How Life Insurance Payouts Work – Pas Trusted News

As you get older, it’s common to wonder what will happen after your passing and how you will be able to support your family in your wake. Having a life insurance policy is one way to help offer financial security after your passing. Life insurance policies offer a payout known as a death benefit after death, but how much is paid out and under which circumstances depend on the type of policy that you have. Understanding your policy type and its life insurance payout is important to ensure that your beneficiaries are able to access the death benefit when it matters most.

Understanding life insurance payouts

Before getting into the details of the death benefit and how the money is distributed, it is important to understand how life insurance policies are designed to be paid. When purchasing a life insurance policy, a policyholder needs to decide who will receive the death benefit. This person is called a beneficiary. How long the death benefit is available to the beneficiary will be determined by the type of life insurance policy. While a term life insurance policy remains active during a specific term for a set amount, a permanent life insurance policy is designed to be active throughout a policyholder’s life as long as premiums are paid.

Beneficiaries

One of the most important elements of the life insurance application process is the designation of a primary beneficiary or beneficiaries. This can be a single person or multiple persons, or it can be an entity such as a charitable organization.

You may also designate a contingent beneficiary. This person or entity is a secondary recipient of your policy payout. If your primary beneficiary dies before you do, the contingent beneficiary would receive your death benefit.

Term life insurance payouts

If you have a term life insurance policy, the coverage lasts for a certain length of time — such as 10, 20 or 30 years — and features a simple payout of the death benefit amount if you pass away during the policy’s lifespan.

Permanent life insurance payouts

The payout for a permanent life insurance policy, such as whole life insurance, is a bit more complicated. A whole life policy also includes a savings component called cash value that the policyholder can draw from during their life. While the cash value of this type of life insurance policy will not be available to the beneficiary, it’s important to note that any money borrowed from the cash value of the life insurance policy and not repaid will be subtracted from the death benefit. If it is a $500,000 whole life policy and $10,000 was borrowed to start a business, the beneficiary would only receive $490,000 unless the $10,000 is repaid before the policyholder dies.

Types of life insurance payouts

There are several ways a beneficiary can receive the death benefit from a life insurance policy. The two most common are:

• Lump sum payment: This is the most common payout type, and is a single payment — usually in the form of a check — that is given to the beneficiary once the amount has been approved by the insurer. That single payment would be for the entire amount of the death benefit, minus any outstanding loan amounts, if applicable.
• Installments: The beneficiary may also be able to choose an installment payment of the death benefit, usually in the form of an annuity. An annuity is the periodic payment of a sum of money over an extended period of time. Some beneficiaries prefer annuities as a way of receiving a continuing income for a longer period of time.

A third option allows the insurer to function like a bank account, holding on to the death benefit until it’s needed. The insurer would issue a checkbook to the beneficiary, so they could draw on the money as needed.

The life insurance payout process

The life insurance payout process is not complicated, but it does require the beneficiary to make some financial decisions and handle some paperwork. Here is what you need to do:

File the claim

As soon as possible after the policyholder’s death, contact the insurance company to find out their procedure for filing a claim. You will likely have to submit a certified copy of the death certificate and complete additional paperwork, such as a claim form. Although there is no deadline for filing a claim, it is wise to handle this as soon as possible. Your state will have laws that indicate how long the insurer has to review your claim once submitted — often 30 to 60 days.

Possible issues

If you file the claim properly and provide all the necessary documents, you will typically receive the death benefit payout of a life insurance policy within a month. However, there are rare circumstances in which delays might occur. The following situations could cause delays:

• Policy purchase date: Policies are typically contestable by the company for the first two years they are in effect, so if the policyholder purchased the policy recently, the insurer may have questions, as life insurance claims on new policies can be a warning sign of fraud. If the death was by suicide, benefits might be denied if there was a suicide clause in the contract.
• Suspected foul play: If the policyholder was murdered, there may be a delay as the insurance company works with police to ensure that the beneficiary was not involved in the crime.
• Fraud: If the policyholder lied on the application, or if false information is discovered, the insurance company can typically do a thorough review to determine if the policy is valid, even after the contestability period ends. Some life insurance policies will have an incontestability clause written into the policy, so it’s important to review the policy with a licensed professional if you have questions.
• Policyholder killed during illegal activity: If the policyholder was killed while committing a crime, the insurer may delay or even deny the death benefit payment due to an insurance review and potential ongoing criminal investigation.

Payout choices

Once everything is approved, you must decide how you would like to receive your payout. The lump sum payout option is by far the most common. Since there are no restrictions on what the money can be used for, a lump sum may help you achieve financial goals such as:

• Paying off a mortgage
• Saving for college tuition
• Paying down consumer debt
• Saving for retirement
• Creating an emergency fund

Generally, a life insurance death benefit is not taxable. However, there are specific situations where the benefit could be taxed, depending on the amount of the benefit and whether the benefit accrues interest. Certain states may also have laws regarding estate taxes if the amount is particularly high. Prior to deciding what to do with a death benefit payout, it may be helpful to contact a financial advisor to discuss any potential tax consequences and to review the best financial options available to you.