While we all know the importance of having life insurance to protect our families in the event of our death, the details of being the beneficiary of a life insurance policy are a little less clear.
Here’s what you need to know about collecting life insurance benefits, so nothing comes as a surprise during a stressful time:
Filing a Claim
A recent troubling investigation of insurance practices has shown that insurers will often fail to pay death benefits to beneficiaries, even if they know that the individual who purchased the policy has died.
In any case, while insurers will sometimes make efforts to contact beneficiaries after a death, there’s not necessarily a contractual requirement for them to do so. That means that the onus is on the beneficiaries to file a claim in order to receive their benefits.
Options for Benefits
In most cases, you’ll receive the benefits as a lump sum cash payment. This is obviously a popular option, as it allows beneficiaries to have control over how the money is invested or spent.
However, there are also settlement options, which will dole out the insurance benefit in installments or at a later date. One plus-side to settlement options is that they allow the money to continue to collect interest for the beneficiary.
On the other hand, some settlement options, such as taking payment as a life annuity, cannot be reversed. Before agreeing to such an option, talk with a financial planner. They might advise you to take the lump sum payment, in order to have more leeway with your investments.
When you receive a life insurance benefit as a single lump sum payment, it generally won’t be included as part of your earned income for the year, meaning you won’t owe taxes on the money. However, there are situations in which you may owe some taxes.
For instance, if you take a settlement option that allows the money to grow, you’ll have to pay taxes on the interest payments, but not on the principal.
In addition, if the deceased was the owner of the policy at the time of death, the death benefits are included as part of the estate, meaning they’re potentially subject to estate taxes. This is why it’s a good idea to make the beneficiary of your policy the owner of the policy, as well. That will protect the death benefits from estate taxes. However, assigning a new policy owner must happen three years prior to the death of the purchaser, or else the IRS will still consider the deceased the policy owner.
The Bottom Line
Life insurance claims are generally paid quickly — usually within a few days. Before you get to the point where you receive your benefits, though, you need to know just what to expect from the claims process, the insurance company, and the IRS.
Have you been a life insurance beneficiary before? Any tips to add?