Life Insurance: Government's Role In Payouts To Beneficiaries

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 the money – lump sum or otherwise – that gets paid to your beneficiaries if you die while your life insurance policy is in effect. The government is not required to pay out life insurance beneficiaries, but the insurance company will pay the death benefit within two months after getting proof of death and verifying your beneficiary.

Who can be a beneficiary?

Almost anyone can be a life insurance beneficiary, including people, organisations and trusts. Here are some common examples:

• A person, such as your spouse, domestic partner, or friend.
• Multiple people, such as your children.
• A charitable organisation.
• A legal entity, like your company.

Some insurers place limits on how many beneficiaries you can name, so if your policy has a limit, be selective when compiling your list.

The beneficiaries you choose when you purchase a policy must have an "insurable interest" in your life. This means they have more to lose than gain by your death, whether that's financial or otherwise. Most insurers will ask you to list the relationship you have with a beneficiary when you fill out the form.

Primary vs. contingent beneficiary

Primary life insurance beneficiaries are the first in line to receive the life insurance death benefit if you die. Contingent (or secondary) life insurance beneficiaries receive the death benefit if the primary beneficiary dies before you do.

Multiple beneficiaries

If you name multiple beneficiaries, you can choose how much of the payout each party receives. For example, you might allocate 50% to your spouse, 30% to your child, and 20% to a local charity. No matter how you divide a life insurance payout among beneficiaries, the percentages must add up to 100%. If you don't list the percentages, the insurer may grant equal shares to each beneficiary.

Irrevocable vs. revocable beneficiaries

You cannot change an irrevocable life insurance beneficiary designation without the beneficiary's approval. For this reason, irrevocable designations aren't common. However, they can be useful if you want to make sure the death benefit reaches a specific person, such as your child.

In contrast, a revocable life insurance beneficiary designation is flexible. You can change, update, add or remove a revocable beneficiary at any time.

How to find out if you're a beneficiary?

If you want to find out whether you're a beneficiary of a life insurance policy, the easiest way is to ask the policyholder directly. They can tell you whether you're a beneficiary and provide information on how to claim the death benefit when they pass away. If the policyholder has already passed away, you may be able to find information about the policy in their paperwork, such as financial documents.

If you know which insurance company the policyholder used, you can contact the insurer directly. They may ask for the policyholder's name and date of birth, the date of their passing, and your full name and relationship to the policyholder.

You can also use a life insurance policy locator service, such as the one provided by the National Association of Insurance Commissioners (NAIC). This service searches a database of known policies from participating companies. Alternatively, you can check with the policyholder's state government, as they maintain an unclaimed property division for unclaimed property, including life insurance death benefits.

If you know the name of the insurance company, you can begin the claims process by filling out a "Request for Benefits" form and providing a copy of the death certificate. The insurance company will then verify the information and pay out the death benefit, usually within 30-60 days.

It's important to note that beneficiaries are not always automatically notified by the insurance company, and there is no automatic process that alerts the company about policyholder deaths. Therefore, it's a good idea to be proactive and take the necessary steps to find out if you're a beneficiary.

How to file a claim?

To file a life insurance claim, there are a few steps you need to follow. Here is a detailed guide:

• Contact the Insurance Company: Get in touch with the insurance company or agent as soon as possible. They will guide you through their specific process for filing a claim. The name of the insurance company will be clearly stated on the life insurance policy. If you remember the agent you or the policyholder worked with, be sure to ask for them.
• Obtain Multiple Copies of the Death Certificate: It is important to get several certified copies of the death certificate from the funeral director. Most life insurance companies will not accept photocopies. You will need these copies not just for the claim but also for other necessary tasks such as cancelling subscriptions, closing accounts, accessing financial accounts, filing taxes, and contacting utility companies.
• Fill Out the Necessary Paperwork: Most insurance companies provide their claim forms online. If not, simply contact the company or agent to find out the next steps and they will likely ask you to send the paperwork along with the death certificate by mail.
• Choose Your Preferred Payout Option: There are several ways in which you can choose to receive the life insurance payout. Some common options include:

• Lump Sum: You receive the entire death benefit in a single payment.
• Specific Income Provision: The insurance company pays you both the principal amount and interest on a predetermined schedule.
• Life Income Option: You receive a guaranteed income for life, with the amount depending on the death benefit and your age and gender at the time of the insured's death.
• Interest Income Option: The insurance company holds the proceeds and pays you interest. The death benefit remains intact and is given to a secondary beneficiary upon your death.

Wait for the Payout: Depending on the state, an insurance company may have up to 30 days to review and accept or reject the claim. However, most companies will pay out the claim within a week or two of receiving the necessary paperwork.

It is important to note that there is no set deadline for filing a life insurance claim, but it is advisable to do so as soon as possible. Additionally, while life insurance death benefits are generally exempt from income tax, any interest received is usually taxable.

What are common life insurance payout options?

When it comes to life insurance, there are several options for how a beneficiary might receive their payout. These include:

• Lump-sum payments: This is the most common option, where the beneficiary receives the entire death benefit at once. This option gives the beneficiary the most flexibility, but receiving a large amount of money at once can be overwhelming.
• Installment payments: The beneficiary can choose to receive the benefit in a series of payments over time. This option gives the beneficiary more control over their payments, as they can increase or decrease the amount as needed.
• Annuities: The payout is converted into an annuity, providing the beneficiary with guaranteed payments for life. This option can be appealing for older beneficiaries who want a guaranteed source of income.
• Retained asset account: The payout is left with the insurance company in an interest-bearing account, and the beneficiary is provided with a checkbook to access the cash. This option eliminates the need to worry about FDIC insurance limits, as the insurance company will protect the entire amount.
• Life income with period certain: This option ensures that payments will continue to be made for a certain period of time, even if the beneficiary dies.
• Specific income payout: The beneficiary can choose to receive the payout in installments over a specific period of time and set the amount of each payment.

Do beneficiaries pay taxes on a life insurance payout?

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 the money paid to the beneficiaries if the insured person dies while the policy is in effect.

In most cases, beneficiaries do not pay taxes on their life insurance payout. However, there are some exceptions.

• Interest: If the beneficiary receives interest on the payout, this interest is taxable. For example, if the beneficiary elects to receive the policy amount in installments, the benefit is placed into an account that can accrue interest. While the beneficiary will not pay taxes on the benefit itself, they will be responsible for paying income taxes on any interest accrued.
• Paid to an estate: If the payout is made to the insured person's estate, rather than an individual or entity, it could be taxable.
• Owner and insured are different: If the owner of the policy is not the same as the insured, the payout to the beneficiary could be considered a taxable gift.

Tips to avoid paying taxes on a life insurance payout

• Transfer policy ownership: You may consider transferring ownership of the policy. However, note that value beyond what was paid for the policy will be regarded as taxable. And if you transfer it within three years of your death, the IRS will treat it as though it still belongs to you.
• Create an irrevocable life insurance trust (ILIT): You can transfer ownership of the policy from yourself to an ILIT and, therefore, remove it from your estate. But, be aware this kind of trust cannot be revoked after you set it up.
• Be aware of gift tax limits: The 2024 annual gift tax exemption is $18,000, and the lifetime exclusion amount is $13.61 million. If you’re careful that your policy's cash value does not exceed these limits, you may be able to avoid taxation.

Frequently asked questions