Understanding Life Insurance Payouts: Who Gets The Money?

Life insurance is a way to provide financial security for your loved ones after you pass away. The death benefit, or life insurance payout, is typically distributed in one of three ways: a lump sum, a life insurance annuity, or a retained asset account. The policyholder can set up the policy so that the beneficiary receives the payout as a single payment or in installments. The policyholder can also choose to give a percentage of the payout to multiple beneficiaries. In the case of term life insurance, the death benefit is only paid out if the insured dies within the term of the policy. For whole life insurance, the death benefit is paid out to beneficiaries, but the policy also contains a savings component.

Who gets the life insurance payout?

The life insurance payout will be sent to the beneficiary or beneficiaries listed on the policy. If there is more than one, each beneficiary will need to submit their own claim. The insurance company will then pay each person or organisation the amount the policyholder left them.

The policyholder can choose to name a single beneficiary or a primary beneficiary and one or more contingent beneficiaries. A contingent beneficiary would receive death benefits from the policy if the primary beneficiary passes away.

If the primary beneficiary is still alive, only this person, charity, or trust can claim and receive the policy's payout. If there are multiple primary beneficiaries, the policyowner will have designated a percentage or dollar amount for each beneficiary.

The beneficiary does not have to be a person. A legal guardian of a minor or a charitable organisation can also be a beneficiary.

If no primary or contingent beneficiary is living when the insured passes, the death benefit will be paid out to the insured's estate. It will go through probate and may be subject to claims from lenders before it is distributed to the insured's heirs.

How long does it take for a life insurance payout to be distributed?

The time it takes for a life insurance payout to be distributed depends on several factors, including the insurer's process, the timing of the claim, the policy duration, and the cause of death. Most states allow up to 30 days for the insurance company to review the claim, and it can take up to 60 days to receive the payout. However, there are some cases where the process can be delayed.

The payout process begins when the beneficiary notifies the insurer of the policyholder's death. The beneficiary will need to provide a death certificate and any other necessary documentation, such as a claim form, to initiate the payout. The insurer will then review the claim, and if everything is in order, the payout will be processed.

There are a few situations that could cause delays in the payout:

• 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 additional questions.
• Suspected foul play: If the policyholder's death was a result of homicide, there may be a delay as the insurance company works with the police to ensure the beneficiary was not involved.
• Fraud: If false information is discovered on the policyholder's application, the insurance company can investigate to determine if the policy is valid, even after the contestability period ends.
• Policyholder killed during illegal activity: If the policyholder died while committing a crime, the insurer may delay or deny the payout due to an insurance review and potential criminal investigation.

It's important to note that there is no set time limit for claiming life insurance, and beneficiaries can initiate the process as soon as the policyholder passes away or wait for an extended period. However, starting the process sooner can help ensure a smoother payout process and avoid potential delays.

How is life insurance paid out to beneficiaries?

The process of paying out life insurance to beneficiaries starts with the beneficiary contacting the insurance company. They will need to provide a death certificate and any other necessary documentation to initiate the payout. The way the death benefit is distributed depends on how the policy was set up.

Types of Payouts

The policyholder can choose to name a single beneficiary or multiple beneficiaries, who will be the individuals or organisations that receive the payout. The death benefit is typically paid out as a lump sum, though some policies may offer other options like instalment payments or an annuity.

Lump Sum

A lump-sum payout is the most common type of life insurance payout. This may be a good choice for beneficiaries who need immediate access to funds to cover expenses and financial obligations, such as funeral costs, outstanding debts or ongoing living expenses. However, this option can also be risky if funds are not properly managed. Additionally, if the payout exceeds $250,000, it may be necessary to place the funds into multiple accounts.

Annuity

With an annuity payout, the beneficiary receives periodic payments rather than a lump sum. These payments can be monthly, quarterly, semi-annually, or annually and continue for a predetermined amount of time or until the funds are exhausted. An annuity payout may be best for individuals who are concerned about managing a large sum of money all at once. However, it's important to note that the total payout amount may be lower compared to a lump sum.

Retained Asset Account

A retained asset account is essentially a checking or money market account set up by the insurance company in the beneficiary's name. Instead of receiving a lump-sum payout, the beneficiary will receive a checkbook or debit card linked to this account. They can then access the money as needed, similar to a regular checking or savings account. They also have the option to leave the funds in the account and earn interest on the balance. This method may be a good option for beneficiaries who are not comfortable managing a large sum of money.

Timing of Payout

In most states, life insurance payouts will be issued within 60 days. Some are distributed in as little as 10 days. However, there are some factors that can delay the payout, such as incomplete or incorrect paperwork, unusual circumstances surrounding the death, criminal activity, or if the policy is still within the contestability period (usually the first one to two years of the policy).

What are the payout options?

There are several payout options for life insurance policies, and the beneficiary can choose the one that best suits their needs. Here are some of the most common options:

Lump-Sum Payment

The most common payout option is the lump-sum payment, where the beneficiary receives the entire death benefit in one go, usually via a tax-free payment. This option provides immediate access to funds, which can be crucial for covering significant expenses or debts. However, this option also comes with the risk of improper fund management. If the payout exceeds $250,000, it may be necessary to distribute the funds across multiple accounts.

Installment Payments

The beneficiary can also opt for installment payments, where they receive the death benefit in regular payments over a fixed period or for their lifetime. This option provides a steady income stream, making financial planning more manageable. The payments can be set to a specific amount and paid monthly, quarterly, or annually until the funds are depleted. However, any interest earned on these payments may be subject to taxation.

Retained Asset Account (RAA)

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

Interest-Only Payout

With this option, the insurer retains the death benefit and only pays the beneficiary the interest earned on the amount. The principal remains intact and can be passed on to other beneficiaries upon the original beneficiary's death. While this option provides a regular income, the interest earned may be taxable.

Lifetime Annuity

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

Fixed-Period Annuity

In this option, 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 method ensures a regular income for a set period.

What do you do with a life insurance payout?

What you do with a life insurance payout depends on your individual needs and preferences. Here are some options:

Lump-Sum Payment

This is the most common type of life insurance payout. Beneficiaries receive the entire death benefit in one go, usually via a tax-free payment. This option provides immediate access to funds, which can be crucial for covering significant expenses or debts. However, it may be necessary to place the funds in multiple accounts if the payout exceeds $250,000. There is also a risk that the funds may not be properly managed.

Installment Payments or Annuities

With this option, beneficiaries receive the death benefit in regular payments over a fixed period or for their lifetime. This can provide a steady income stream, making financial planning easier. Payments can be set to a specific amount and paid monthly, quarterly, semi-annually, or annually. However, any interest earned on these payments may be subject to taxation, and the total payout may be lower compared to a lump sum.

Retained Asset Account

The insurer holds the death benefit in an interest-bearing account, and the beneficiary can withdraw funds as needed. This option provides flexibility and easy access to funds while also 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. The principal remains intact and can be passed on to other beneficiaries upon the original beneficiary's death. While this option provides regular income, the interest may be subject to taxation.

Lifetime Annuity

A lifetime annuity provides guaranteed payments to the beneficiary for their life. 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

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.

Regardless of the chosen payout method, it is important to remember that there are no restrictions on how the money from a life insurance payout can be spent. Common uses include paying off mortgages, saving for college tuition, paying down debts, investing in retirement accounts, or creating an emergency fund.

Frequently asked questions