What is a Death Benefit?
The death benefit in life insurance represents the amount a policy pays to the beneficiary when the policyholder dies. This beneficiary is a person or entity chosen by the policyholder. Death benefits are the primary reason for purchasing a life insurance policy, as people want to ensure their loved ones are financially cared for in the event of their death. Death benefits are also known as life insurance payouts, survivor benefits, and end-of-life settlement.
Generally, policyholders can name any person or persons of their choice as the beneficiary or beneficiaries. The death benefit, or predetermined cash value of the policy, is typically tax-free. Beneficiaries may choose to receive the death benefit payout all at once or through multiple payments.
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The Importance of the Death Benefit
Beneficiaries are not only able to use the death benefit for living expenses after the policyholder passes away, but these funds can also cover expensive funeral and burial or cremation services, or to pay off debts or make major purchases such as a new home.
As an example of how big of a difference having life insurance can make in the lives of your loved ones, 68% of life-insurance-owning households noted that they would feel financially secure if the primary wage earner suddenly passed away, versus 47% of households where residents do not own life insurance.
How Does a Life Insurance Payout Work?
Who gets the payout?
Beneficiaries selected by policyholder
When is it paid?
After policyholder’s death
How much is the death benefit?
Amount set by policyholder
What can it be used for?
Typically no restrictions on usage
Policyholders must designate a beneficiary when they enroll in a life insurance policy. Then, upon the death of the policyholder, the life insurance payout amount goes to the named beneficiary. However, in the event the primary beneficiary does not claim it, a contingent beneficiary may claim the payout.
Beneficiaries can only receive the survivor benefit if the policyholder dies while the plan is still active. Most insurers do not impose restrictions on how beneficiaries may use the funds.
It’s important to note that policies with no named beneficiary are subject to taxes and creditors, and funds must go through probate court.
Life Insurance Payouts By Life Insurance Policy Type
While death benefits are included in every type of life insurance policy, policies differ slightly in their valuation and payout processes. Policyholders should consider whether a term or whole life insurance plan fits their budget and goals, as well as their beneficiary’s individual needs when considering an amount to assign to the payout.
Term Life Insurance Policies
Term life insurance policies offer payouts if the policyholder dies within a set period, typically 10-30 years. Term life policies are popular for their affordable monthly premium rates but only pay out if the policyholder dies while the policy is still active. If you outlive your term life insurance policy, it simply expires with no payout.
Term-based life insurance policies may include decreasing term options, with payouts contingent on a specific debt, like a mortgage, being paid off, and decreasing over time as the beneficiary matures and requires less of a payout. However, policyholders looking for a more comprehensive plan may choose an alternative option such as a whole life insurance policy, which can last for a lifetime.
Whole Life Insurance Policies
A whole life insurance policy does not limit coverage to a set term. As long as premiums continue to be paid, the policy lasts for the life of the policyholder and guarantees a payout. Additionally, some whole life insurance policies may include living benefits such as a cash value aspect that can grow tax-free indefinitely. If needed, policyholders can access that cash benefit while still living.
Many policyholders prefer whole life insurance for its added protections and are willing to pay higher premiums for such an investment. Unlike term life insurance policies, whole life insurance premiums never change and coverage will not expire after a set period.
Who Gets the Death Benefit: Your Beneficiaries
Policyholders must choose a beneficiary to receive the survivor benefit. Unlike an heir in a will, life insurance policies do not include a default beneficiary or “next of kin” clause. The following are options for naming one or multiple life insurance beneficiaries:
- Person or People: Many policyholders name their spouse and/or children as beneficiaries. However, policyholders can name any person or people they choose, including non-relatives.
- Charity: Policyholders can name a charity as their beneficiary or make a permanent donation to the charity while they are still alive by gifting their life insurance policy to that organization.
- Trusts: A policyholder may choose to transfer ownership of their policy to a trust. When they die, the trust receives the life insurance payout and a designated trustee distributes the funds according to the life insurance contract.
- Businesses: People may name a business or corporation as their beneficiary to pay off a debt to that company or posthumously grow their business for the benefit of their family.
Naming primary and contingent beneficiaries is key. As an example, if your primary beneficiary cannot claim the survivor benefit because they precede you in death or cannot be located, your life insurance payout goes to your contingent beneficiary.
When and How Is the Death Benefit Paid?
Death benefits are paid 30-60 days after the policyholder’s death, pending claim verification. Policies most commonly pay through one of the following methods:
- Lump sum: A lump sum payment provides the beneficiaries with the full amount of the payout all at once. While the rewards seem obvious, beneficiaries with unreliable spending habits may seek the advice of a financial manager to receive benefits this way.
- Annuity: Annuities provide a steady stream of income based on the purchase price of the annuity plan. The regular income stream continues for the entirety of a set term but is contingent on future annuity payments.
- Installments: Beneficiaries may receive their payout in monthly installments. An insurer may retain the payout in an interest-building account and distribute payments as requested by the beneficiary. You can ask for more or less each month.
- Retained Asset Accounts: Retained asset accounts (RAAs) function as checking accounts, opened and funded with payouts from life insurance policies. These accounts include fixed interest rates guaranteed by the insurer.
- Graded Death Benefit: A graded death benefit pays less than the full value of the policy if the policyholder dies of natural causes within the first few years of purchase. Policies typically only reach face value after 2-3 years of active status.
Survivor benefits in life insurance offer a variety of payment options and payout amounts. You should budget for the best policy you can afford based on your financial goals and lifestyle.
Most end-of-life settlements are tax-free, meaning these funds are not considered part of your gross income and therefore not taxable by the IRS. Some discrepancies exist, however, depending on how a beneficiary chooses to receive their funds. For example, a lump sum is tax-free but an annuity is considered income and subject to your regular income tax rate.
Calculate the Death Benefit Amount: Your Policy Value and Coverages
Calculating how much life insurance you need is a personal decision. However, systems like the DIME (debt, income, mortgage, education) method or 10X income replacement can help. You should consider the following when determining your death benefit:
- Income replacement: Consider how far your life insurance payouts can go in replacing the full regular monthly income of your named beneficiaries. The 10X income replacement rule (multiply your annual salary by 10) can provide a starting point.
- Outstanding debts: Creditors and collection agencies can come after the money you owe if they do not receive payback immediately from the life insurance payout.
- Burial costs: You can help relieve the financial stress of costly burial, cremation, and funeral expenses.
- Financial needs of your beneficiaries: Your beneficiaries may require more or less coverage, depending on factors like their age, employment, and health status. The DIME method can also help assess their future financial needs around major expenditures.
- Liquid assets: You may require a higher level of liquidity for your survivor benefits, including for a loan or to use as collateral.
Policyholders can multiply their end-of-life settlement by adding certain features. Add-ons like riders cost more but also maximize the value of your policy if you die sooner than expected or by accident.
Add Death Benefit Riders
You may choose to incorporate a death benefit rider, or add-on benefit, to your base policy for an additional cost. The following are the most common types of riders:
- Accidental Death Benefit (ADB): ADB riders can add to the cash value of a policy in the event that the policyholder dies as the result of a qualifying accident, such as a car crash, drowning, or choking incident. The face value of the ADB equals the additional amount added to the death benefit, provided the accident meets contract requirements.
- Accidental Death and Dismemberment (AD&D): AD&D riders provide additional benefits when a policyholder dies or suffers a catastrophic injury, such as the loss of a limb, paralysis, or blindness. AD&D riders can as much as double the value of your death benefit. Some events may qualify policyholders to receive AD&D benefits while still alive.
- Accelerated Death Benefit: Accelerated death benefits suit policyholders with a qualifying terminal illness or condition and a life expectancy of 1-2 years. Adding an accelerated death benefit rider decreases your payout amount but allows you to put money toward medical expenses.
How to Claim the Survivor Benefit of a Life Insurance Policy
There are many aspects involved in becoming a life insurance beneficiary. The following steps can help you understand your rights and responsibilities during this process.
Determine If You’re a Beneficiary
You should seek confirmation if someone you know expresses their intention to add you as a beneficiary on their life insurance policy. Policyholders may not clearly notify beneficiaries or keep them updated if they are added or removed from a policy.
Insurers do not always automatically notify beneficiaries when the policyholder dies. You can inquire with the insurer to find out if you are a beneficiary when someone you know passes away. You should check even if you are fairly sure, since policyholders can change their beneficiaries at any time before death.
How to Claim a Survivor Benefit
The process of claiming a survivor benefit begins with the gathering of critical policy information and requires some important decision-making around how you prefer to receive your payout. Beneficiaries should follow these steps to successfully claim their life insurance survivor benefits.
1. Collect important Information and documents
There are several key pieces of information and important documents you need to claim a survivor benefit, including:
- Death certificate: You must obtain a certified copy of the policyholder’s death certificate from their funeral home, medical examiner, or vital records office for their place of death. This document is universally required by insurers to process a claim for life insurance survivor benefits.
- Policyholder’s life insurance policy documents: You also need copies of the insurance policy for which you are a named beneficiary. If you do not have access to the policy documents you can try other avenues including contacting their financial advisor or employer for a record of their enrollment in the policy, or checking the online National Association of Insurance Commissioners’ Life Insurance Policy Locator Service database.
2. Contact the policyholder’s life insurance company to start the claims process
First and foremost, you must know which insurer holds the policy so you can contact them directly to begin the process, either by phone or through their website. You must complete a claim form which requires information including your full name, social security number, and policy number. The insurance company may require you to mail, email, or submit the completed claim form online.
3. Elect how you would like to receive the payout
Insurers let beneficiaries decide how they want to receive the life insurance payout. Distribution options include a lump sum, annuity, installments, RAA, or graded death benefits. While death benefits in life insurance are typically tax-free, you might still consult with a tax advisor.
Remember to consider a broad array of factors in choosing your payment method. Give the same careful introspection to this phase of the process that the policyholder likely did in selecting you as a beneficiary. If applicable, ask the insurer to help set up an annuity or RAA.
If you are the primary beneficiary, you can expect to receive the full survivor benefit payout amount; however, if there are others, you will only receive your individual share of the funds.
4. Receive the survivor benefit in a lump sum or in whatever method you chose
After completing the above steps you can expect to receive the payouts via your preferred mode of delivery in approximately 30-60 days. Insurers may delay or deny the claim if they suspect fraud, your form contains errors, or the policy lapsed before the policyholder died.
What If Your Claim Is Denied?
Insurance companies may deny a beneficiary’s claim for death benefits. However, in some cases you can appeal the decision and try again. The following are among the most common reasons for a claim to be denied:
- You made an error on your claim form: Insurers will automatically deny a claim if they determine a beneficiary or policyholder intentionally lied. If you simply made a clerical mistake, you may contact the insurer and request to resubmit your claim.
- The life insurance policy had lapsed: A policy does not pay out an end-of-life settlement if it lapses. If the policyholder stopped making payments before they died, the policy becomes inactive and the death benefit no longer applies.
- The cause of death is excluded from coverage: Some causes of death, such as suicide, criminal acts, or high-risk behavior, are excluded from coverage and can trigger a rejected claim.
- You are not eligible to be the beneficiary: You may not be incarcerated or under criminal investigation and claim benefits. Contingent beneficiaries are only eligible for payouts if the primary beneficiary dies or opts out.
Putting It All Together
Death benefits are the primary reason for purchasing a life insurance policy. Insurers offer a variety of life insurance plans and features, each with unique advantages depending on how much the policyholder can afford and their goal life insurance payout amount. Policyholders must choose at least one beneficiary to receive the survivor benefit.
As long as a policyholder meets the terms of their contract, the end-of-life settlement is paid to the beneficiary through a simple claims process. Beneficiaries must present a death certificate and policy documents to claim the death benefit, in their choice of a lump sum, installments, annuity, or retained assets account.