneficiaries, or a contingent beneficiary. You’ll also want to know where the policy is located so you can file a claim for a payout.

Know the death benefit amount

It might seem awkward to ask how much money you’ll receive when a loved one dies. But knowing the amount of the death benefit you will receive can help you decide on the best and most feasible uses for the money.

Also, take time to discuss final wishes in regard to funeral planning and any specific ways he or she would like the policy’s death benefit to be used.

Pro tip: Ask the policy owner whether he or she has used any living benefits riders, such as an accelerated death benefit rider, that could potentially reduce the death benefit.

Understand the different payout options

Insurers typically offer a variety of payout options for life insurance death benefits:

Lump sum

The entire benefit amount is paid at once by check or electronic transfer. This is the default payment for most policies, and is typically tax-free.

Specific income

The beneficiary can specify a period over which to receive payments. Payments are made until the death benefit is depleted.

Life income

This option works like an annuity and allows a beneficiary to receive insurance proceeds as guaranteed income for life in fixed monthly payments.

Life income with a period certain

The beneficiary receives guaranteed payments for life or over a certain period (five, ten or 20 years), whichever is longer.

Interest income

Some insurers allow beneficiaries to leave a death benefit in an interest-bearing account, then receive interest payments periodically. The original benefit can be paid to a secondary beneficiary when the beneficiary dies.

Pro tip: If you are paid in installments or receive interest on your payments, a portion of those payments or interest could be taxable. Consult with a financial professional to help you explore ways to use the policy payout while minimizing any tax implications.

File a life insurance claim

The insurance company won’t automatically pay a death benefit when a loved one dies. If you are a beneficiary, here are steps you will likely need to take to file a claim to receive life insurance proceeds:

1. Get a few copies of the insured’s death certificate by contacting your county or state vital records department. Or the funeral home you’re working with can help you get death certificate copies.
2. Notify the insurance company of the insured’s death. You’ll be sent claim forms to fill out and return. If there are multiple beneficiaries, each might need to fill out a separate claim.
3. The insurance company will then review the claim to determine whether it will be approved or denied. The life insurance company could deny the claim, for example, if the death was the result of suicide within two years after the policy was purchased, or from a pre-existing condition that wasn’t disclosed during the application, or a cause that wasn’t covered by the policy.
4. If the claim is approved, then you’ll have to decide how you want to receive the payout and what to do with the money.

Note: The life insurance claims process generally takes around two to four weeks. In some situations, it could take longer. Follow up with the insurer if you have questions or concerns.

Pro tip: Take your time after receiving a life insurance policy payout. Managing a life insurance payout while dealing with grief can be overwhelming. Working with a financial professional can help you come up with a plan for the money.

The possibilities for life insurance money

Here are some ways to use a life insurance payout:

Immediate expenses

Funerals and other costs associated with the end of life can be expensive. If you are taking time away from work to grieve, you might also need the money to cover lost income.

Every day expenses

One reason people get life insurance is to replace their income if they die, so their dependents don’t suffer financial hardship. In keeping with this, a life insurance payout can be used to pay for housing, clothes, groceries, bills, and more — often many years’ worth.

An emergency fund

One of your first priorities might be to create an emergency fund if you don’t have one already. Having cash set aside will help you avoid racking up debt to pay for unexpected expenses.

High-interest debt

If you have high-interest debt, such as credit card debt, you could use life insurance proceeds to pay it off quickly.

The mortgage

If you have a mortgage, you might be tempted to use a life insurance payout to pay it off. But it may not be the best long-term choice for your finances. Discuss your options with a financial professional before making large financial decisions, especially when you are dealing with loss and grief.

Education

You could invest in a 529 plan or other college savings accounts, some of which offer tax advantages and can even be used for private elementary and secondary school tuition.

Leaving a legacy

If your financial needs are met, you could use a life insurance payout to memorialize your loved one. You could donate some or all of the proceeds or create a scholarship fund. Or you could use the money for a family trip or reunion in honor of your loved one.

The lasting value of life insurance

A life insurance policy payout can’t bring back a loved one. But it can help you live out the dreams, goals, and wishes you both crafted, and can be a way to truly honor the life someone lived.