What to Expect When You’re a Life Insurance Beneficiary

by Emily Guy Birken · 3 comments

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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.

Tax Considerations

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? 

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{ 3 comments… read them below or add one }

Alex C May 3, 2013 at 5:58 am

Do not forget to talk about what you get if you have cash value insurance vs term insurance. With cash value insurance, when you are alive and paying the premium, money goes towards your policy and some of the other money goes towards a “savings account”.

When someone dies it would make sense for someone to get two, but most likely it isnt. If you have a cash value policy and die, your beneficiary will receive only the face amount of coverage and your “savings account” will be forfeited to the insurance agency. So if you die, you are paying for two only to get one. Would anyone ever put their money into an investment they knew they were going to loose if they died?

In term insurance there is no savings account so the money you pay goes towards your coverage. Then take the difference of the payment of a cash value policy and term policy, and invest it. Now if you die, your beneficiary receives both the face amount and investments.

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Johnny May 3, 2013 at 8:10 pm

Take the lump sum. You’re likely not earning much interest from the interest bearing account anyways.

Put the lump sum in the stock market after a market crash. Check the charts and buy stock market indexes such as SPY after a market crash and you will see a much greater return than letting Miss Piggy handle your money at the bank. She will give you a dime a year and tell you that you’re earning good interest.

Tell Miss Piggy to cough up the lump sum and wait for a market crash. You may have to wait up to 5 years, but you’ll always get a major crash after a set period of time.

These days, you just can’t trust financial planners.

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zimmy@moneyandpotatoes.com May 20, 2013 at 6:50 pm

I have made sure that my wife is 100% clear on exactly what insurance benefits she will get if I die. The main part of the insurance is through my work and they will do the heavy lifting for her to get the benefits. My wife just needs to make sure to get about 10 copies of the death certificate because everyone is going to want one.

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