Life insurance provides financial protection for your loved ones in the event of your death. When you pass away, the life insurance company will pay out a lump sum of money known as a death benefit to your listed beneficiaries. This money can help cover final expenses, daily living costs, and other financial needs for those left behind. But how exactly do life insurance payouts work after the death of the policyholder? Here is an in-depth look at the life insurance claims process and how benefits are paid out.
Initiating a Claim
After the passing of the insured, the beneficiaries or executor will need to contact the life insurance company to begin a claim. The insurance company will ask for a certified copy of the death certificate as proof that the insured has died. Beneficiaries may also need to provide additional documentation such as a copy of the policy, their identification, and possibly a copy of the will if the estate is the beneficiary. The insurance company will review the claim paperwork and confirm that the policy was active at the time of death.
Determining Eligible Beneficiaries
A key part of the claims process involves identifying the correct beneficiaries. This is determined at the time the policy is taken out. Beneficiaries can include individuals specifically named on the policy like family members. Or beneficiaries can be more general like “estate of the insured.” If beneficiaries have passed away before the insured, then secondary beneficiaries may be entitled to the payout. The insurance company will determine the rightful beneficiaries before dispersing funds.
Selecting a Payout Method
Beneficiaries are usually given some options in terms of how they can receive life insurance proceeds. Common payout methods include:
Lump sum payment – The full death benefit is paid out at once.
Installments – The death benefit is dispersed over time in increments. This provides ongoing income for beneficiaries.
An interest-earning checking account places the lump sum into an account where beneficiaries can withdraw funds as needed. Interest accrues on the principal.
The beneficiary uses benefits to purchase an annuity that provides set payments for a period of time or even the beneficiary’s lifetime.
The beneficiaries will work with the insurance company to select the payout method that best suits their financial needs and situation.
Accidental Death Benefits
Some life insurance policies have an accidental death provision which pays out extra funds if the insured dies due to an accident. This also requires submitting additional proof such as a police report. Accidental death benefits are usually double the face value of the policy. This added protection can provide further financial security for beneficiaries dealing with an unexpected death.
In some cases, a life insurance claim may be denied if the death occurred outside the terms of the policy. For example, suicide within the first two years of the policy may exclude payout. High risk activities like dangerous hobbies may also prevent payment of benefits. Insurance companies investigate claims thoroughly to check for fraud. Beneficiaries can appeal any claim denials if they believe the death should be covered.
Taxes on Benefits
Income tax purposes generally do not tax life insurance proceeds paid to individual beneficiaries as income. However, if the insured’s estate is the beneficiary then the death benefit may be taxable. Interest earned on benefits deposited into an account will be taxed as regular income. Consulting a tax advisor can clarify any potential taxes owed on benefits.
Once the beneficiaries accept the claim. A few settlement options will be presented to them. Most insurance companies give beneficiaries 60-90 days to consider the choices:
- Receive the lump sum payout upfront
- Take the total amount as an extended payment over time
- Leave funds with the insurance company to accumulate interest
Settlement options give beneficiaries flexibility if they are not ready to receive the full payout immediately.
Using the Benefits
The policy predetermines the death benefit amount, but beneficiaries can use the funds flexibly. Some common needs the payout can cover include:
- Paying off the insured’s debts like medical bills or a mortgage
- Covering funeral and burial costs
- Replacing lost income from the insured’s salary
- Funding college for children
- Making major purchases or lifestyle adjustments
- Donating to charity
- Investing the lump sum for increased earnings
- Using the monthly payout as retirement income
Ultimately, the beneficiary gets to decide the most prudent and meaningful way to use the life insurance benefits.
The passing of a loved one is an enormously difficult time. But life insurance can provide reassurance that financial needs will be met after you’re gone. Knowing how the claims process works and what payout options are available enables you to make informed choices when purchasing coverage. With the right life insurance policy in place, beneficiaries can honor the insured’s memory by putting the benefits towards a purposeful cause.