Purchasing a life insurance policy can give you peace of mind. That’s because you know it will provide a payout of the policy’s death benefit to help support your loved ones if something happens to you.
Because that payout can be a lifeline for those you leave behind, it’s important to make sure that you have enough coverage to help meet your loved ones’ financial needs. It’s also essential for those who will receive proceeds from a life insurance policy to understand the process of collecting the death benefit.
Here’s what you need to know about how a life insurance policy payout works after the policy owner passes away.
Figure out your beneficiary status
When you buy a life insurance policy, you can choose a beneficiary – a person or people who will receive a payout from your policy when you die. You also can name a contingent beneficiary, who will receive your policy payout if something happens to your primary beneficiaries. If you name more than one primary or contingent beneficiary, you can spell out what percentage of the death benefit proceeds each will receive. At Haven Life, for example, policyholders to name up to 10 primary beneficiaries and 10 contingent beneficiaries.
You should let your beneficiaries know that you’ve chosen them to receive a payout when you die. And you should check with your loved ones to find out whether they’ve named you a beneficiary. You’ll also want to know whether you’re a sole beneficiary, one of many beneficiaries or a contingent beneficiary.
If you’re a beneficiary for a loved one, you need to know where the policy is located so you can file a claim for a payout. This will help you avoid having to track down a lost policy.
Know the death benefit amount
It might seem awkward to ask how much money you’ll receive when a loved one dies. But you need to know this information if you’re the beneficiary of a life insurance policy.
If the insured is your partner or spouse and is the primary breadwinner in your household, it’s important to consider whether the death benefit could be enough to help replace lost income if they were to pass away. Experts often recommend that you buy coverage with a death benefit that is equal to five to 10 times your annual salary. Remember that pay disparities among women and men can lead to a life insurance gender gap, so this rule of thumb doesn’t always stack up.
To find out how much coverage you need, use an online life insurance calculator for a personalized recommendation.
Getting this much coverage can be surprisingly affordable. The following are sample quotes for a Haven Term policy, issued by MassMutual, for people in excellent health.
30-year term life insurance rates Age Coverage $250,000 $500,000 $750,000 $1,000,000 25 Male $20.03 $31.51 $44.27 $57.02 Female $16.59 $25.69 $35.54 $45.38 30 Male $21.91 $34.88 $49.32 $63.77 Female $18.01 $27.69 $38.54 $49.38 35 Male $24.84 $40.25 $57.38 $74.51 Female $21.10 $33.53 $47.29 $61.06 40 Male $34.31 $59.11 $85.66 $112.22 Female $29.47 $46.83 $67.25 $87.67 20-year term life insurance rates Age Coverage $250,000 $500,000 $750,000 $1,000,000 25 Male $13.61 $19.76 $26.64 $33.52 Female $12.07 $16.95 $22.42 $27.90 30 Male $13.82 $20.19 $27.28 $34.37 Female $12.50 $17.82 $23.72 $29.63 35 Male $14.93 $22.34 $30.51 $38.67 Female $13.39 $19.33 $25.99 $32.66 40 Male $21.32 $34.59 $48.88 $63.17 Female $18.01 $28.27 $39.41 $50.54 10-year term life insurance rates Age Coverage $250,000 $500,000 $750,000 $1,000,000 25 Male $10.53 $13.95 $17.92 $21.90 Female $9.86 $12.66 $15.99 $19.32 30 Male $10.53 $13.95 $17.92 $21.90 Female $9.86 $12.66 $15.99 $19.32 35 Male $10.83 $14.38 $18.57 $22.77 Female $10.08 $13.09 $16.64 $20.18 40 Male $14.05 $20.32 $27.49 $34.65 Female $12.95 $18.53 $24.79 $31.06 Source: Haven Life
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, ask the policy owner whether he or she has any living benefits riders that could potentially reduce the death benefit. For example, an accelerated death benefit rider allows a policyholder with a terminal illness to receive a portion of the death benefit to help pay for medical costs or whatever expense the policyholder may have. Haven Term policyholders can receive an advance of up to 75% of the amount of their death benefit while they are alive — up to a maximum of $250,000 — in the event they are diagnosed with a terminal illness. However, accessing the accelerated death benefit will reduce the payout dollar for dollar when the policyholder dies. There may also be an administrative fee if the rider is exercised.
When talking with the policy owner about the death benefit, take the time to also 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.
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Understand the different payout options
Insurers typically offer a variety of payout options for life insurance death benefits. As the beneficiary, you can choose how you want to receive the proceeds, so it’s crucial to be aware of the options that are available.
The entire benefit amount is paid at once by check or electronic transfer. A lump-sum life insurance payout is the default payment for most policies. Some policies offer additional payment options.
The beneficiary can specify a period over which to receive payments. Payments are made until the death benefit is depleted.
This option works like an annuity and allows a beneficiary to receive insurance proceeds as guaranteed income for life in fixed monthly payments. The amount of each payment is based on the amount of the death benefit and the beneficiary’s gender and age at the time of the policyholder’s death.
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.
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.
A lump-sum life insurance payout usually is tax-free. However, if you are paid in installments, a portion of those payments could be taxable. If you receive interest on your payments, that interest could be taxed as regular income. Consulting with a financial professional can help you explore ways you might wish 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. Here are steps you have to take to file a claim to receive life insurance proceeds.
First, 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.
You’ll need the death certificate when you file an insurance claim with the insurance company. When you 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.
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 occured within two years after the policy was purchased or if the death was the result of suicide or a pre-existing condition, if those weren’t covered by the policy.
The life insurance claims process generally takes around two to four weeks, however in some situations, factors could extend that out further. 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.
Take your time after receiving a life insurance policy payout
Managing a life insurance payout while dealing with grief can be overwhelming. That’s why you shouldn’t rush to make any decisions about how to use the money. If you opt to receive a lump-sum payout, you might want to let the money sit in your bank account for a while as you evaluate your financial needs.
Keep in mind that you don’t have to make these decisions by yourself. Working with a financial professional can help you come up with a plan for the money.
Evaluate all the possibilities for using life insurance money
After making sure you’ve covered immediate expenses such as funeral costs, take a big-picture view of your financial situation to figure out how best to use a life insurance payout. Here are some key things to consider.
An emergency fund
One of your first priorities will 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.
If you have high-interest debt, such as credit card debt, you could use life insurance proceeds to pay it off quickly. Then you’ll have more room in your budget for other living expenses and to save for your future.
You might be tempted to use a life insurance payout to pay off your mortgage. It could give you peace of mind knowing that you won’t have to make this monthly payment – but it may not be the best choice for the long-term. Plus, there might be other reasons not to use the bulk of an insurance payout to pay off your mortgage. It makes sense to discuss this with your financial professional before making large financial decisions, especially when you are dealing with loss and grief.
The proceeds, or a portion of proceeds from a life insurance policy could be used to help pay for the cost of the children’s education. There are a number of college savings accounts to consider, such as a 529 plan or other college savings accounts. Some of these accounts offer tax advantages and in the case of 529 plans, can be withdrawn tax-free for qualified education expenses, including private elementary and secondary school tuition. Research all the options available to you, because the tax treatment varies, and there are other factors to consider. You can also work with a financial planner for assistance in making the right decision for your situation.
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, create a scholarship fund or leave a legacy for your loved one. Or you could use the money for a family trip or reunion in honor of your loved one.
The lasting value of life insurance
Remember, if you’re the beneficiary of a life insurance benefit, it’s OK to take your time to figure out the best use of the money. And seek help with managing the payout from a financial professional, if necessary.
If you have life insurance coverage, make sure you let your beneficiaries know that they will be protected financially when you pass away. And take the time to discuss with them how much they will receive.
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.
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Cameron Huddleston is the author of Mom and Dad, We Need to Talk: How to Have Essential Conversations With Your Parents About Their Finances. She also is an award-winning journalist who has been writing about personal finance for more than 17 years. You can learn more about her at CameronHuddleston.com.
Haven Life Insurance Agency (Haven Life) does not provide tax, legal or investment advice. This material has been prepared for educational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or investment advice. You should consult your own tax, legal, and investment advisors before engaging in any transaction. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.