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Life Insurance Payout Options

In essence, life insurance is a contract between a policyholder and an insurer. If the insured passes away while the life insurance coverage is active, the insurer agrees to provide a payout to the policyholder’s beneficiaries.

The payout from a life insurance policy is also known as a death benefit. In 2022, life insurers paid out more than $88.7 billion in death benefits. People who claim a death benefit can choose to receive their payouts in a variety of ways, including:

  • Lump sum life insurance payouts
  • Installment life insurance payouts
  • Annuity life insurance payouts
  • Interest-bearing account life insurance payouts

There are advantages and disadvantages to choosing each of these payouts. Keep reading for details about how each common life insurance payout option works and what to consider when making a decision.

What Is a Death Benefit?

Put simply, a death benefit is the amount of the payout you can expect to receive as a beneficiary following the insured’s death. While that is nearly universal among life insurance policies, the method by which it is distributed varies. Here’s a little bit more information on your choices.

Lump Sum Life Insurance Payouts

A lump sum life insurance payout means the insurer pays the entire death benefit at once. For example, if you’re the sole beneficiary of a $1 million policy, you receive the entire $1 million payout in a single check or electronic funds transfer.

Beneficiaries who receive a lump sum payout may worry about the tax implications. Fortunately, death benefits usually do not count toward a beneficiary’s gross income. That means beneficiaries do not need to pay income tax on the amount.

Pros and Cons of Lump Sum Payouts

  • Money is not subject to income tax
  • Beneficiaries have full control over the money
  • Ability to pay for large expenses upfront
  • Large amount can feel overwhelming
  • Large amount can lead to irresponsible spending

Lump sum payouts are the default life insurance payout option due to the many advantages they offer, but there are some potential drawbacks.

A major benefit is that when a lump sum is paid to a named beneficiary, the money is not subject to income tax. Beneficiaries also enjoy full control over the money, with the flexibility to pay for large expenses upfront. For example, a lump sum payment is useful for paying funeral and other end-of-life expenses or paying off outstanding debts. 

However, there are also some disadvantages. Some people who receive a large amount of money all at once may feel tempted to spend impulsively. Others feel overwhelmed with the responsibility of managing and preserving the funds. If either of these describes you, a more measured payout option may be a better choice.

Portioned Life Insurance Payouts 

Some life insurers give beneficiaries the option to receive portions of the death benefit over time rather than in one lump sum. Check the table below for an overview of each life insurance settlement option.

Payout Type
Payout Frequency
Payout Growth
Paid out in regular intervals over a set period of time.
Variable based on the variety of annuity.
Interest-bearing Account
Beneficiary’s choice

Installment Life Insurance Payouts

With installment life insurance payouts, the insurer pays the death benefit in a series of monthly payments. For example, if the death benefit was $750,000, the beneficiary might request $3,125 per month for 20 years, as opposed to getting the entire $750,000 in one payment. Keep in mind that an added benefit of installment payments is that the total value of the payouts appreciates over time.

Installment payments appeal to some people because they provide a steady source of funds. Regular payments can make budgeting easier than getting a large lump sum all at once. It may be possible to adjust the installment amount later.

Despite their advantages, installment payments have some drawbacks compared to lump sum payments. They’re less flexible since beneficiaries do not immediately get access to the entire amount. Taxes are another consideration, as any interest earned on the installment payments counts toward your gross income.

Annuity Life Insurance Payouts

Some insurance companies give beneficiaries the option to convert their life insurance payout to an annuity. An annuity is an investment product that earns interest and provides fixed payments at regular intervals. It allows the death benefit to be paid out over time.

The appeal of annuities is that they provide a steady income stream for a predetermined number of years or the rest of your life. Regular payments make for predictable budgeting without the need to manage a large sum of money on your own.

However, there are some disadvantages to choosing annuity payouts. As with installment payments, it can take years to receive the full death benefit, and any interest earned is taxable. Plus, since annuities are longer-term investments, fees or penalties may apply if you need to withdraw additional money.

Interest-Bearing Account Life Insurance Payouts

With this life insurance settlement option, the insurer deposits the benefit funds in a retained asset account that earns interest and works similarly to a checking account, except with the funds are held by the insurer.

A key advantage of a retained asset account is it gives you a secure place to store the death benefit while you think about your long-term financial goals. You have the flexibility to take out portions of the money as needed or even withdraw the entire amount.

While interest-bearing accounts have advantages, it’s important to consider the potential drawbacks. The interest rate is set by the insurer and may be lower than other payout options. A lower interest rate means the funds grow at a slower rate over time.

Choosing a Payout Type 

Life insurance payout options vary depending on the insurance company. For example, some companies only offer lump sum payouts. Others might give beneficiaries the choice between a lump sum payout and one or more alternative options.

If the insurer offers various life insurance payout options, carefully consider your needs before choosing how to receive the payout. For example, a lump sum could make sense if you want to pay off large expenses and feel comfortable handling the money. A portioned option could be better if you need ongoing funds for monthly expenses. 

In some cases, it’s possible to switch to another payout type later if your needs change. For example, an insurer may allow a person receiving installment payments to withdraw the entire remaining balance as a lump sum. Ask the insurer for details before choosing a payout option.

How to File a Life Insurance Claim

A beneficiary in a life insurance policy can start the claims process immediately after the policyholder passes away. Here’s how the process works, step-by-step.

  1. Notify the insurance company: Contact the insurer for details about the claims process. If you’re not sure which insurer held the policy, check your loved one’s papers and files to find the policy documents, or ask their insurance agent or financial advisor. 
  2. Gather supporting documentation: Typically, beneficiaries need a certified copy of the death certificate to claim a life insurance payout. Life insurance companies sometimes request additional documentation, such as police or autopsy reports.
  3. Fill out the claims paperwork: Complete the insurer’s required forms. Be prepared to provide information like the policy number, cause of death, and your Social Security number.
  4. Choose a payout option: Decide how you want to receive the life insurance payout. If you do not make a selection, insurers typically default to a lump sum check.
  5. Submit the claim: Provide the completed claims forms and supporting documentation to the insurer, then wait for a decision.

Common Reasons for Claims Denial 

It’s rare for insurers to deny life insurance claims. When a claim is denied, it’s typically because of one of the following reasons:

  • Non-payment of premiums: Policies lapse when premiums are not paid as agreed. However, there is typically a grace period for overdue payments, and deaths during the grace period may be covered.
  • Material misrepresentations: Insurers who discover a policyholder lied about or omitted a significant health issue during the application process may decline to pay claims.
  • Policy exclusions: Policies often do not cover certain causes of death, such as suicide within two years of the issue date or deaths due to war or military service.

Factors That Can Impact a Life Insurance Payout Amount 

In certain situations, a beneficiary might receive a payout that’s less than the policy’s original coverage amount. This could happen if:

  • The policyholder used living benefits: Some policies give policyholders the option to access part of their death benefit if they’re diagnosed with a critical, chronic, or terminal illness. Any money advanced during their lifetime comes out of the death benefit.
  • The policyholder accessed the cash value: Some permanent life insurance policies accumulate a cash value. Policyholders have the option to withdraw or borrow money from the cash value or use it to pay premiums. Accessing the cash value reduces the death benefit available to beneficiaries. 
  • The policy had an adjustable death benefit: Some policies give policyholders the flexibility to raise or lower their death benefit amount. If they decrease the death benefit, beneficiaries may receive a lower amount than they were expecting.

What This Means for You 

Life insurance beneficiaries typically have options when it comes to receiving their payout. Common options include getting a lump sum payout, choosing installment payments, or converting the payout to an annuity, depending on the policy terms.

The right payout option varies depending on your financial needs and spending habits. If you’ve been named as a beneficiary, consider talking to a trusted financial advisor before choosing how to accept the payout.

Frequently Asked Questions

Generally, life insurance payouts do not count toward the beneficiary’s gross income. Beneficiaries receive the full death benefit without needing to pay income tax on the funds. However, any interest the beneficiary earns on the death benefit is taxable. Before choosing a life insurance settlement option, it’s a good idea to discuss the tax implications with a tax professional.

Yes, so long as the insurer offers multiple payout options and allows beneficiaries to make another selection later. Some insurance companies only offer a lump sum payout option, while others offer more than one type of payout. 

Changing your mind may be more difficult after converting the life insurance payout to an annuity. Surrender charges may apply if you want to withdraw the remaining balance as a lump sum.

Depending on the policy and insurer, it typically takes anywhere from a few days to a few weeks to get the death benefit payout. In some circumstances, it takes longer for the insurer to investigate the claim. 

Once you receive the payout, the funds might not be available to spend right away. Some banks take a couple days to validate large payouts before making the money available in your account.

Plan for your family’s future. Get a life insurance quote today.

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Plan for your family’s future. Get a life insurance quote today.

Get a quote