Q

What should you do with the life insurance death benefit?

A

The death benefit offers financial security in the event that you lose a loved one, but how you spend it is determined by your current expenses and financial needs.

Nupur Gambhir

Nupur Gambhir

Published January 8, 2020

KEY TAKEAWAYS

  • The main reason people purchase a life insurance policy is the death benefit; it provides financial security to compensate for the loss of the policyholder

  • The death benefit can be paid out all at once or over the course of an individual’s lifetime

  • There are no restrictions on how the death benefit can be used, and it is up to the recipient’s discretion to decide what their financial needs are

  • When the life insurance policy’s beneficiary receives the death benefit, they should consult with a financial advisor to create a strategy to spend the death benefit effectively

When purchasing a life insurance policy, one of the most important considerations is the death benefit. The financial security that the death benefit provides for loved ones is the reason most people purchase a life insurance policy in the first place.

The policyholder pays life insurance premiums through the term of the policy so that when they die, the carrier pays out the death benefit to the beneficiaries. The death benefit can be spent however the beneficiaries want, though it’s a good idea to consult with financial professionals and consider the best options.

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What is the life insurance death benefit

The death benefit of a life insurance policy is the sum that is paid out to the policy’s beneficiary when the policyholder dies. If the insured has dependents, the death benefit compensates for the income they are no longer able to provide and ensures their loved ones’ financial security.

The death benefit is generally not taxed, though there are a few exceptions when the payout is taxable. The life insurance carrier may tax the death benefit if the policy falls into one of the following categories:

  • Life insurance policy with incremental payouts
  • An estate that exceeds the estate tax
  • Group life insurance
  • The policy has a cash-value
  • You sold the policy for profit

How much do you receive from the death benefit?

The amount received from the life insurance death benefit depends on the face value of the life insurance policy. Life insurance coverage can range from a few thousand to millions of dollars. The coverage amount varies depending on the type of financial protection needed for the policyholder’s dependents or to pay off any outstanding debts.

How is the death benefit paid out?

The life insurance death benefit can be paid out in two ways: a lump sum or in an annuity.

Receiving the death benefit as a lump sum means you will get the entire death benefit at one time, whereas receiving it in an annuity means you will receive the benefit in yearly installments until the benefit runs out.

There are two types of annuities to choose from:

  • Fixed-period annuities — Payments occur for a set period of time, usually over 10, 15, or 20 years. If you die before the period ends, the remaining amount will be dispersed to an additional beneficiary that you choose when you fill out the paperwork to receive the death benefit in an annuity
  • Lifetime annuities — Payments occur for life. This is option is best for young people and vampires

Most people choose to have the death benefit paid out as a lump sum, but some choose a payout in an annuity because of its ability to earn interest or because they have fewer expenses at present.

How long does it take to get the death benefit?

To receive the death benefit, the first thing you’ll have to do is submit a claim to the life insurance company. While each carrier has its own process for claim submissions, most allow for claims to be submitted online. Filing a claim will require the deceased’s name, date of birth, policy number, and cause of death.

You’ll likely also be asked to submit some supplemental documentation. The graph below shows the most common documents that carriers ask for:

DOCUMENTDOCUMENT INFO
Claim formAlso known as a claims packet. If you file online, the information you enter on the website should be equivalent to filling out a paper claim form. Depending on the carrier, you could also be sent a paper version of the claims form or be asked to download and print one out. The claim form will ask for information about you and the policyholder and will require your signature or e-signature if filing online. You’ll also use the claim form to state how you’d like the death benefit to be paid (as a lump sum or an annuity).
Death certificateYou should get multiple copies of the death certificate, just in case you need to use it more than once.
Obituary or newspaper articleIf available, it is beneficial to provide some supplemental information regarding the death.
A copy of the policyYou can contact the life insurance company to get this, but be prepared to show them proof that you are the beneficiary.
Proof of your own identityYou can use a form of ID or a social security number.

Depending on the policy and circumstances of the policyholder’s death, the amount of time it takes to receive the death benefit can vary from as little as one week to as long as two months. Providing the correct documentation from the get-go speeds up the claims process and will likely minimize the amount of time it takes to receive the death benefit.

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Who is eligible to receive the death benefit?

The recipient of the death benefit is the individual or individuals listed by the policyholder as the beneficiary. The policyholder can list more than one beneficiary so that multiple people can receive the death benefit.

If the beneficiary dies and is unable to receive the death benefit, then a court will decide what should happen with the life insurance policy money. To prevent this from happening, the policyholder can designate a contingent beneficiary. A contingent beneficiary receives the death benefit only if the primary beneficiary cannot accept the life insurance payout.

If the primary beneficiary is still alive when the policyholder dies, then the contingent beneficiary will not receive any part of the life insurance death benefit. The death benefit can only go to multiple people when multiple primary beneficiaries are listed on the policy.

How should you spend the death benefit?

The death benefit provides a financial safety net to compensate for the loss of the policyholder, and how you spend it is dependent on the financial obligations you have. There are no restrictions on how it is used, meaning you can disperse it according to your financial needs.

The first thing you should do when you receive a life insurance death benefit is consult with financial and tax advisors to come up with a strategy that caters to your individual needs. Each advisor will likely have their own unique approach, so speaking to multiple advisors increases the likelihood that you’ll find a financial strategy that suits your needs and that you feel comfortable with.

Often times, the death benefit is used for the following:

Annuitizing or investing for the future

If you don’t have a lot of expenses at the moment, you may decide that the death benefit is best used as an investment.

A financial advisor can help you determine how to best invest the death benefit, or you can opt to receive the death benefit in an annuity, which can gain interest and end up paying out more than the original death benefit if you live long enough. However, you may end up paying fees on an annuity that you wouldn’t otherwise pay with other investment vehicles.

The interest rate you earn on an annuity varies depending on the type of annuity you choose. The two most common types of interest rates of an annuity are:

  • Fixed annuities — Earns interest at a fixed rate that is set at the beginning of the death benefit payout
  • Variable annuities — Earns interest at a rate that is dependent on market trends and can increase or decrease over the life of the annuity.

College tuition

The death benefit doesn’t need to be used immediately; it can be saved and used on future costs. If there are plans for college in the foreseeable future, then the death benefit can be saved and used towards that.

One way to save for future college costs is by putting the money from the death benefit into a 529 college savings account. 529 plans are a great way to save for a child’s tuition because the earnings on the investments are tax-deferred and any withdrawals won’t be taxed as long as the money is spent on eligible expenses.

Monthly bills & everyday expenses

Whether you’ve lost a primary breadwinner or a stay-at-home parent, their contribution to the household will need to be accounted for if they die. The death benefit can be used to pay for groceries, bills, or services such as childcare that were taken care of by the individual before they passed away.

Outstanding debts

When an individual passes away, debts such as mortgages or car loans often fall on the shoulders of family members left behind. If there is a co-signer, the responsibility of the debt falls on them. Using the death benefit to pay off any outstanding loans the policyholder had when they died can lessen the financial burden placed on the people left behind.

Childcare or dependent care

If the policyholder left behind any children (or grandchildren), the death benefit can be put towards their support. This could be by paying for daycare, school tuition, after-school programs, or any other necessary care.

If the primary income earner of the household dies and the spouse left behind needs to either return to work or work more, then the cost may be best used towards child and home care. The same stands if a stay-at-home parent dies.

The death benefit can also be used to care for aging parents or any other care for dependents.

Medical expenses

Depending on the state, the family members of the deceased might be responsible for any medical bills left unpaid before their death. The death benefit can be put towards these costs or towards any future medical bills that the beneficiary might incur.

Final expenses

If the life insurance policyholder didn’t have final expense life insurance to cover their funeral expenses, the death benefit can be used to help alleviate some of the costs. End of life expenses can cost as much as $10,000, if not more, and the death benefit can cover the costs of services such as burial or cremation, items such as caskets and urns, and any other end of life expenses.

When can a life insurance company refuse to pay out the death benefit?

While a life insurance policy will pay out for most causes of death, there are a few caveats. Though mostly out of your control, it’s good to be prepared for any situations that may prevent you from receiving the death benefit.

The contestability period

The contestability period is the one to two year period after a life insurance policy is in force where coverage can be reviewed by the carrier. If the policyholder lies on their life insurance application about their medical history or any other circumstance, the carrier can invalidate the coverage and refuse to pay out to the beneficiaries.

A life insurance carrier is most likely to investigate any claims of fraud during the contestability period, but that doesn’t mean that any investigations that invalidate a policy can’t occur after the fact. If a life insurance carrier finds out that the policyholder lied on their life insurance application, they can withhold the death benefit from the beneficiaries. While this is out of your control if you are the individual receiving the death benefit, if you’re the policyholder, you should always be as honest as possible on your life insurance application to ensure that the beneficiaries receive the death benefit.

The suicide clause

Another instance that may warrant a refusal to pay out from the life insurance carrier is the suicide clause that is in most life insurance policies. The suicide clause allows carriers to withhold the death benefit if the policyholder dies from suicide during the first two years of the policy.

Murder

If the policyholder is murdered, the beneficiary will likely still receive the death benefit. If the beneficiary intentionally caused or played a part in the policyholder’s death, however, the life insurance carrier will not pay out the death benefit to them. This is called the “slayer statute” and is applicable in most states.

Lapsed policy

Finally, if the policyholder stopped paying the life insurance premiums, then the policy will have lapsed and no death benefit will be paid out.