Understanding Life Insurance Payouts [2020 Guide]
Life insurance forms the financial backbone for many consumers and their families. Replacing the income that is lost if the primary (or even secondary) breadwinner dies prematurely can be vitally important, especially for young families that depend heavily on the breadwinner’s income for survival.
Beneficiaries of life insurance policies today have more choices about how they receive the life insurance death benefit payout than they did in the past. Life insurance has traditionally been paid out in a single lump-sum soon after the death of the insured. But now many policies can pay out over a period of time, such as annually for 5 years, or even as an annuity calculated to last for the rest of the beneficiary’s life. However, the single lump-sum payout is still the most popular choice for beneficiaries today because of the lack of tax consequences to the payout. All life insurance death benefit proceeds are unconditionally exempt from taxation at any level (except for rare exceptions where corporately-owned life insurance is used).
Life insurance payouts can be delayed if the life insurance carrier requests additional information from the beneficiary besides the death certificate. In most cases, life insurance carriers will pay out the policy proceeds within 30 to 60 days of receiving the death certificate. However, payouts can be delayed if the beneficiary fails to get the request for additional information, or else if the insurance carrier has reason to believe that there is fraud involved with the policy or the beneficiary is suspected of murdering the insured. But beyond that, most life insurance carriers will pay their death claims within a maximum of 60 days. Those that fail to do so can face substantial interest charges under state law.
Many life insurance policies also have a contestability clause, where the life insurance carrier reserves the right to carefully investigate the nature of the insured’s death if the insured dies within two years of purchasing the policy. This clause is generally used to determine whether there was any fraud involved or if the insured had any preexisting underlying health conditions that were not disclosed on the policy application or medical report.
If the insurance carrier determines that the applicant did lie on the application, then it may refuse to pay out the death benefit to the beneficiary. And they can do this even if the cause of the insured’s death had no relation to the condition about which he or she lied about on the application. For example, if the applicant had cancer when he took out the policy but failed to mention this on his application, and then dies within the next two years of a heart attack, then the carrier may refuse payment if they discover that he lied. For this reason, it is always smart for applicants to be completely honest and truthful when they file their applications, so that their beneficiaries aren’t subject to subsequent legal ramifications.
What you will learn:
Here is a breakdown of the steps involved in a life insurance payout:
- The insured dies. If the insured purchased a cash-value life insurance policy, then the policy death benefit will pay out to the beneficiary. If a term policy is used, then the death benefit will also be paid out to the beneficiary, usually within 30 to 60 days, unless the carrier requires more information or has reason to suspect fraud or foul play.
- The beneficiary or beneficiaries must furnish a certified copy of the insured’s death certificate to the life insurance carrier in the state where the insured lived, and then file a death claim. The majority of life insurance carriers today allow beneficiaries to do this online. In most cases, the carrier has up to 30 days to process the claim and up to 30 more days to issue the proceeds of the policy. The majority of life insurance carriers will also usually require the beneficiaries to file a benefits claim, as a life insurance policy can be quite complex in nature, and this form helps them evaluate the amount of death benefit to be paid. For example, if the insured buys a policy that will pay double the face amount if he or she dies in an accident, then the benefits claim form would provide that information so that the carrier can pay the correct amount. This form would also outline the nature of the accident and disclose whether the accident was partially or totally their fault. If no fault can be determined, then the policy will pay out twice the death benefit under the accidental death rider. The amount of death benefit that is paid will depend upon the information contained in the benefits claim and can be adjusted either upwards or downwards depending up the provisions set forth in the policy. If the insured died while involved in an illegal activity, then the carrier may deny the claim despite the fact that all other provisions were satisfied. Beneficiaries should always have the original copy of the insured’s death certificate plus a few certified copies on hand along with the original policy application and benefits claim form when they notify the insurer of the insured’s death. Policies that are contained inside revocable or irrevocable trusts will also require the beneficiary to furnish a copy of the trust for the carrier if one is not on file with them already.
- If the insured buys an accidental death rider that doubles the death benefit if the insured dies in an accident and then dies a few months later, the contestability clause may allow the insurance carrier to wait until two years from the time the policy was taken out to pay the death benefit. Many policies also have a suicide clause that allows them to deny payout if the insured kills him or herself within the first two years of the policy.
- Once the death claim has been processed, the death benefit must be paid out. This can happen as quickly as a couple of weeks after the claim is processed up to about 45 days. The beneficiary or beneficiaries on the policy will determine who gets the death benefit. Once the insured dies, no new beneficiaries may be named.
- Payout options – As mentioned previously, there are several payout options that beneficiaries can choose from. These include:
- Lump sum
- Installment payments
- Straight Life
- Life with period certain
- Joint life with survivorship
- Interest only
As mentioned previously, life insurance death benefit proceeds are almost always tax-free for beneficiaries. However, if the beneficiary elects to receive the death benefit over period of five years, then the death benefit will pay interest on the unpaid amounts until the entire death benefit is exhausted. And this interest is fully taxable as ordinary income to the beneficiary. Also, if the death benefit is large enough, the insured’s estate may be required to pay estate tax on the death benefit. Beneficiaries should consult an estate planning expert if this is the case.
Filing the Claim
Upon the death of the injured, the beneficiary initiates the payout process by filing a claim and submitting a copy of the death certificate to the insurance company. Most states allow the insurer thirty days to review the claim, and after that time they can issue the payout, deny the claim or request more information. There is one type of insurance policy that can actually pay out before the insured’s death; in the case of an accelerated death benefit, policyholders are allowed to draw against the value of a policy in the event of a chronic, critical or terminal illness.
Factors that Affect Payouts
The chief situation that can slow down a payout is when the insures dies within two years of the policy. Most insurance policies include a “contestability and suicide period” of two years that goes into effect when the policy becomes active . If the insured dies within that period the insurer will usually slow down the process to fully investigate the information on the application. If everything is determined to be accurate, the insurer does have to pay. If the cause of death is suicide within the contestability period, the insurer can refuse to pay the beneficiary.
Who Gets the Payout?
Traditionally life insurance payouts have been distributed in a lump sum, but today a beneficiary has a range of options for receiving the money from a policy. Payouts can also come through installment payments, annuities that are guaranteed to last for the rest of the survivor’s life, interest-only payments or plans with provisions for contingent beneficiaries or payouts based on two different survivors.
Life Insurance Payout Taxation
Life insurance payments are not subject to income tax, and this tax-free status is in effect no matter how the payout is administered. The only exception is in the case of an insurance policy taken out on an employee within a business; this type of policy might be partially subject to income taxes. Even if the proceeds from insurance payouts are not taxed, however, any interest generated on the payout is taxed as ordinary income.
When a payout isn’t the best outcome
As beneficial as a life insurance payout can be for survivors in many circumstances, there are other cases where an insurance policy becomes more of a burden than a help while the injured is alive. If the circumstances surrounding the beneficiary have changed, or the premium payments have become so burdensome that the cost outweighs the future payoff, it could be that a life settlement is a course of action to explore. By selling a policy in a life settlement, the completion of the sale, while the buyer assumes the premium payments and receives the benefit upon the insured’s death.
Life settlements offer an alternative to letting a policy lapse or waiting for a payout, and professionals at Magna Life Settlements stand ready to help you or your loved ones understand the process and eligibility for settlements. Use our simple calculator today to determine if a settlement today might be a better outcome for you than a payout in the future.
 Contestability and suicide periods are regulated by state insurance las and vary depending on where you live. Make sure to read your policy carefully to determine the actual length of the contestability and suicide period.
 This material has been prepared for informational purposes only, and is not intended to provide, and should not be relief on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transactions.