How Do Life Insurance Payouts Work?

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Life insurance provides funds to help you and your loved ones stay afloat financially after someone dies. But claiming a death benefit can be complicated, especially during a time of emotional stress. Knowing your options and what to expect can make the experience go more smoothly.

How Life Insurance Works

A life insurance policy pays out a death benefit when an insured person dies. To secure coverage for yourself (or someone else), you purchase a policy and pay premiums to an insurance company. When setting up a policy, the policy owner names one or more beneficiaries who receive the death benefit, and that money is often free from federal income taxes.

Life insurance comes in several forms, generally broken down into two categories: term insurance and permanent insurance. Term insurance, with relatively low monthly premiums, provides coverage for a specific number of years, such as 30. Term policies are a suitable option for families protecting against the untimely death of a parent or provider. Permanent policies are designed to last a lifetime; they include a cash value that ideally accumulates over time and can be accessed by the policy owner.

In some cases, tapping the cash value of a permanent life insurance policy can result in a loss of coverage, a smaller payout for beneficiaries, or potential tax consequences.

Regardless of policy type, if the insured dies while the policy is active, the beneficiaries named in the policy are (typically) entitled to the death benefit.

Your Beneficiary Status

Life insurance policies pay a death benefit to beneficiaries, so it’s important to know who the beneficiaries are. Beneficiaries often include spouses or partners, parents or other family members, business partners, charities, and family trusts. If no beneficiary is named on a policy, or if no beneficiaries can be found, the funds typically go to the deceased’s estate.

The death benefit goes to primary beneficiaries first. There may be multiple primary beneficiaries, and the policy owner specifies what percentage goes to each one (the percentages don’t need to be equal). If a primary beneficiary dies or cannot be found before the policy pays out, the death benefit may go to contingent beneficiaries.

Note: Community property states may require that you receive a waiver from your spouse in order to name anyone else as a beneficiary on your life insurance policy.

A policy with multiple beneficiaries can get confusing. For example, when a parent names two children as beneficiaries and one of them predeceases the parent, the details of the policy dictate what happens next (or state law does if the policy doesn’t specify). Beneficiaries can be designated as “per stirpes” or “per capita” or nothing at all. The surviving sibling gets everything  (per capita), or that sibling splits the proceeds with any descendants of the deceased sibling (per stirpes), or your state may assume one or the other designation if not specified.

Also note that minor children cannot receive a life insurance payout directly; the state, in this case, may appoint a legal guardian who may or may not use the funds for your child’s best interests.

If you’re the beneficiary on a life insurance policy, get details about the policy so you can access the death benefit when needed. It’s important to know how much money to expect and who else may be entitled to funds from the policy.

Payout Options

Beneficiaries can often choose how they receive the death benefit. While a lump-sum payout is a popular option, you might not need or want all of the money right away. Insurance companies typically offer several choices for handling the death benefit:

  • Lifetime income: You can receive payments that last for the rest of your life. The amount you receive depends on your age and the size of the death benefit.
  • Fixed amount: If you want to receive a specific amount each year or month, you can specify that payment. Once the funds are depleted, payments stop.
  • Interest income: You leave the death benefit intact with the insurance company to earn interest, and the insurer only pays out interest earnings.
  • Life with period certain: You receive income for life. But you can also select a minimum number of years (15, for example) for payments to continue. Your beneficiaries get any remaining payments if you die before that period ends.
  • Lump sum: The insurance company pays out the entire death benefit at once. With that approach, you can pay off debts or choose savings and investment vehicles besides the insurance company’s offerings.

Filing a Claim

Life insurance policies don’t automatically pay out after an insured person dies. You need to notify the insurer and provide information to make a claim. Begin by contacting the life insurance company and asking what the requirements are to collect the death benefit. In most cases, you need to submit a request for benefits (typically a form) and a death certificate.

The request for benefits tells the insurer how to provide your payout. If there are multiple beneficiaries, each one may need to provide a separate request form. To ensure that the process goes smoothly, review your request form before submitting it, and make sure you’ve addressed all of the details. If you have any confusion about what’s required, contact the life insurance company and ask—rejected forms can cause delays and frustration.

It’s hard to have too many death certificates. When somebody dies, request a few more than you think you need.

How Quickly Are Benefits Paid?

The insurance company should complete the process of reviewing documents and paying claims within one month, in most cases. However, things can certainly move faster. To improve the chances of speedy processing, triple-check your request for benefits. Any incomplete items or missing documentation will cause delays.

In some cases, the insurance company needs to investigate the claim, resulting in a longer processing time. For example, if the insured dies within the first two years of the policy (during the contestability period), the insurer may examine the original application and the details of the insured person’s death. Suicide, homicide, and death during illegal activity (driving under the influence, for example) can also lead to increased scrutiny, a possible denial of benefits, or slower payouts.

Are Life Insurance Benefits Taxable?

The death benefit from a life insurance policy is often tax-free for beneficiaries. When a family member dies and survivors get a lump-sum payout, it’s unlikely that you’ll owe taxes.

However, there are exceptions, such as life insurance policies used in business planning. Also, if you do not receive the death benefit as a lump sum, you typically earn interest on any money that stays with the insurance company. Those interest earnings are generally included in your taxable income.

If you’re getting lifetime payments or installment payments, expect to report some income on your taxes.

Unclaimed Life Insurance Benefits

Sometimes beneficiaries don’t claim the money they’re owed from a life insurance policy. Insurance companies try to contact beneficiaries with any information they have, but those efforts aren’t always successful. For example, it can be hard to find somebody who moves or changes their name. Sometimes, the insurer doesn’t even know about the insured person’s death.

You may be able to find lost life insurance payouts through several sources. Review the deceased’s records for any clues regarding insurance policies, insurance agents, or financial advisors. You can also check your state’s unclaimed property division. Finally, the NAIC Life Insurance Policy Locator may be able to help, although you might not get an answer if it’s unclear how you’re connected to the policy.

Key Takeaways

  • Life insurance payouts can provide crucial funding after a loved one’s death.
  • Collecting the death benefit is easiest when beneficiaries have details about life insurance policies readily available.
  • Payouts are not automatic—beneficiaries need to submit a request for benefits.
  • In many cases, insurers pay death benefits within one month.