What is a Death Benefit?
The death benefit of a life insurance policy is the amount of money the life insurance provider pays out when the insured passes away. When you buy a life insurance policy, you get to choose the death benefit, or how much it will pay when you die, up to a certain extent.
How a death benefit works
A key piece of understanding death benefits comes down to clarifying who receives them. The person, people, or entity that gets your death benefit is known as your beneficiary. You get to choose your beneficiary when you buy your policy (that’s why it is also known as survivor’s benefit).
The beneficiary or beneficiaries listed on your policy become eligible to collect your death benefit when you die. In order to receive the death benefit at that time, your beneficiaries will need to file a claim with the life insurance provider. They will usually need to provide a copy of your death certificate and the life insurance policy as part of the claims process.
Figuring out your death benefit
Generally, people choose death benefits of somewhere between $500,000 and $2 million. That said, if you just want burial insurance, you may opt for a significantly smaller policy. Or as you consider your beneficiaries’ financial needs, you might realize you need a more sizable payout for them.
There are essentially two distinct use cases for death benefits, and each comes with its own considerations.
Death benefits as income replacement
As a general rule of thumb, you should multiply your annual income by 10. Insurance experts agree that the number you arrive at will leave your beneficiaries with a comfortable cushion.
It can be helpful to consider your specific financial situation, though. If ten times your yearly salary is still less than what you owe on your mortgage, for example, you will most likely want to increase your death benefit. You may also want to factor in the cost of the ideal education for any children you have.
Death benefits for other needs
Plenty of people choose a death benefit for reasons other than salary replacement.
If you’re a stay-at-home parent, for example, you might purchase a policy to cover the cost of childcare, food and laundry services, etc. Again, considering the 10-year picture can help here.
Ballpark the cost of what you think your family would need, but make sure you factor in changes through the years. If your kids will go to public school, for example, you can eliminate the childcare budget once they reach school age. But if you want to send them to private school, you may opt for a death benefit that can cover some or all of their tuition.
If you own a business, you may also want to buy a life insurance policy to protect the company you’ve built. In this case, the situation hinges entirely on your business’s current state of affairs — and what they would look like without you. Meeting with any business partners and your bookkeeper or accountant can help you determine the right death benefit to keep your company from strain when you die.
The death benefit cap
You should also know that most life insurance providers consider your annual income when determining your death benefit eligibility. They will generally cap the death benefit at an amount that’s reasonable based on your financial situation.
In other words, you most likely won’t be able to buy a policy with a death benefit that significantly overextends your family’s monetary needs. In short, a death benefit isn’t a way to make your beneficiaries wealthy overnight — although it can help to set them up for financial success moving forward.