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How do life insurance payouts work?

As a beneficiary, you’re legally entitled to some or all of the death benefit once the insurer approves the claim.

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Since life insurance policies are paid out upon a policyholder’s death, they can be an awkward subject to navigate. But as the beneficiary, it’s important to know where you stand so you receive the funds that were left to you by your loved one.

How is life insurance paid out to beneficiaries?

As the beneficiary, you can choose how you want to receive the death benefit. Depending on the insurer’s flexibility, you may be given the following options:

  • Lump sum payment. This is the simplest payout option and the default on most policies. You get a one-time payment from the insurance company.
  • Installments and annuities. You can choose to receive the money in installments — usually over the course of five to 40 years. For example, you might ask to get 25% of the death benefit every year for four years, or 10% every year for 10 years. This is also known as a systematic withdrawal, and the beneficiary usually earns interest on the unpaid amount while the insurance provider holds it. Many people choose this for the guaranteed income stream.
  • Retained asset account. The insurance company keeps the funds in an account and allows you to write checks against the balance. The account accrues interest, but you won’t be able to make deposits into it.
  • Interest-only account. The insurance company holds the death benefit and pays the beneficiary the interest generated from that amount.

The best payment option for you comes down to your situation. If you have debts and expenses that need to be covered, a lump-sum payment might make the most sense. But if you’re financially comfortable and don’t want to make any decisions about how you’ll use the money, you might want to elect for installments or annuities.

Can life insurance be paid out to multiple beneficiaries?

Yes. Policyholders can name more than one person to receive the proceeds of their life insurance policy. They can also allocate how much money will go to each. For example, many parents will divide the policy equally among their children.

There are three types of beneficiaries:

  • Primary beneficiaries are the first to receive a payout.
  • Secondary or contingent beneficiaries receive the payout if something happens to the primary beneficiary or beneficiaries.
  • Final beneficiaries get the death benefit if something happens to both the primary and secondary beneficiaries.

Not all policyholders name primary, secondary and final beneficiaries. Some will simply name a sole beneficiary and that person will receive the entire death benefit.

If you’re a policyholder, it’s a good idea to talk over the beneficiary designation with your loved ones to prevent any surprises after your death.

What happens if a beneficiary dies before the policyholder?

Your contingent beneficiary is next in line to receive your death benefit, otherwise the policy will be paid to the owner’s estate. Policyholders can update their beneficiaries at any time by filling out a form and submitting it to their life insurance company.

You can divide the death benefit ‘per capita,’ i.e. per person. So if one primary beneficiary dies, the proceeds are divided equally among all the survivors of that beneficiary and your other primary beneficiaries. Or, you can choose to divide it ‘per stirpes’ — i.e. by branch of the family — instead. This means that if you outlive one of your primary beneficiaries, their portion of the money will go to their children or grandchildren, and the rest to the other listed primary beneficiaries.

Do beneficiaries pay taxes on life insurance policies?

Usually, no — life insurance proceeds are not considered taxable income. This means your beneficiaries will receive the full payout.

However, if your beneficiaries choose to receive the death benefit in installments, they may have to pay income tax on any interest earned on that account.

Let’s say your $100,000 policy earns $10,000 in interest between the time of your death and the payout to your beneficiaries. They’ll most likely owe taxes on that $10,000.

I think I’m owed a payout. What are my next steps?

If you believe you’re owed a payout, you’ll need to take action since the insurance company won’t do it on your behalf. Your steps to follow:

  1. Get a certified copy of the policyholder’s death certificate. The funeral home or your state or county’s records department will be able to help you with that.
  2. Collect any other supporting documentation. For example, if the policyholder died in an accident or as a result of a medical condition, gather proof.
  3. Request and fill out the claim form. The provider will guide you through the process. Each beneficiary who’s claiming part of the death benefit will need to complete and sign a claim form.
  4. File the claim. Submit the claim form and any other information the insurer requests.
  5. Wait for the claim to be reviewed. The insurer will assess the policy and circumstances surrounding the policyholder’s death. They’ll then approve or deny your claim. If the claim is approved, the insurance company will issue the payout within a specific timeframe.
  6. Choose a payment option. Let the insurance company know which payout option you prefer.

How can I find an unclaimed life insurance policy?

There’s over a billion dollars in unclaimed life insurance floating around the US. If you think you might be owed money, start by searching any records the individual may have kept. If you come up empty, check with your state insurance department or use the NAIC’s life insurance policy locator service.

How long does the payout process take?

This depends on your state’s laws. Typically, insurers have to pay out beneficiaries 30 to 60 days after the claim is filed. If it takes longer, it’ll have to pay accrued interest on the proceeds.

Can you contest a denied life insurance claim?

Yes. Insurers base their claims decisions on solid evidence, so you’ll need to prove them wrong. To contest a claim, collect any evidence in your favor and present it to the life insurance company. If the claim is still denied, you can pursue legal action.

When might the life insurance payout be delayed?

Delays may occur if the policyholder:

  • Died within the first two years of taking out the policy. Insurers can delay payment for up to two years while they investigate if fraud was committed. This is known as the two-year contestability period, and it also applies to suicide.
  • Died in suspicious circumstances. Like homicide — the insurance company might need to rule out the beneficiary as a suspect.
  • Died while doing an illegal activity, like driving under the influence.
  • Lied on the application. If the insurer discovers that the policyholder omitted health conditions or details about their lifestyle, they may deny or delay the claim.

Bottom line

In most cases, collecting a life insurance policy is straightforward. As a beneficiary, you’ll need to contact the insurance company to file a claim. If everything checks out, you should receive a payout in 30 to 60 days. But if the insurer needs to conduct an investigation, you may not get paid for months or years — or at all.

If you want to take out a policy yourself, be sure to compare life insurance companies.

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