How Do Life Insurance Payouts Work?

Life insurance provides funds to help you and your loved ones stay afloat after someone dies. But claiming a death benefit can be tricky, especially during a time of stress. Knowing your options and what to expect can make things go more smoothly.

How Does Life Insurance Work?

A life insurance policy pays out a death benefit when an insured person dies. To secure coverage for yourself (or someone else), you purchase a policy and pay premiums to an insurance company. When setting up a policy, the policy owner names one or more beneficiaries who receive the death benefit. That money is often free from federal income taxes.

Life insurance comes in several forms. There are two main types: term insurance and permanent insurance. Term insurance has lower monthly premiums. It offers coverage for a certain number of years, such as 30. Term policies are a good choice for families who are protecting against the untimely death of a parent. Permanent policies are meant to last a lifetime. They include a cash value that may build over time. The policy owner can tap into that value during their lifetime.

With any type of policy, if the insured dies while the policy is active, the beneficiaries named are entitled to the death benefit.

Your Beneficiary Status

Life insurance policies pay a death benefit to beneficiaries. It’s vital to know who the beneficiaries are. They often include spouses or partners, parents, business partners, charities, and family trusts. If no beneficiary is named on a policy, or if none can be found, the funds often go to the estate.

The death benefit goes to primary beneficiaries first. There may be more than one. The policy owner states what percentage goes to each one. (The percentages don’t need to be equal.) If a primary beneficiary dies or cannot be found before the policy pays out, the death benefit may go to contingent beneficiaries.

A policy with multiple beneficiaries can get confusing. For instance, when a parent names two children as beneficiaries, and one of them dies before the parent, the details of the policy dictate what happens next. (Alternatively, state law does if the policy doesn’t say.) Beneficiaries can be designated as “per stirpes” or “per capita” or nothing at all. The surviving sibling gets everything  (per capita). Or, that sibling splits the proceeds with any descendants of the deceased sibling (per stirpes). Your state may assume one or the other designation if not stated.

Also, note that minor children cannot receive a life insurance payout directly. The state, in that case, may appoint a legal guardian. The person may or may not use the funds for your child’s best interests.

Payout Options

Beneficiaries can often choose how they receive the death benefit. While a lump-sum payout is a popular option, you might not need or want all of the money right away. Insurers often offer several choices:

• Lifetime income: You can receive payments that last for the rest of your life. The amount you receive depends on your age and the size of the death benefit.
• Fixed amount: You can choose to receive a set amount each month or year. Once the funds are depleted, payments stop.
• Interest income: You leave the death benefit intact with the insurer to earn interest. The insurer only pays out interest earnings.
• Life with period certain: You receive income for life. But you can also select a minimum number of years (15, for instance) for payments to continue. Your beneficiaries get any remaining payments if you die before that period ends.
• Lump sum: The insurer pays out the entire death benefit at once. With that approach, you can pay off debts. You can also choose savings or invest the money with a different firm.

Filing a Claim

Life insurance policies don’t automatically pay out after an insured person dies. You need to inform the insurer to make a claim. Begin by contacting the company. Ask how to collect the death benefit. In most cases, you need to submit a request for benefits (often a form) and a death certificate.

The request tells the insurer how to provide your payout. If there are multiple beneficiaries, each one may need to provide a request form. To ensure that the process goes smoothly, review your request form before sending it. Make sure you’ve taken care of all the details. If you have any confusion about what’s required, contact the life insurer and ask. Rejected forms can cause delays.

How Quickly Are Benefits Paid?

The insurer should complete the process of reviewing documents and paying claims within one month, in most cases. But, things can move faster. To speed up the process, triple-check your request. Any missing items will cause delays.

In some cases, the insurer needs to investigate the claim. This can result in a longer processing time. For instance, if the insured dies within the first two years of the policy, the insurer may examine the original application and the details of the insured person’s death. Suicide, homicide, and death during illegal activity can also lead to increased scrutiny. This may mean a denial of benefits or slower payouts.

Are Life Insurance Benefits Taxable?

The death benefit from a life insurance policy is often tax-free. When a family member dies and you get a lump-sum payout, it’s unlikely that you’ll owe taxes.

However, there are exceptions. Also, if you do not receive the death benefit as a lump sum, you will likely earn interest on any money that stays with the insurer. Those interest earnings are often taxed.

Unclaimed Life Insurance Benefits

Sometimes beneficiaries don’t claim the money they’re owed. Insurers try to contact them, but don't always succeed. For instance, it can be hard to find someone who moves or changes their name. Sometimes, the insurer doesn’t even know about the insured person’s death.

You may be able to find lost life insurance payouts through a few sources. Review the deceased’s records for any clues. You can also check your state’s unclaimed property division. Finally, the NAIC Life Insurance Policy Locator may be able to help. But, you might not get an answer if it’s unclear how you’re connected to the policy.

Frequently Asked Questions (FAQs)