Life Insurance Payouts: Lump Sum Benefits Explained

Life insurance is an asset used in long-term financial planning to provide financial support to loved ones after the policyholder's death. The death benefit is typically paid out as a lump sum, though some policies may offer alternative options such as installment payments or an annuity. The lump-sum payment is the most common and preferred payout method as it provides immediate access to the full amount, offering flexibility and control over the money. However, receiving a large sum at once can be overwhelming, and there may be a need to spread the money across multiple accounts for amounts over $250,000 due to FDIC insurance limits. It is important to understand the various payout options to make an informed decision that aligns with one's financial goals and circumstances.

Lump-sum payments are the most common way to receive a life insurance payout

However, receiving a large amount of money all at once can be overwhelming, and it's up to the beneficiary to make it last. If the payout is large, it may need to be spread across several bank accounts. Federal Deposit Insurance Corp (FDIC) deposit insurance, for example, will only cover up to $250,000 per depositor, per FDIC-insured bank.

Lump-sum payments are generally recommended by financial experts. This is because they give the beneficiary full control over the money, which can be put to good use right away. A lump-sum payment can be invested wisely, providing plenty of money to live on and leave a large, lasting legacy.

While a lump-sum payment is the most common and often the most beneficial option, there are other ways to receive a life insurance payout. These include installment payments, annuities, and retained asset accounts.

Installment payments are another option, allowing beneficiaries to receive the death benefit in regular payments over a fixed period

Installment Payments: A Fixed Income Stream for Beneficiaries

Life insurance policies offer beneficiaries the option to receive the death benefit in regular payments over a fixed period. This provides a steady income stream, making financial planning easier for the beneficiary. The installments can be set at a specific amount, paid at regular intervals such as monthly, quarterly, or annually, until the entire death benefit is paid out.

For example, if the death benefit is $250,000, the beneficiary could choose to receive $25,000 per year for ten years. This option gives the beneficiary more flexibility than a traditional life income option, as they can set the payout terms. However, it offers less flexibility than a lump-sum payment, and any interest earned on these payments may be subject to taxation.

The portion of the death benefit that has not been paid out yet continues to earn interest for the beneficiary. This interest income is generally subject to taxation. Therefore, beneficiaries might end up paying more in taxes on the interest if the death benefit is high, and they may be better off with a lump-sum payment.

Some insurers also offer a "life income with period certain" option, which guarantees that payments will continue to be made for a specified period, even if the beneficiary dies before the end of that period. For instance, if the beneficiary chooses a 10-year period and passes away in year three, their designated beneficiaries will continue to receive payments for the remaining seven years. However, the payment amounts will be lower than those of a traditional life income option.

A retained asset account is an interest-bearing account where the insurer holds the death benefit and provides the beneficiary with a checkbook to draw funds as needed

A retained asset account is an option for receiving a life insurance benefit. This account is set up by the insurer and operates like a checking account, with the death benefit as the initial balance. The beneficiary can withdraw their balance at any time and the account is interest-bearing, with the principal and a minimum rate of interest guaranteed by the insurer. The beneficiary is provided with free checks and periodic reports on the status of their account.

Retained asset accounts were established in 1984 to address the issue of beneficiaries not wanting to deal with death-related financial matters immediately, or being unable to manage large sums of money effectively. These accounts allow beneficiaries to keep their money safe and available until they are better able to use it. The money can be withdrawn immediately by writing a check for the full amount, or it can be left in the account for as long as the beneficiary wants. While the death benefit is income-tax exempt, tax considerations might affect when the beneficiary might most advantageously withdraw the money.

The money in a retained asset account stays with the life insurer and is not in an FDIC-insured bank, even if a bank's name is associated with the account. The money is protected and the beneficiary has full access to the funds at all times. The money is as safe, if not safer, with the insurer than with a bank, as historically, many more banks have failed than insurers. Additionally, there is a state guaranty fund system that insures at least as much as, or more than, the FDIC does. The money in the retained asset account is also beyond the reach of the beneficiary's creditors.

Insurers generally earn a higher rate on their investments than they pay on these accounts but still offer a competitive interest rate. They bear all the investment risk and provide a guaranteed positive rate of return, irrespective of market conditions. The difference between the insurer's overall rate and the credited rate is sometimes small, as some insurers credit interest based on prevailing rates at the time of the death. It's important to note that the only money that can be added to a retained asset account is from another life insurance death benefit from the same insurance company.

Interest-only payout: the insurer keeps the death benefit and pays the beneficiary only the interest earned

An interest-only payout is one of several options for how a life insurance benefit is paid out. In this scenario, the insurer keeps the death benefit and pays the beneficiary only the interest accrued on the sum. This option is available for whole life insurance policies, which have a savings component.

With an interest-only payout, the beneficiary receives regular payments over their lifetime, rather than a one-time lump sum. This option can be appealing to those who worry about spending a large sum too quickly. It also removes the risk of losing money by investing it. However, the younger the beneficiary, the smaller the annual payout, as it will need to be spread out over a longer period. There may also be fees associated with this option, and if the beneficiary dies before receiving the full benefit, the insurance company keeps the remainder.

Interest earned on the account through an interest-only payout is taxable, though the original insurance payout is not.

Lifetime annuity: the insurer provides guaranteed payments to the beneficiary for the rest of their life

Lifetime annuities, sometimes called guaranteed lifetime income annuities, are contracts sold by insurance companies. They are a financial product that promises to pay the owner a regular income for the rest of their life.

The buyer of a guaranteed lifetime annuity pays the insurer either a lump sum of money (a single-premium annuity) or a series of premiums (a multiple-premium annuity). In return, the insurer agrees to provide the buyer—and their spouse or another person, in the case of a joint and survivor annuity—with a guaranteed income for life, regardless of how long they live.

The income from a guaranteed lifetime annuity can either start immediately or be deferred to some future date. The older the owner is when they begin receiving income, the higher their payments will be because their life expectancy is shorter.

There are several types of guaranteed lifetime annuities:

• Immediate Annuity vs. Deferred Annuity: With an immediate annuity, the owner can begin to receive income right away, whereas with a deferred annuity, the income stream will start at some agreed-upon point in the future.
• Fixed Annuity vs. Variable Annuity: A fixed annuity will pay the owner a predetermined interest rate on their money during the accumulation phase, while a variable annuity will pay a return based on the owner's chosen investments, typically mutual funds.
• Single Life Annuity vs. Joint and Survivor Annuity: A single life annuity stops paying income when the owner dies, while a joint and survivor annuity continues to pay income to another person (usually a surviving spouse) after the owner's death.

Guaranteed lifetime annuities can be an appropriate choice for people who want a regular source of income to supplement their Social Security benefits, pensions, or other investments. However, they can be expensive, and many contracts make it costly or impossible to withdraw money early. In addition, the owner's heirs will not receive anything from the annuity after the owner dies unless a death benefit rider is added.

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