Life Insurance: Understanding Average Payouts

Life insurance is a financial safety net that provides financial security to the loved ones of the policyholder in the event of their passing. The payout, also known as a death benefit, is the amount of money paid out to the beneficiary or beneficiaries of a life insurance policy. The average life insurance payout in the US is about $168,000, but this can vary depending on various factors such as the type of policy, the coverage amount, the insurance provider, and the age and health of the insured.

Payout options: lump sum, annuity, or retained asset account

When it comes to life insurance payouts, there are typically three main options available: a lump-sum payout, an annuity, or a retained asset account. Each of these options has its own unique characteristics and may suit different individuals depending on their financial goals and circumstances. Here is a detailed overview of each payout option:

Lump-Sum Payout

The lump-sum payout is the most common and preferred method of receiving a life insurance payout. It provides the beneficiary with immediate access to the full amount of the death benefit, offering flexibility and control over the money. This option is generally tax-free and allows the beneficiary to utilise the funds for various purposes, such as funeral expenses, outstanding debts, or other financial obligations. However, receiving a large sum at once can be overwhelming, and for amounts over a certain threshold (e.g., $250,000 in the US), it may be necessary to spread the money across multiple accounts due to deposit insurance limits.

Annuity

The annuity option provides the beneficiary with a steady income stream over a set period or for their lifetime. In this case, the insurer pays out the death benefit in regular instalments while keeping the remaining amount in an account that earns interest until it is fully paid out. This option may not always be available, and any interest earned on the remaining death benefit may be subject to taxation. Annuities can provide financial stability and make financial planning easier for the beneficiary, especially if they choose a fixed-period annuity, which guarantees payments for a specified period, even if the beneficiary dies before the end of that period.

Retained Asset Account

A retained asset account is an interest-bearing account set up by the insurer, where the death benefit is held. The beneficiary is provided with a payout chequebook and can withdraw funds as needed. This option offers flexibility and easy access to funds, similar to a checking account. The account accrues interest, and any interest earned may be subject to taxation, while the original insurance payout remains tax-free. Retained asset accounts are suitable for beneficiaries who may not want to deal with financial matters immediately after the loss of a loved one or who prefer to keep their money safe and available until they are ready to use it.

Term life insurance payouts

Term life insurance is a simple and cost-effective form of life insurance. It is typically purchased for a specific period, ranging from 10 to 30 years, and provides a death benefit to the beneficiaries upon the policyholder's death during that term. This type of insurance is a contract between the policy owner and the insurance company, where the owner agrees to pay a premium for a specified term, and the insurer promises to pay a death benefit to the beneficiaries. The death benefit is usually tax-free and can be a lump-sum payment or installments.

Term life insurance policies have no cash value and do not accumulate cash value over time. The premiums remain level throughout the term, making it a cost-effective option. Additionally, term life insurance policies offer flexibility in choosing the term length and the death benefit amount. The application process involves a medical exam and assessment of the applicant's health, occupation, lifestyle, and hobbies to determine the risk and set the premium.

The payout process for term life insurance is straightforward. When the insured individual passes away, the beneficiaries file a death claim with the insurance company, providing a certified copy of the death certificate and any other required documentation. The insurance company then reviews the claim and processes the payout, which is typically completed within 30 to 60 days. The default payout option is usually a lump-sum payment, but beneficiaries can also choose installment payments or annuities, depending on their financial needs and preferences.

Term life insurance provides financial security for loved ones, ensuring they receive the death benefit to cover immediate and future expenses. It is important to note that term life insurance policies do not offer any payout if the insured individual survives the policy term. However, some policies may offer a return of premium option, where a portion or all of the premiums are refunded if the insured outlives the policy term.

Whole life insurance payouts

Whole life insurance is a permanent policy designed to last a lifetime and build cash value over time. These policies provide a guaranteed death benefit and a cash value account that accumulates interest. While the premiums are considerably higher than term life insurance, the benefits include lifelong coverage. If premiums are unpaid, the policy risks cancellation.

When the insured dies, the policy pays the death benefit to the named beneficiaries. If a whole life policy has flexible payout options, the beneficiaries have several options for how they can receive the death benefit, whether in a lump sum, installments, or as an annuity.

The cash value component of whole life insurance policies is a savings component that grows tax-deferred and can be borrowed against or withdrawn. If the policyholder borrows from the cash value and doesn't repay it, the amount borrowed plus any interest will be deducted from the death benefit. Withdrawals, on the other hand, permanently reduce the death benefit and cannot be repaid.

Some whole life insurance policies pay dividends to policyholders, which can be used to buy paid-up additions (PUAs). PUAs are small amounts of additional life insurance that have their own death benefit and cash value, increasing the overall value of the policy over time.

Universal life insurance payouts

Universal life insurance is a type of permanent life insurance that offers flexible premiums, death benefits, and coverage for your entire life. It is meant to be flexible because you can choose how much premium you pay. The minimum premium amount covers the death benefit and administrative fees, and anything you pay over that is added to your cash value, which is guaranteed to grow according to a minimum annual interest rate set by the insurance company.

There are two types of death benefits to choose from: level death benefit and increasing death benefit. In most cases, the death benefit amount remains the same through the life of the policy. For example, if you buy $100,000 of coverage and build up $60,000 of cash value, your beneficiaries receive $100,000 when you die. In the case of an increasing death benefit, your cash value balance is added to the death benefit. So, in the previous example, your beneficiaries would get $160,000: the death benefit plus the cash value. This option comes with higher premiums.

The main perk of universal life insurance is the ability to adjust your premiums. You can pay more than the minimum premium, up to a certain limit, and the additional funds—minus any administrative charges—are funnelled into your cash value. Alternatively, you can pay less than the minimum premium. If you do this, make sure you have sufficient cash value to cover the cost of insurance and other expense charges, or your coverage may lapse.

The cash value of a universal life insurance policy grows tax-deferred and can be accessed through loans or withdrawals. The interest rates on these loans are often lower than those available for a personal loan, and they don't require a credit check. However, unpaid loans will reduce the death benefit by the outstanding amount.

When a policyholder dies, the insurance company keeps the account's cash value, and the beneficiaries will be paid just the death benefit. However, some life insurance policies allow you to increase the death benefit as you build the cash value.

Factors influencing payout amounts

Several factors influence the payout amount of a life insurance policy. Here are some key considerations:

Policy Type

The type of policy you have plays a significant role in determining the payout amount. Term life insurance policies, which offer coverage for a specified period, generally provide lower death benefits than permanent life insurance policies such as whole life or universal life. Whole life insurance, for example, accumulates cash value over time, resulting in higher payouts. Universal life insurance also offers flexible premium and death benefit options, allowing for potential growth in the payout amount.

Premiums Paid

The amount paid in premiums directly impacts the payout. Higher premiums typically lead to larger payouts, ensuring greater financial security for the beneficiaries. When choosing a policy, it's important to consider the level of coverage desired and select an option that aligns with your financial goals and ability to pay premiums.

Age and Health of the Insured

The age and health of the insured person are crucial factors. Younger and healthier individuals often qualify for higher coverage amounts and pay lower premiums because they are considered lower-risk. Insurers assess the risk associated with insuring an individual and set the premiums and coverage amounts accordingly.

Policy Add-ons

Adding riders, or optional supplements, to your life insurance policy can increase the overall payout. Riders such as accidental death or critical illness coverage provide additional financial protection by enhancing the policy's benefits. These add-ons come at an extra cost but can be valuable in certain situations, such as covering medical expenses or providing additional support to beneficiaries.

Frequently asked questions