Life insurance death benefits: What you need to know
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There are a lot of different kinds of life insurance: A policy can be temporary or last a lifetime. It can have a cash value component – or not. But the one defining feature shared by all life insurance policies is a death benefit. It’s the primary reason to get life insurance, and how policies are almost always described: when someone says they have a $100,000 policy, it really means they have $100,000 worth of death benefit insurance. This article will tell you more about:
What is a death benefit and how does it work?
To start, let’s define death benefit: It’s the money – lump sum or otherwise – that gets paid to your beneficiaries if you die while your life insurance policy is in effect. Whether you’re buying life insurance, or you’re filing a claim on a life insurance policy, there are a few things you need to know about beneficiaries:
A beneficiary needs to be specifically designated in the life insurance policy
There can be more than one beneficiary – and in practice, there often is
A beneficiary doesn’t have to be a person – it can also be an entity such as a charity, family trust, or even a business
An heir is not necessarily the same thing as a life insurance beneficiary
An heir is assumed, but a beneficiary is designated. This means that if a person dies intestate (i.e., without a will), his or her heirs are the people who may be legally entitled to inherit the deceased’s estate – their spouse, children, and so forth1. One or more heirs are usually named as beneficiaries on a life insurance policy, but they don’t have to be. In fact, there are many reasons for naming someone other than your spouse or children as beneficiaries, including:
You want to leave money to care for other family members, such as parents or a sibling
You could leave money to a family-run business to help ensure continuity of operations after you’re gone
You decide to leave money to your grandchildren (instead of your children) as part of your tax strategy
Even though anybody can be named as a beneficiary, you may need permission from your spouse
The most common reason people buy life insurance is to help protect their family’s financial well-being. That’s why married people commonly designate their spouse as the only primary beneficiary, especially when their children are still at home. However, if you live in a state with common property laws, you must name your spouse as the only beneficiary unless you have his or her consent to name someone else. One more thing: underage children can’t ordinarily be named as beneficiaries; if you want to leave money to a minor, you may have to set up a trust to manage the financial payout until they become of age.
Beneficiaries can be changed
When you buy an insurance policy, you can designate each beneficiary as either revocable or irrevocable. When beneficiaries are irrevocable, it can be difficult to remove them from policies or change their share without their consent. For revocable beneficiaries, the change process is relatively easy, and you don’t need permission (unless it’s your spouse and you live in a common property state). For example, with Guardian, a beneficiary change can be done online in a few minutes by going to Guardianlife.com and signing in or registering for an account. Other life insurance companies may require a phone call or ask you to fill out a form and send it back. An annual review with your agent or financial professional can be a great way to ensure your beneficiaries are up to date.
A life insurance death benefit can be divided up any way the policyholder wants
If you’re one of four beneficiaries, that doesn’t automatically mean you’ll get one quarter of the death benefits. The policyholder can allocate different percentages to different beneficiaries.
Beneficiaries can use the money any way they want
There are no stipulations or conditions on benefit payouts. You can take the lump sum and use it for living expenses if you need, but you can also use it for any other purpose, from education to retirement savings – or even going on vacation.
The payout may not be subject to taxes
Generally speaking, life insurance death benefits are exempt from income tax (which is one of the most important life insurance tax benefits). While the benefit is usually income tax-free, you should consult with your tax advisor if you receive a death benefit payment.
Sometimes, part of the benefit can be paid out before death
Many life insurance policies have an Accelerated Death Benefit rider (i.e., optional provision) which allows policyholders with a terminal illness to access part of the death benefit amount while they are still alive – usually to help pay for needed care2. The company may need Proof of Life Expectancy from a medical provider in order to accelerate the death benefit; sums paid out will typically reduce the amount disbursed to beneficiaries after death.
Under certain circumstances a death benefit may be decreased
While every reputable company has a long history of paying out insurance death benefits in full, there are some situations in which a death benefit may be reduced:
If an Accelerated Death Benefit was provided (see above)
If the policyholder willfully misrepresented his or her information during the application process to obtain lower premiums, the company can reduce the benefit amount accordingly – or in some cases cancel coverage altogether
If there were outstanding loans against the cash value (this is typically not applicable to a term life policy with no cash value)3
If the policy had an adjustable death benefit (which can be a feature of universal life insurance policies designed for flexibility), the payout may be lower than the original coverage amount
Beneficiaries can be charities or other 501(c)(3) organizations
As a means of creating a legacy, some policyholders may choose to designate a charity or other organization as their beneficiary. On some products, a policyholder can even elect to use certain options like a charitable benefit rider, which automatically provides a payout to the charity of their choice above and beyond the beneficiary payout.4
How to find out if you’re a beneficiary – and file a claim
When someone buys a policy, they should try to make it as easy as possible for the life insurance company to identify each beneficiary when it comes time to pay out death benefits, which could be years or decades down the road. It really isn’t enough to provide a beneficiary’s name, because people can and do change their names over time. Ideally, the policyholder will have provided the following identifying information for each beneficiary:
Full name, correctly spelled, including any middle names
Any maiden or former names
Date of birth
Social security number
If not a U.S. citizen, their nationality and passport number
Don’t rely on the insurance company to tell you you’re a beneficiary
When a life insurance company learns of an insured’s death, they will use the information they have to try to locate all beneficiaries. But people have similar names and can be hard to track down. Also, the company may not be looking for beneficiaries because they haven't been provided with a death certificate and don’t know the insured has died.
If you have an elderly parent or close relative, you should try to find out if they have named you as a life insurance beneficiary when discussing their final wishes. If you already know about such a policy, you should confirm that it is still in force, and find out where the documents are kept so they can be accessed when the time comes.
What if you can’t find the policy documents?
Paperwork can get misplaced. People grow forgetful, or sometimes pass away before giving relatives the information they should have. If you believe you are named as a life insurance beneficiary, check online with the National Association of Insurance Commissioners' Life Insurance Policy Locator Service, which searches a database of known policies from participating companies. However, not everyone will get an answer: Life insurance companies will respond to the request only if they have reason to believe there is a policy in the name of the deceased, and you are entitled to death benefits as a designated beneficiary or authorized to receive information.
Payouts don’t happen automatically
Beneficiaries typically need to alert the life insurance company to the insured’s death by filing a claim. If you have the policy documents, they will tell you everything you need to know about the coverage and how to file a claim. But even if you do not have all the paperwork, as long as you know you are a beneficiary you should be able to begin the claims process if you have these three things:
The name of the insurance company
The policy number
The insured’s death certificate
While every company’s process varies somewhat, you’ll basically have to fill out a claims form called a “Request for Benefits” and provide a copy of the death certificate. If you are in touch with the insured’s insurance agent, they can help you through the claims process. Otherwise, go to a search engine and enter, “File death benefit claim - [Company Name]” for the contact information you need to start.
Getting a payout – and what to consider
Once the insurance company has your claim, they will verify the information and likely pay out death benefits within 30-60 days of the date the claim was filed. You’ll typically be given a choice of getting your payout in one of 3 different ways:
1. A lump sum payment
This is the most popular option, and the default choice: you get a large amount of cash, to do as you please. You can use the lump sum to pay off the mortgage, use it to live on, invest it, buy a new car, take a vacation, or whatever else you want. You should consider consulting a trusted financial professional to help you if you are considering taking a lump sum. If you are unsure what to do – and afraid that you might spend it too quickly on things you may regret – then consider one of the other options.
2. An annuity
Not sure what an annuity is? An annuity can provide you with a stream of income payments created from monies you use to purchase the annuity. The income payments will start on a date in the future that you select. You should consider your liquidity needs before any money is used to purchase the annuity.5 You may not have access to the premium except through the future stream of fixed income payments created by your purchase payment. The main benefit to this option is that annuity income never stops. The main downside is if you are a relatively young widow or widower, the amount you receive may not be enough to replace the monthly income your spouse would have otherwise provided.
3. Installment payments
You can also choose to have the benefit amount sent to you in a series of payments over time. The insurance company holds the money in an account that pays interest and sends you a monthly check for whatever amount you choose until the principal runs out. This option can give you more control over your payments compared to an annuity: if you decide you need more financial resources each month, you can up the amount – and the principal runs out that much sooner. Conversely, you can stop taking payments for a while and let the principal grow until you need more.
Remember: once you file a claim, you’ll have at least a month – and possibly two – before getting your share of the benefit. If it’s a substantial sum of money, you should think about what you want and need it for. Do you need financial support so you can stay at home while your children are growing up? Do you want to help maintain your lifestyle in retirement? Launch your own business? Use this time to talk about your goals with a financial professional and make a strategy for the best way to use the gift from someone who cares deeply about you.