More on Life Insurance
More on Life Insurance
Updated September 22, 2020
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The life insurance payout is dispersed in a tax-free lump sum or in installments and can be spent however the recipients want — though it’s a good idea to consult with certified financial professionals about the best options pertaining to your individual needs.
But how, exactly, should you spend such a large amount of money? What you do with the life insurance death benefit depends on your current expenses — such as housing, bills, or the cost of raising a child. If there’s anything left over after you’ve covered those costs, you can invest the death benefit and save for retirement.
Life insurance proceeds can be paid out all at once or over the course of your lifetime
There are no restrictions on how you can spend the life insurance payout, and it is up your discretion to decide what your financial needs are
If there are extra funds, you can invest the money
You should consult with a certified financial advisor to create a strategy to spend the death benefit effectively
The death benefit of a life insurance policy is the sum that is paid out to the beneficiary when the policyholder dies. The death benefit compensates for the income or services they are no longer able to provide and ensures their loved ones’ financial security.
You’ll usually get this sum untaxed, though there are a few exceptions when the payout is taxable. The life insurance company may tax the death benefit if the policy falls into one of the following categories:
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.
Life insurance money is 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 money runs out.
Most people choose to have the death benefit paid out as a lump sum, but some choose a payout in an annuity if they have fewer expenses and because it earns interest over time. There are two types of annuities to choose from:
A certified financial advisor can help you determine which method is best suited for you.
Depending on the policy and circumstances of the policyholder’s death, the time receiving the death benefit can take one week to two months. Providing the correct documentation from the get-go speeds up the claims process and minimizes the amount of time it takes to receive the death benefit.
To receive the life insurance death benefit, the first thing you’ll have to do is submit a claim to the life insurance company. While each life insurance company 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 may also be asked to submit some supplemental documentation. The graph below shows the most common documents that life insurance companies ask for:
|Claim form||Also 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 certificate||You should get multiple copies of the death certificate, just in case you need to use it more than once.|
|Obituary or newspaper article||If available, it is beneficial to provide some supplemental information regarding the death.|
|A copy of the policy||You 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 identity||You can use a form of ID or a social security number.|
The above information is based on requirements from policies offered by Policygenius as of September 2020.
The only people who can get the death benefit payout are the people listed as the beneficiaries on the life insurance policy. Regardless of your relationship with the policyholder, if you’re not listed on the policy, you cannot collect the death benefit. Creditors and debt collectors also have no access to the payout.
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 to receive 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 there are multiple primary beneficiaries listed on the policy.
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How you spend the life insurance payout is dependent on your financial obligations. There are no restrictions on how it is used, meaning you can disperse it according to your needs.
The first thing you should do when you receive a life insurance death benefit is consult with certified financial and tax advisors to come up with a personalized strategy. 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 you feel comfortable with.
“If you come into a lump sum of money… sit down with a certified financial planner, not [just] an investment advisor. An investment advisor can only invest your money. A CFP can do both. They can first come up with a plan to figure out how much [of this money] you need every month — or [if] you don't really need the money and it needs to be invested for your retirement,” says Karen DeRose, Founder of DeRose Financial Planning Group.
Often times, the death benefit is used for the following:
The cost of a college education is notoriously high, and it continues to get more expensive. According to a study conducted by College Board, the median cost of attending a not-profit university in the 2019-20 school year was $12,710. Some saw costs that were even higher: 26% of students surveyed paid more than $30,000 in fees.
Because the death benefit doesn’t need to be used immediately, it can be saved and used on future costs — including the cost of a college education. One way to save for future college costs is by putting the money from the life insurance payout into a 529 college savings account. These 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.
Everyday expenses add up. For example, the averagecost of caring for a newborn in, say, Green Bay, Wisconsin, is $12,567 a year. In Green Bay, the average person spends $189.74 on monthly bills and $880.47 on monthly rent.
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, services such as childcare, and more.
Parents can end up spending $233,610 raising a child through age 18. If the policyholder left behind any children (or grandchildren), the death benefit can be put towards 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.
When an individual passes away, debts such as mortgages or car loans often fall on the shoulders of family members left behind. Or if someone cosigned their student loans, 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.
Final medical expenses can be exceedingly high — sometimes in the tens of thousands. 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 you might incur.
Funeral costs can be as high as $10,000, if not more, and the life insurance payout can cover the costs of services such as burial or cremation, items such as caskets and urns, and any other end of life expenses.
If you don’t have a lot of expenses at the moment — or if there are some funds remaining after you’ve covered all of your expenses — you may decide that the life insurance payout is best used as an investment.
A certified 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’ll end up paying fees on an annuity that you wouldn’t otherwise pay with other traditional investment vehicles — so getting the payout as a lump sum and then creating a separate investment portfolio may get you more bang for your buck.
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:
While a life insurance policy will pay out for most causes of death, there are a few caveats:
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 insurer. If the policyholder lies on their life insurance application about their medical history, whether or not they smoke, or just about anything else, the life insurance company can invalidate the coverage and refuse to pay out to the beneficiaries.
A life insurance company 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 an insurer finds out that the policyholder lied on their life insurance application, they can withhold the life insurance payout from the beneficiaries. While this is out of your control if you are the individual receiving the payout, if you’re the policyholder, you should always be as honest as possible on your life insurance application to ensure that your beneficiaries receive the death benefit.
Another instance where the insurance company may deny a pay out is the suicide clause that is in most life insurance policies. The suicide clause allows insurers to withhold the death benefit if the policyholder dies from suicide during the first two years of the policy.
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.
Finally, if the policyholder stopped paying the life insurance premiums, then the policy will have lapsed and no death benefit will be paid out.
Nupur Gambhir is a life insurance editor at Policygenius in New York City. She has researched and written extensively about life insurance since 2019, with specialties in life insurance companies, policy types, and end-of-life planning. Her writing on insurance and finance has appeared on MSN, The Financial Gym, and end-of-life planning service Cake. Previously, she worked in marketing and business development for travel and tech.
Nupur has a B.A. in Economics from Ohio State University.
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