Life Insurance Beneficiaries: How And When They Get Paid

Life insurance is a contract between a policyholder and an insurance company that pays out a death benefit when the insured person passes away. The death benefit is typically paid out as a lump sum, though some policies may offer other options like instalment payments or an annuity. The policyholder designates one or more beneficiaries, who are the individuals or organisations that will receive the payout. The key is that the payout process begins when the beneficiary notifies the insurer. The insurer will review the claim, and as long as everything is in order, the payout will be processed, helping provide financial security for the beneficiary.

Lump-sum payment

A lump-sum payment is the most common type of life insurance payout. It is often the preferred choice when there are multiple beneficiaries, as it provides immediate access to the entire death benefit in a single, usually tax-free, payment. This can be crucial for covering significant expenses or debts, such as funeral costs, outstanding debts, or ongoing living expenses. However, this option also carries the risk of poor financial management, and if the payout exceeds $250,000, the funds may need to be placed into multiple accounts.

The beneficiary can choose to receive the entire death benefit in one go and is then free to invest the money as they see fit. This option gives the beneficiary greater control over their finances and is often the simplest choice. For example, if the beneficiary needs to pay off large debts quickly or cover immediate expenses, a lump-sum payment would be the best option.

The lump-sum option also has tax advantages over other payout methods. While the death benefit itself is typically tax-free, any interest earned on the payout may be subject to taxation. With a lump-sum payment, the beneficiary can invest the money in a way that minimises tax liabilities, which is not possible with other payout options.

While a lump-sum payment is the most common and often the most advantageous option, it may not be suitable for everyone. Some beneficiaries may feel overwhelmed by the responsibility of managing a large sum of money, and in such cases, other payout options, like annuities or retained asset accounts, may be more appropriate.

Installment payments

The installment payment option allows beneficiaries to receive the death benefit in regular payments over a fixed period or for their lifetime. This option can provide a steady income stream, making financial planning easier and more manageable. The installments can be set to a specific amount, paid monthly, quarterly, or annually, until the entire death benefit is depleted.

For example, if the death benefit is $750,000, the beneficiary could request the insurance company to pay out $75,000 per year for 10 years. However, there will be no more money after the specified period ends. Some insurance companies offer lifetime installment plans, but these come with certain drawbacks. The insurance company estimates how long the beneficiary will live and bases the installment amount on this estimation. If the beneficiary passes away before receiving the entire payout, the remaining money stays with the insurance company and cannot be passed on to anyone else.

To avoid this, some people choose a period-certain installment, where the insurance company distributes the payout for a set amount of time, such as 20 years. If the beneficiary passes away within this time, the remaining payments will go to a secondary beneficiary listed on the original policy, if there is one.

It is important to note that any interest earned on these installment payments may be subject to taxation. Therefore, beneficiaries should carefully consider their options and consult with a financial advisor or tax professional to make the most suitable choice for their circumstances.

Retained asset account

A Retained Asset Account (RAA) is an account that is set up in the beneficiary's name by the insurer. This account functions like a checking account, with the initial balance being the death benefit. The beneficiary is provided with a checkbook and can withdraw funds by writing checks. The beneficiary can also choose to keep the money in the account, which will earn interest. The principal and a minimum rate of interest are guaranteed by the insurer, and additional interest is credited to the account at a rate declared by the insurer, which is comparable to that of similar accounts offered by banks and money-market mutual funds.

There are several payout options available to the beneficiary with a retained asset account:

• Lump-sum payment: The beneficiary can write a check for the full amount and receive the entire payout at once.
• Installment payout: The beneficiary can choose to receive fixed monthly, quarterly, or annual payments for a set period or until the account is depleted.
• Interest-only payout: The beneficiary can opt to receive only the interest from the account on a monthly, quarterly, or annual basis. The principal amount remains in the account and can continue to earn interest. When the beneficiary passes away, the money in the account can be passed on to their beneficiaries.

While a retained asset account offers flexibility and the ability to earn interest, there are some risks associated with it. The money in the account is not federally protected, and in the event of the insurer's default, there is no guarantee that the beneficiary will be reimbursed. Additionally, state law may not provide protection for the account, and it is unclear if state guaranty funds will reimburse beneficiaries who own a retained asset account if the insurance company becomes insolvent.

Lifetime annuity

Lifetime annuities, also known as life annuities, are a form of personal pension plan. They are a financial product sold by insurance companies, providing a predetermined periodic payout until the death of the annuitant (the annuity owner).

Lifetime annuities can be purchased either all at once or in separate instalments over time. Annuitants may pay into the annuity periodically or make a single, lump-sum payment, usually at retirement. The insurance company then makes regular payments to the annuitant, which can be monthly, quarterly, semi-annually, or annually. The monthly payout amount is calculated based on the annuitant's age and life expectancy.

Lifetime annuities are commonly used to provide a guaranteed and/or supplemental retirement income. They are often used by those who want the certainty and security of a regular and guaranteed income stream. This type of annuity ensures that the annuitant receives income for as long as they live, even if all the money contributed is exhausted.

The payments can also be increased to cover a second person, known as a "Joint and Survivor" annuity. This option typically results in smaller payout amounts as the insurance company needs to cover the longer of the two lifetimes.

It is important to note that most lifetime annuity payouts stop at the death of the annuitant. However, if the annuitant purchases a rider or another option on the annuity, the payments may continue to their estate or beneficiary.

Fixed-period annuity

A fixed-period annuity is a financial product that provides a safe place for cash to accumulate tax-deferred interest. Fixed-period annuities are the most straightforward type of annuity and provide the most predictable and reliable income stream, usually with the lowest fees.

The insurance company will issue regular payments to the beneficiary over a fixed period, such as 10 or 20 years. The payout is calculated by dividing the death benefit by the number of years chosen. The beneficiary can also choose their own beneficiary to receive any remaining payments if they pass away before the time period ends.

Fixed-period annuities are ideal for conservative investors who want to preserve their principal but want their money to grow faster than a savings account or a CD. They are also a good choice for investors in high tax brackets, as the tax-deferred compounding can result in a higher return than a taxable option.

One disadvantage of fixed-period annuities is that they may not keep up with inflation, as the fixed rate does not adjust for inflation. Additionally, there may be penalties for early withdrawals, and the money withdrawn is taxed as ordinary income.

Overall, fixed-period annuities offer a safe and predictable income stream, making them a good option for those seeking financial security over a fixed period of time.

Frequently asked questions