Life Insurance Payout: Managing Your Sudden Windfall Wisely

Life insurance payouts are a difficult topic to navigate, especially when grieving the loss of a loved one. It's important to understand how life insurance payouts work so that you can make the best decisions for yourself and your family. The process begins when the beneficiary contacts the insurance company and provides necessary documentation, such as a death certificate, to initiate the payout. The way the death benefit is distributed depends on how the policy was set up, with the policyholder designating one or more beneficiaries. While there is no time limit to claim life insurance, it is recommended to do so as soon as possible to honour the intentions of the deceased.

There are several options for receiving a life insurance payout, each with its own pros and cons. The most common and recommended option is a lump-sum payment, where the beneficiary receives the entire death benefit at once. This provides flexibility and control over the money. However, receiving a large amount of money at once can be overwhelming, and it is the beneficiary's responsibility to make it last. Other options include installment payments, retained asset accounts, interest-only payouts, and lifetime annuities, each offering different levels of flexibility, income streams, and tax implications.

The life insurance payout process typically takes between one week and two months, depending on the review and approval of the claim by the insurance company. It is important to provide correct and complete documentation to speed up the process. Delays may occur due to incorrect or incomplete paperwork, the policyholder's death within the two-year contestability period, or extenuating circumstances such as homicide. Understanding how life insurance payouts work can help beneficiaries make informed decisions and ensure they receive the support they need during a difficult time.

Lump-sum payments

Lump-sum life insurance payments are the most common type of payout, and for good reason. This option gives you the most flexibility, putting you in control of the money and allowing you to use it however you want. You can put the money to good use immediately, covering essential expenses such as funeral costs, medical bills, and monthly bills. You can also use the money to pay off debt, including mortgages and student loans.

While the lump-sum option is simple and provides immediate access to funds, receiving such a large amount of money can be overwhelming. It is up to the beneficiary to make the money last and manage it wisely. If you receive a large payout, you may need to spread it across several accounts to stay within Federal Deposit Insurance Corp. deposit insurance limits. Despite this, the lump-sum option is still recommended by experts over other types of payouts, such as annuities or retained asset accounts.

Lump-sum life insurance payments are usually tax-free, whereas the interest earned on other types of payouts, such as annuities, is taxable. This is another reason why the lump-sum option is generally considered the best choice.

Installment payments

One option for receiving your life insurance payout is to have the life insurance company pay you a certain amount of money on a regular schedule (usually monthly, quarterly, or yearly). This type of payout is known as an installment payment plan. The money will be paid out over a certain period of time, which you can choose. For example, if you receive a $750,000 life insurance payout, you could choose to receive $75,000 per year for 10 years.

However, it's important to keep in mind that there will be no more money after the specified period ends. Some insurance companies offer installments that last for the rest of your life, but these types of plans have their own set of drawbacks. For instance, the insurance company will base the amount of money they give you on their estimate of how long you will live. Therefore, if your loved one passes away when you are relatively young, the monthly payout may not even be enough to cover your rent. Additionally, if you pass away before receiving the entire payout, the insurance company will keep the remaining money, and you won't be able to leave it to anyone else.

Another option within installment payments is to choose a period-certain installment. This means that the insurance company will continue to distribute the payout for a set amount of time, such as 20 years. If you pass away during this time, the remaining payments will go to the secondary beneficiary listed on the original policy, if they are still alive. However, if there is no surviving secondary beneficiary, the insurance company will keep the remaining money.

It's worth noting that any interest earned on installment payments may be subject to taxation. Therefore, carefully consider your financial needs and goals when deciding between a lump-sum payout and an installment plan.

Annuities

When you're ready, you can start collecting income payments from the annuity. You can set these payments up over a fixed period or have them guaranteed to last for the rest of your life. This makes annuities a form of insurance against living too long and running out of money.

You can set up a death benefit on an annuity contract. With this feature, the annuity would pay your heir a payout based on the contract terms and your balance. For example, if you bought an annuity for $500,000 and collected $300,000 of income payments, the annuity death benefit might pay the remaining $200,000 to your heirs.

There are several types of annuity payout options:

• Fixed Amount: You can select the amount of payment you want to receive each month. The payments continue until you stop them or you run out of money. The insurance company does not guarantee that you won't outlive your income payments.
• Fixed Period: You choose a defined period (e.g., 10, 15, or 20 years) to receive the payout of your annuity. Payments after your death may go to your designated beneficiary.
• Joint and Survivor Life: The company pays you or your survivor for as long as either of you is alive. The amount of the regular payments is typically smaller than the Life Only option, as the company now pays for the longer of two lifetimes.
• Life with Period Certain: This option gives you an income stream for life and the option to select a guaranteed period, such as a 10-year guaranteed term. This means your annuity must pay your estate or beneficiaries even if you die before the guaranteed period ends.

Retained asset accounts

RAAs are generally provided as an option to the beneficiary, but for some group policies, the employer may have agreed that an RAA is the only way life insurance claims are settled. The beneficiary can choose to write one check to access the entire proceeds at any time, or they can opt for an installment payout, receiving a fixed monthly, quarterly, or annual payment for a set period or until the account runs out. They can also choose an interest-only payout, where they receive interest from the account on a regular basis and the principal remains intact, to be passed on to other beneficiaries upon the original beneficiary's death.

It's important to note that beneficiaries may be able to earn a higher rate of interest on the life insurance proceeds if they select a different payout option. Additionally, any interest earned on the account will be taxable.

Interest-only payout

An interest-only payout is a life insurance payout option that provides the beneficiary with regular income. The insurer keeps the death benefit and pays the beneficiary only the interest earned on the amount. The principal remains intact and can be passed on to other beneficiaries upon the original beneficiary's death.

This option offers flexibility and easy access to funds while earning interest. However, the interest earned may be subject to taxes.

Compared to a lump-sum payment, an interest-only payout may be a better option if you are more concerned about having money to support your family over time. If you are unsure, it is best to consult an experienced financial professional to help you weigh the pros and cons of each option, including any potential tax ramifications.

Frequently asked questions