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What is a Life Insurance Payout?

A life insurance payout is what happens when the insured passes away, their beneficiaries file a claim to receive their life insurance policy’s benefit, and the insurance company approves the claim.

Claiming a life insurance payout

Life insurance payouts aren’t automatic. In other words, the life insurance company won’t track down the beneficiaries and cut them a check. Instead, whenever someone with life insurance dies, their beneficiary or beneficiaries need to file a claim with the insurance company.

Usually, this means showing them a copy of the death certificate and, if it’s available, a copy of the life insurance policy. That said, the company should have the policy on file, so the death certificate alone — along with knowledge that you’re one of the policy’s named beneficiaries — should be enough.

Once a claim gets filed, state law dictates how long the company has to review it. In many states, that’s 30 days.

That doesn’t mean you’re one month from a payout, though. The insurance company has 30 days to make a decision on the claim, but the decision they make could be one to pursue further investigation.

When payouts get delayed

Usually, if the insured dies once the policy has been in force for at least a couple of years, the life insurance claim gets approved without hiccups. That’s because most life insurance policies come with a contestability clause that lasts two years.

During those first two years, the life insurance company can dig into any filed claims to check for fraud. After the clause expires, though, the coverage becomes incontestable — and the claim process gets significantly streamlined.

In those first two years, claims can face roadblocks. The insurance company has legal rights to (and probably will) look very closely at the insured’s life and health records to ensure no misrepresentation occurred on their life insurance application. In that case, the claims process can take six months or longer, during which time the beneficiaries need to wait for their payout.

How payouts get distributed

If the life insurance policy only named one beneficiary (e.g., the insured’s spouse) and they’re the one to file the claim, the payout is pretty simple. They get it all.

But the life insurance policy owner may have named more than one beneficiary and specified how the death benefit should get distributed between those parties.

Additionally, if the policy named a primary beneficiary but that person can’t be located, a waiting period may kick off. Once that expires, the death benefit gets paid out to the contingent beneficiary.

Ultimately, if someone is naming you as a beneficiary on their life insurance policy, you may want to ask about the details so you know what to expect when the time comes to file a claim.

Life insurance payout options

Historically, life insurance beneficiaries received their portion of the death benefit as a lump sum of money. Good news: that money isn’t subject to taxation. Bad news: managing a large amount of money, especially when it needs to last you a while, can be challenging. And because bank accounts are only FDIC-insured up to $250,000, you might need to split the money you get across multiple bank accounts.

To better serve the financial needs of beneficiaries, many life insurance companies now offer options beyond a lump-sum payment, like:

Retained asset accounts: Some life insurance companies will offer to keep the death benefit in an interest-earning account for you with an associated checkbook. You can then use that checkbook to pull from the death benefit as you need or want. You’ll get paid the interest the account earns. With a retained asset account, the life insurer will generally back the full amount in the account, even if it exceeds the FDIC’s $250,000 limit.Annuities: These structured payment plans put your death benefit into an interest-earning account, then distribute a specific amount of it to you on a predetermined timeline. Many annuities distribute the money to you, plus the earned interest, for a set number of years. You might get a $500,000 death benefit in $25,000 chunks annually for 20 years, for example.Alternatively, you might choose to establish your annuity to provide lifetime income. In that case, the annuity provider calculates the amount you’ll get paid in each installment based on your age now and the size of the death benefit. You’ll most likely need to specify that any amount leftover when you die should go to a beneficiary or it will automatically go to the annuity provider.

To give you a better idea of how the annuity could work, here’s a sample payout timeline for the first five years with that $500,000 death benefit and 20-year payment plan we mentioned above. This doesn’t include interest because rates vary from institution to institution.

Account Amount (funded by the death benefit)500000475000450000425000400000

One more quick note about annuities: while the death benefit isn’t taxable as it gets distributed to you, any interest you earn on it is. Talk with a tax professional about the tax ramifications of your annuity so you’re not surprised by a big bill in April.

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