How Do Life Insurance Payouts Work When Someone Dies?
Your beneficiary choice can have far-reaching financial ramifications
Life insurance can give you peace of mind that your family and assets are protected should the unthinkable happen and you are no longer able to provide for them. There are different types of life insurance policy options that lead to different forms of payouts to survivors. If you’re looking to purchase a policy or recently received one as a benefit from an employer, here’s what to know about designating beneficiaries, various policy options, and how the payout process works when someone dies.
For life insurance, a beneficiary is defined as a person, persons, or entity you designate to receive the death benefit, or payout, from your policy after you die. Choosing the beneficiary of your life insurance policy can be a very personal and important decision. Your choice of beneficiary could have far-reaching financial, legal, and personal ramifications. If you don’t name a beneficiary, the death benefit is paid out to your estate and the funds could be tied up in a lengthy legal process.
There are two basic types of life insurance beneficiaries.
- Primary: The primary beneficiary of a life insurance policy is the person, persons, or entity you designate to receive the proceeds or payout of your life insurance policy when you die.
- Contingent: If the primary beneficiary you choose should die, then the secondary or contingent beneficiary receives your life insurance proceeds. The contingent beneficiary can only receive the life insurance payout if the primary beneficiary dies prior to the life insurance policyholder, and another primary beneficiary isn’t named.
You are allowed to designate more than one beneficiary to receive part of the life insurance payout after you die.
Life Insurance Policy Types
Life insurance is available through two main types of policies: whole life insurance (also known as permanent) and term life insurance. Whole life insurance is a lifetime policy and offers coverage over one’s entire lifetime. A term life insurance policy is available for a designated time period or offers temporary coverage, generally in 10- to 30-year term limits. Some insurers allow you to convert a term policy into a whole life insurance policy at the end of the policy term.
There are advantages to both types of insurance policy types. A term life policy may be less expensive than a whole life policy, and may be an option to consider if you have a limited budget. Whole life insurance offers additional benefits such as income-generating, interest-bearing accounts with a cash value benefit that can be borrowed against.
While whole life insurance cash value policies may be borrowed against, that doesn’t mean you necessarily should. Any loans taken out against the value of a life insurance policy are borrowed against the death benefit, so any unpaid loan balance will be deducted from the death payout distributed to your beneficiary.
You can choose to pay life insurance premiums monthly or annually. The payment terms available to you will vary depending on the type of life insurance policy, whole or term, and the policy term length. For help in determining life insurance premiums, you can use a life insurance calculator.
For example, a 25-year-old female in excellent health living in Illinois could expect to pay around $19.14 per month for a 30-year, $250,000 term life insurance policy from State Farm.
Some financial advisors say it’s not necessary for single people to get life insurance unless they want to offer financial support to a family member. But keep in mind that life insurance premiums are cheaper for those who are younger and in good health.
The Life Insurance Payout
After someone dies, the beneficiary of the life insurance policy will need to file a death claim to receive the payout. The beneficiary submits the death certificate to the insurance company. The insurance company investigates the claim and then pays out the death benefit. The face value of the policy is the benefit paid out to the beneficiary. Term-life policies pay the face value as a death benefit to the beneficiary. Whole or permanent life insurance policies pay the face value and possibly more or less. If the insured chose a cash value option that potentially accrued interest and added to the death benefit payout, it’ll be more. But if they took a loan from the policy, it could be less if there is any outstanding balance.
The life insurance policy must have been active leading up to the death of the named insured for the benefit to be paid. Otherwise, the coverage will lapse and there will be no payout to the beneficiary.
Most life insurance companies require a benefits claim to be filed before a life insurance payout is made. There is often a set of documents that need to be completed with information about how the death occurred, the cause of death, and other details. This is important because, depending on any policy endorsements or riders, the death benefit payout may be increased. For example, if an accidental death policy rider was added before the policyholder’s death, the benefit may be higher.
Once the death claim is investigated and it is determined that the death benefit payment will be made to the beneficiary, the insurance company will arrange the payout. It may give the option for the beneficiary to receive either a lump-sum payment or ongoing annual payment disbursements. The laws of your state regulate when the insurance company is required to make the first life insurance payout after the death insurance claim has been filed. Typically, death benefits are paid out in between 10 and 60 days after the claim is filed.
Life insurance policy death benefits are usually not included as taxable income. So if a beneficiary is to receive a $50,000 benefit, he or she shouldn’t have to pay taxes on it. The only time a beneficiary may need to pay taxes on the benefit is if it earned interest or dividends.
The Bottom Line
Choosing a life insurance policy may be one of the most important decisions you'll ever make for the financial security of your family. Carefully weigh all the options before deciding on the right life policy for you and your family. Once it is in place, you can move forward knowing that your beneficiaries now have financial protection for years to come.
Related: Best Whole Life Insurance Policies
III.org. "What is a Beneficiary?" Accessed Jan. 6, 2020.
Guardian Life. "How to Buy Life Insurance." Accessed Jan. 6, 2020.
III.org. "Life Insurance Basics." Accessed Jan. 6, 2020.
State Farm. "Life Insurance Quote." Accessed Jan. 6, 2020.
Thelawdictionary.org. "About How Long Should It Take to Receive Life Insurance Money?" Accessed Jan. 6, 2020.