Updated February 12, 2021|6 min read
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The life insurance payout is disbursed in a tax-free lump sum or installments and can be spent however the recipients want.
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. Consult with a financial professional about the best options for your individual needs.
Life insurance proceeds can be paid out all at once or throughout your lifetime
There are no restrictions on how you spend the life insurance payout
After covering expenses like childcare and end-of-life costs, you can invest any remaining money
Consult with a certified financial advisor to create a strategy for spending the death benefit effectively
The best way to spend your life insurance payout depends on your financial obligations. There are no restrictions on how it is used, meaning you can spend it when and how you need to.
Certified financial and tax advisors can help you build a personalized strategy for how to handle the lump-sum payment. Each advisor will likely have their own approach, so speaking to multiple advisors will help you decide which financial strategy 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,” says Karen DeRose, Founder of DeRose Financial Planning Group. 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.”
Often, the death benefit is used for final expenses, medical expenses, paying off debts, and everyday costs of living.
Everyday expenses add up. For example, the average cost of caring for a newborn in Green Bay, Wisconsin, is $12,567 per year. The average Green Bay resident spends $357.12 on utilities and $880.47 on rent each month.
Whether you’ve lost a primary breadwinner or a stay-at-home parent, you’ll need to replace their contributions to the household. The death benefit can be used to pay for groceries, bills, services such as housecleaning, and more.
Parents can spend more than $233,610 raising a child through age 18. If the policyholder left behind any children or grandchildren, the death benefit can be put toward daycare, school tuition, after-school programs, or any other necessities.
If the primary 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 toward child and home care. The same is true if a stay-at-home parent dies.
The death benefit can also be used to care for aging parents or any other dependents.
According to a study conducted by College Board, the median cost of attending a private nonprofit university in the 2020-21 school year was $15,990.
One way to save for future college costs is by putting a portion of the life insurance payout into a 529 college savings account. The earnings on 529 investments are tax-deferred and any withdrawals won’t be taxed as long as the money is spent on eligible education expenses.
When you pass away, debts such as mortgages or car loans often fall on the shoulders of family members left behind. If someone cosigned your student loans, the responsibility of that debt falls on the cosigner. The death benefit 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, family members of the deceased might be responsible for any medical bills left unpaid before their death. The death benefit can go toward those costs or any future medical bills you might incur.
Funerals can cost as much 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 funerary expenses.
If there are 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.
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Life insurance money is paid out in a few ways: a lump sum, in an annuity (also known as life income), or in a retained asset account.
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:
Fixed-period annuities/Specific income — Payments occur for a set period, usually over 10, 15, or 20 years. If you die before the period ends, the remaining amount is disbursed to a beneficiary that you choose (also called life income with period certain).
Lifetime annuities/Life income — Payments occur for life. This option is best for young people.
Retained asset accounts operate like checking accounts controlled by a life insurance provider. The death benefit is held in the account and earns a low rate of interest, and you make withdrawals from the account using a checkbook provided by the insurer.
Lump-sum life insurance payments are normally untaxed, but interest earned on annuities or retained asset accounts are subject to income tax. You can also be taxed if the policyholder’s assets exceed the estate tax threshold.
You may pay additional fees on an annuity that you wouldn’t pay on other traditional investments, so taking the payout as a lump sum and then creating a separate investment portfolio may get you more bang for your buck.
Depending on the policy and circumstances of the policyholder’s death, it can take one week to two months to receive the life insurance proceeds. 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 requires the deceased’s name, date of birth, policy number, and cause of death.
You may also be asked to submit some supplemental documentation. The most common documents that life insurance companies ask for include:
A copy of the policy
Proof of your identity
Obituary or article about the death
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 primary beneficiary dies and is unable to receive the death benefit, then the payout goes to the contingent beneficiary. If no beneficiaries outlive the policyholder, a court decides who receives the insurance proceeds.
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While a life insurance policy pays out for most causes of death, there are a few caveats:
The contestability period: The first two years your policy is active, claims can be reviewed by the insurance provider and denied if the policyholder lied on their application. Claims can also be denied after contestability ends if lies are found.
The suicide clause: Insurers will deny the death benefit if a policyholder dies from suicide within the first two or three years their policy is active.
Murder: Policies don’t pay out if the policyholder is murdered and the beneficiary was involved in the policyholder’s death.
Policy lapse: If the deceased fell behind on policy payments, their coverage will have lapsed and is no longer active.
How you spend the funds from a life insurance claim ultimately comes down to your financial needs. A young surviving spouse may need the funds to support a child, whereas an older spouse may simply use the payout to support their retirement. A licensed financial professional can help you spend the funds wisely.
There are no limitations on spending life insurance proceeds. Work with a financial planner to decide how to spend and invest the funds according to your needs.
You can choose to be paid in a tax-free lump sum, in an annuity/life income payout (payments spread over several years), or in a retained asset fund (payments withdrawn from an account at your discretion).
The death benefit is usually tax-free. If you receive the payments in installments vs. a lump sum, you may need to report any interest gained as taxable income.
Life insurance terminology doesn't have to be confusing. Here are definitions of the most common terms and phrases you'll find in a policy.
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