How does a life insurance policy payout work?

Peace of mind. Financial protection. Future plans. When discussing life insurance, we often talk about the value in terms of the intangibles that come with purchasing a policy. But of course, the monetary value of a policy is central.

Because the payout of a life insurance policy comes upon the death of the insured, the money is a tricky subject to talk about. But knowing exactly how a life insurance policy payout will be paid and could be used by a beneficiary can help you understand the full value of your policy. Here we’ll talk about how a life insurance policy payout works after you die, how it may be used, and how discussing the potential uses of a policy payout now can make decisions easier later on.

Anticipate options (and your expected payout)

First, it’s important to know whether you were the sole beneficiary of a loved ones policy, or if your loved one listed multiple beneficiaries. For example, if your spouse helped her aging parents with their bills, it may have made sense for your spouse and her surviving parent to be joint policy beneficiaries.

There’s a lesson here for you. For your own policy (and your partner’s), make sure you and your loved ones are on the same page regarding named beneficiaries to minimize surprises at an already stressful time if one of you were to die.

Second, know where to find important documents. If you are a beneficiary for a loved one, know the policy information and how to access accounts and information. Let your own beneficiaries know they’re named, and make sure their identifying info is up to date on your policy.

Third, expect the insurance company to present you with options: a lump sum payout or installment payments from an interest-earning account it creates for you. Some policies also offer lifetime income options (similar to annuitization options for annuities), which aren’t invested in a retained asset account.

The payout option is your choice. Many people choose to receive their payment in a lump sum, but if a survivor is overwhelmed, or has minimal debts and their immediate bills covered or doesn’t yet wish to make a decision on how to use the money, installments may make sense.

Is a life insurance policy payout taxable? Generally, no. (Although the interest earned on any money held by the life insurance company likely is taxable.) But consulting with a financial professional can help give you peace of mind and can help you explore ways you might wish to use the policy payout.

Give yourself time to make financial decisions

Managing a new lump sum of money while dealing with grief can be overwhelming. While everyone’s process is different, experts say you shouldn’t feel rushed to use the money. You may find it helpful to take a few months and live as close to normal as you can — pay bills, go about your routine — before making huge financial decisions like paying off a mortgage.

Also, remember, you don’t have to make these decisions by yourself. Talking to a CERTIFIED FINANCIAL PLANNER® professional or financial professional you trust may help guide you as you tackle big decisions and come up with a plan.

“My family tends to be a do-it-yourself one,” explains Matt Wolf, Product and Actuarial Lead at Haven Life. “After my father had passed away, there was an immediate pressure for us, my mother, in particular, to take on all of the things he used to do himself – the taxes, managing retirement assets, and paying the bills. We helped my mother locate a few financial advisors to speak with about her situation. In the end, she decided not to work with any of them on an ongoing basis. However, initial consultations gave her comfort that she was aware of all her options and not missing important decisions.”

Triage your financial decisions

When you do feel ready to make a financial move with the money from a payout, people who’ve been through the process say it’s smart to take a big-picture view of all the debts you have now, like credit card balances or a mortgage, and financial obligations expected in the future, like college for your children. Personal finance common sense says that, generally, it’s smart to handle the higher-interest debts you have first before looking at less costly debt or future obligations. As you consider how to allocate your payout, here are some of the major financial buckets to consider:

High-interest debt

From credit cards to car payments, it’s smart to pay off balances with a high-interest rate quickly. In addition, it can be helpful to consider how those balances were accrued in the first place and consider ways to budget for the future. A life insurance policy payout can make you feel like you have a financial safety net, but remember that the money is finite, and smart savings and spending strategies can be a helpful tool for any family for the long term.


Housing options

If the policy payout is enough to cover the mortgage, then that’s what you should do, right? Not necessarily. You may also want to consider taxes, maintenance, and general cost of living — how will you pay for those expenses going forward, even after the mortgage has been paid?

Other options, like downsizing to a smaller property or moving to another part of the country where you may have more friends and family, may make sense. Remember that there is no “right” answer. These big questions are where a professional, family and friends, and even time can help. There is no deadline for spending a life insurance policy payout. Consider maintaining the status quo until the next steps are more clear to you.

College and other educational expenses

One of the driving motivations for many people who purchase life insurance policies is to make sure the cost of their children’s education is covered. Assuming the life insurance policy payout is large enough, and depending on the ages of the children, consider putting money into a college savings plan as it offers the potential to grow over time and can be accessed by children for their education at a later date.

A four-year college degree is expected to cost around $176,000 by 2030. If you know the policyholder wanted to fund his/her child’s college expenses, then that’s a lasting legacy you may wish to honor. Also, money in a 529 plan doesn’t have to be used exclusively for a university education. In 2018, 529 plans were expanded so that they can be used for private K-12 school tuition as well. You can withdraw up to $10,000 per student per year from a 529 plan to pay for primary or secondary education. This money can only be used for tuition (not school supplies or books). You can also consider a Coverdell account, which offers tax-advantages similar to a 529 plan, but funds can be used for qualified education expenses at an eligible postsecondary school, elementary school, or secondary school.

Investing life insurance proceeds

Another option (and remember, a life insurance policy payout is your money and you have the option to use it for a combination of things) is to invest the money so it has the potential to grow in value.

You can place the funds in an investment account that you already have, or open a new one. Bear in mind that investing involves risk, and past performance doesn’t guarantee future results.

Again, working with a financial professional can be helpful, and they can also keep you attuned to other ways to grow your cash besides the stock market.

Leaving a legacy

Remember that there is no “should.” People can advise you, but at the end of the day, it’s your money, it’s your memory, and it’s your life to craft after the death of a loved one. Some people find that they like to use some of the money from a life insurance payout to memorialize their loved one, in the form of a donation to their alma mater, funding a scholarship, or putting up a memorial bench as a tangible way to leave a legacy. Others like to memorialize their loved one through a family vacation, reunion, or celebration of life.

It’s okay to use some of the money for something fun. Remember, your loved one named you as a beneficiary for a reason. They trusted that you would be able to use the money in a way that could help you maintain quality of life even in the face of loss.

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Give yourself time and space

Grief has no timeline and there is no due date for your financial decisions. You may feel ready to allocate funds right away, or you may take a while. Either is normal. Professional advice can be helpful but isn’t doctrine, and it’s up to you to spend the funds and consider the future in a way you feel most comfortable.

Have these conversations with your loved ones now. These topics may feel awkward — nothing like talking about “what if I were to die” to spice up a Friday date night, right? — but talking about what ifs can help you make sure you and your loved one are on the same page. Clear communication can help make the decisions more apparent for a beneficiary if one of you were to die.

A life insurance policy payout can’t bring back your 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.

Anna Davies is an editor at Haven Life. She has written for The New York Times, New York Magazine, Refinery29, Glamour, Elle, and others, and has published 13 young adult novels. She lives in Jersey City, NJ, with her family and loves traveling, running, and trying to find the best cold brew coffee in town.

This discussion is intended for general education only and is not legal, tax or investment advice. You should consult your own tax, legal, and investment advisors before engaging in any transaction. Haven Life doesn’t recommend any products or services discussed.

Haven Term is a Term Life Insurance Policy (ICC17DTC) issued by Massachusetts Mutual Life Insurance Company (MassMutual), Springfield, MA 01111 and offered exclusively through Haven Life Insurance Agency, LLC. Policy and rider form numbers and features may vary by state and may not be available in all states. In New York, Haven Term is DTC-NY 1017. Our Agency license number in California is OK71922 and in Arkansas, 100139527.

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