Life Insurance: When And How To Collect

Life insurance is a financial safety net for your loved ones after you pass away. It is a contract between the policyholder and the insurance company, which pays out a death benefit to the chosen beneficiary when the insured person dies. There are two main types: term life insurance, which covers a set period, and whole life insurance, which lasts a lifetime. The process of claiming life insurance proceeds is straightforward but can be emotionally challenging, especially if the beneficiary was financially dependent on the deceased. It is important to understand the steps to access the insurance funds as quickly and smoothly as possible.

Naming a beneficiary

You can choose to name a single beneficiary, or a primary beneficiary and one or more contingent beneficiaries. While you can name anyone as a beneficiary, it is recommended that you notify them and provide them with a copy of your life insurance policy. Otherwise, they may not know to or be able to file a claim when the time comes.

It is also important to keep your beneficiary designations up to date as your life changes (marriage, children, divorce, etc.). You can change your beneficiary at any time, although the process becomes complex if you have irrevocable beneficiaries. In this case, you cannot remove or change the designated payout without their express consent.

When designating a beneficiary, it is important to be as specific as possible. For a person, you will need to provide their full legal name and their relationship to you (spouse, child, mother, etc.). Some beneficiary designations also include information such as mailing address, email, phone number, date of birth, and Social Security number.

Your beneficiary can be a person, a charity, a trust, or your estate. Almost any person can be named as a beneficiary, although your state of residence or the provider of your benefits may restrict who you can name. Make sure you research your state’s laws before naming your beneficiary.

Choosing a payout type

When choosing a payout type, it's important to consider your financial goals and needs. Here are some options to choose from:

Lump-Sum Payment

This is the most common payout option, where beneficiaries receive the entire death benefit in a single payment. This option provides immediate access to the full amount, which can be crucial for covering significant expenses or debts. However, receiving a large sum of money at once can be overwhelming, and you are responsible for making it last. Additionally, if you choose to put the money in a bank account, you might need to spread it across multiple accounts due to deposit insurance limits.

Installment Payments

With this option, beneficiaries can choose to receive the death benefit in installments over a fixed period or for their lifetime. This option provides a steady income stream, making financial planning easier. You can set the amount to be paid monthly, quarterly, or annually until the proceeds are depleted. However, any interest earned on these payments may be subject to taxation.

Retained Asset Account (RAA)

In this case, the insurer holds the death benefit in an interest-bearing account and provides the beneficiary with a checkbook to draw funds as needed. This option offers flexibility and easy access to the funds while earning interest. However, the interest earned may be taxable.

Interest-Only Payout

The insurer keeps the death benefit and pays the beneficiary only the interest earned on the amount with this option. The principal remains intact and can be passed on to other beneficiaries upon the original beneficiary's death. This option provides regular income but may come with taxable interest.

Lifetime Annuity

A lifetime annuity provides guaranteed payments to the beneficiary for their lifetime. The amount is determined by the death benefit and the beneficiary's age. If the beneficiary dies before the entire death benefit is paid out, the remaining amount typically goes back to the insurer.

Fixed-Period Annuity

In a fixed-period annuity, the death benefit is paid out over a specified period, such as 10 or 20 years. If the beneficiary dies before the end of this period, their designated beneficiaries can continue to receive the remaining payments. This option ensures a regular income for a set period.

The death benefit

Choosing beneficiaries

There can be more than one beneficiary, and in practice, there often is. A beneficiary doesn't have to be a person – it can be an entity such as a charity, family trust, or business. An heir is not necessarily the same as a life insurance beneficiary. An heir is assumed, but a beneficiary is designated. This means that if a person dies intestate (i.e. without a will), their heirs are the people who may be legally entitled to inherit their estate, but one or more heirs are usually named as beneficiaries on a life insurance policy.

Underage children cannot ordinarily be named as beneficiaries; if you want to leave money to a minor, you may have to set up a trust to manage the financial payout until they become of age.

Changing beneficiaries

When you buy an insurance policy, you can designate each beneficiary as either revocable or irrevocable. For revocable beneficiaries, the change process is relatively easy, and you don't need permission (unless it's your spouse and you live in a common-property state).

Allocating the benefit

The policyholder can allocate different percentages of the death benefit to different beneficiaries.

Using the benefit

Beneficiaries can use the money any way they want. There are no stipulations or conditions on benefit payouts. You can take the lump sum and use it for living expenses if you need, but you can also use it for any other purpose, from education to retirement savings, or even going on vacation.

Tax implications

Generally speaking, life insurance death benefits are exempt from income tax. While the benefit is usually income tax-free, you should consult a tax advisor if you receive a death benefit payment.

Accessing the benefit before death

Many life insurance policies have an Accelerated Death Benefit rider (i.e. an optional provision) that allows policyholders with a terminal illness to access part of the death benefit amount while they are still alive, usually to help pay for needed care. The company may need Proof of Life Expectancy from a medical provider to accelerate the death benefit; sums paid out will typically reduce the amount disbursed to beneficiaries after death.

When the benefit may be decreased

While reputable companies have a long history of paying out insurance death benefits in full, there are some situations in which a death benefit may be reduced:

• If an Accelerated Death Benefit was provided (see above)
• If the policyholder willfully misrepresented their information during the application process to obtain lower premiums, the company can reduce the benefit amount or cancel coverage altogether
• If there were outstanding loans against the cash value (this is typically not applicable to a term life policy with no cash value)
• If the policy had an adjustable death benefit (a feature of some universal life insurance policies), the payout may be lower than the original coverage amount

Charities as beneficiaries

As a means of creating a legacy, some policyholders may choose to designate a charity or other organisation as their beneficiary. A policyholder can even elect to use certain options like a charitable benefit rider, which automatically provides a payout to the charity of their choice above and beyond the beneficiary payout.

Who can take out a life insurance policy on someone

Taking out a life insurance policy on someone else requires meeting two legal conditions. An insurance company will not approve the policy unless both are met.

Firstly, the person taking out the policy must have what is known as an "insurable interest" in the person being insured. This means that the policyholder depends on the insured person financially, and would suffer a significant financial loss if they were to die. For example, the insured person may be the primary earner in a household, or the policyholder may rely on them for care.

Secondly, the insured person must consent to the policy. They must be aware of and agree to the policy, and will usually need to sign a consent form and undergo a medical exam.

Therefore, it is not possible to take out a life insurance policy on just anyone. The insured person must have a relationship with the policyholder, such as:

• Spouse or life partner
• Former spouse or life partner
• Minor child (under 18)
• Parent
• Business partner or key employee
• Sibling or other family member
• Grandchild
• Creditor or debtor

How to file a claim

To file a life insurance claim, you'll need to follow a few steps. While the process can vary depending on the insurance company, here is a general overview:

Find the Policy or Contact the Insurer:

Locate the insured's life insurance policy, which should include the insurance company's contact information and claim instructions. If you are unable to find the policy but know the insurance company's name, they can assist you in tracking down the policy details. They may provide you with a claim form to complete or direct you to an online claim form.

Gather Required Documentation:

Obtain multiple certified copies of the death certificate, as this is a crucial document for filing the claim. Additionally, gather other relevant information, such as personal details of the deceased and yourself.

Complete the Claim Form:

Fill out the claim form provided by the insurance company or accessed online. Provide all the requested information accurately and completely.

Choose Your Payout Type:

Decide how you would like to receive the payout. You may have the option of a lump sum payment, which is the most common choice, or alternative options such as a life insurance annuity, which pays out over a specified timeframe. Consult with the insurer and a financial advisor to understand the implications of each choice.

Submit the Claim:

Once you have completed the claim form, gathered the necessary documentation, and decided on the payout option, submit your claim to the insurer. If there are no issues, you may receive your payout within a few days to a few weeks.

It is important to note that there is no deadline for filing a life insurance claim, but it is advisable to do so promptly to initiate the process. Additionally, be prepared to address any potential delays or denials of the claim due to factors such as policy lapses, inaccurate information, or contestability periods.

Frequently asked questions