Understanding Life Insurance: Death Benefits Explained

A life insurance death benefit is a payout to the beneficiary of a life insurance policy, annuity, or pension when the insured person or annuitant dies. The death benefit is the primary reason why someone would purchase a life insurance policy. It is the amount of money paid to the beneficiary (the person chosen to receive the money) when the policyholder (insured person) dies. This money is typically tax-free and can be paid out as a lump sum or in instalments.

Who receives the death benefit?

The death benefit payout from a life insurance policy is paid to the beneficiary or beneficiaries named by the policyholder. This is the person or entity chosen by the policyholder to receive the payout in the event of their death. The policyholder can name one or multiple beneficiaries, and can also choose secondary beneficiaries who will receive the money if the primary beneficiary dies before the policyholder.

The beneficiary of a life insurance policy does not have to be a person. While the most common beneficiaries are partners, children, or other close family members, the policyholder can technically name any person or organisation as a beneficiary. This could include charities, family trusts, or businesses.

If the policyholder has named more than one beneficiary, they can specify how much of the death benefit they want each to receive. They can also name contingent beneficiaries, who will only receive the death benefit if all primary beneficiaries are no longer alive when the policyholder passes away.

Beneficiaries are typically required to submit a death claim form and provide a copy of the death certificate to the insurance company to receive the benefit.

How much should a death benefit be?

The death benefit amount is based on the face value of the life insurance policy, with subtractions for any withdrawals you made from cash value or policy loans you didn't pay back. For example, if you bought a $500,000 term life insurance policy, the payout to your beneficiaries will be $500,000.

When deciding how much money you should provide to your beneficiaries, consider your reasons for buying life insurance. If you want to provide funds to replace your income for 10 years, you could choose a death benefit that closely matches your income multiplied by 10.

The size of your death benefit is one factor that affects how much you'll pay in life insurance premiums. Other factors include the type of life insurance, your age, gender, health, and whether you use nicotine.

The following are some examples of premium payments for certain death benefit amounts:

• Term life insurance death benefit amount of $250,000: $16 for a 30-year-old male and $13 for a 30-year-old female per month.
• Term life insurance death benefit amount of $500,000: $18 for a 30-year-old male and $15 for a 30-year-old female per month.
• Term life insurance death benefit amount of $1,000,000: $30 for a 30-year-old male and $24 for a 30-year-old female per month.

Note that these examples are meant for comparison only. The most accurate way to see how much you'd pay for a certain policy is to compare life insurance quotes.

Are death benefits taxable?

Typically, the death benefit payout from a life insurance policy is not taxable. This means that the money paid to the beneficiaries of a policy is not considered part of their gross income and is therefore not subject to income or estate taxes. However, there are some instances where a death benefit can be taxed.

Firstly, if the payout is structured in a way that sees the beneficiary receive multiple payments over time, these payments can be taxable. For example, if the death benefit is converted into an annuity, the payments will include proceeds and interest, and these payments can be subject to taxes.

Secondly, if the policyholder has withdrawn money or taken out a loan against the policy, and the amount withdrawn or loaned exceeds the total amount of the premiums paid, then the excess amount may be taxable.

Thirdly, if the policyholder surrenders their policy, any funds received over the policy's cash basis will be taxed as regular income.

Fourthly, in the case of an employer-paid group life plan, if the payout exceeds $50,000, it may be taxable according to the Internal Revenue Service (IRS).

Lastly, if the death benefit, when combined with the total value of the deceased's estate, exceeds the federal estate tax threshold (which is $12.92 million as of 2023), estate taxes must be paid on the proceeds over the allowed limit.

It is worth noting that any interest accrued on the policy is also taxable and should be reported as interest received.

How do beneficiaries claim the death benefit?

To claim the death benefit, beneficiaries typically need to file a death claim with the insurer. This involves contacting the insurance company to find out what forms need to be filled out and submitting them along with a copy of the insured's death certificate. The process can vary depending on the company, but it generally involves filling out a "Request for Benefits" form. It is important to have the necessary information, such as the name of the insurance company and the insured's death certificate, to initiate the claim process.

Once the insurance company receives the claim, they will verify the information and typically pay out the death benefit within 30 to 60 days. Beneficiaries usually have a choice in how they receive the payout, with the most common option being a lump-sum payment. Other options include installment payments, annuity, or a retained asset account.

It is worth noting that, in some cases, the death benefit may be reduced or cancelled altogether due to certain circumstances, such as the policyholder misrepresenting information during the application process or having outstanding loans against the cash value of the policy. Additionally, the death benefit may not be paid out if the policy has expired or if the cause of death is excluded or violates the terms of the policy.

When is a death benefit paid?

A death benefit is paid out to the beneficiaries of a life insurance policy when the policyholder dies, provided that the policy is still in force. The death benefit is usually tax-free and can be paid out as a lump sum or in instalments.

The death benefit is paid out when the beneficiary submits a death claim form and provides a copy of the death certificate. The insurance company will then verify the information and pay out the benefit within 30-60 days.

It is important to note that the death benefit may be reduced in certain circumstances, such as if the policyholder misrepresented their information during the application process or if there were outstanding loans against the policy's cash value. Additionally, if the policy has expired before the death of the policyholder, the beneficiaries will not receive a death benefit unless a new policy is purchased.

The death benefit can be used by the beneficiaries for any purpose, such as living expenses, education, retirement savings, or even vacations. It is a way to provide financial support and make a final gift to loved ones after passing away.

Frequently asked questions