Receiving a life insurance benefit is a huge blessing in a difficult season, but you may not know what to do with it.
In addition to the emotional burden of a loved one passing, you will have to navigate payout options and plan for expenses such as final costs and paying off debts. It can feel overwhelming, but with a plan it can be a little easier.
In this article, you’ll learn:
Your payout options
What costs you should plan for
How to find outstanding debts
Differences between a whole life benefit and a term life benefit
Let’s jump in.
You’ll have to evaluate your circumstances and decide which payout option is best for your situation and which ones the insurance company will allow.
Here are seven different payout options you can choose from:
A lump-sum is the total amount of the payout all at once. You can receive it by check or through electronic transfer.
This payout is the most standard and straightforward payout option that beneficiaries use. However, some beneficiaries prefer to pace themselves with a different payout method.
Installments are periodic payments for a designated amount of time until you deplete the total payout. You can choose the size and when to receive the payments.
For example, if you have a five million dollar payout, you can spread that over five years in annual installments of one million dollars. Also, the insurance company pays you the interest it makes off the payout. The results in a higher payout, but you lose the ability to invest the full amount of the payment up front, which could give you more money in the long-term.
Please note that any interest you accumulate from your payout may be subject to taxes.
Life income also pays you in increments. This option is based on the duration of your life, as determined by a projection model. The insurance company will look at factors like your age and gender, then estimate how much longer you will live.
The insurance company will spread that payout over a period of time, and you can choose if you want to receive payments monthly, quarterly, or annually.
This option is a variation of lifetime income. One disadvantage of regular life income is that if the beneficiary dies after the payout starts, the insurance company can keep the remaining money.
With this option, you select a contingent beneficiary who will receive payments if you pass away. You choose a “period certain,” which guarantees the insurance company will continue to pay life income to your contingent beneficiary for a specific window of time.
For example, if you select 30 years as your period for life income, you will start getting your payments. But if you pass away ten years later, your contingent beneficiary will start receiving those payments for the next 20 years.
A downside to this option is that the payments are less than the regular life-income because it comes with guarantees.
Joint life with survivorship is another variation of life income. In this case, the insurance company will base the payout on the lives of two individuals and will continue payments as long as one is living.
You can also add a period certain to this type of payout. However, this option also pays less than regular life income because it comes with certain guarantees.
With interest income, the insurance company keeps the payout and gives you the interest it accumulates. This payout option is the most sustainable long-term option. However, the downside is that you may owe taxes on the interest you earn.
The retained asset account functions like a bank account. The insurance company will give you a card or checkbook, and you can use the account whenever you feel like it until the money is gone.
Now that you know your payout options, it’s time to look at how to plan for expenses.
There are a few costs to consider after you receive a life insurance benefit. Here’s a list of four common expenses that beneficiaries use payouts for:
Final costs are the expenses for a funeral or cremation and sometimes medical bills. Unfortunately, the final costs can be very high since the burials are expensive. For example, a casket can cost anywhere from $2,000 to $10,000.
The Federal Trade Commission created a funeral pricing checklist that you can use to calculate the cost of the funeral you’re planning. Keep in mind that sometimes people have final expense insurance, which covers these costs.
If the primary breadwinner of your home passed away, you have to know how to replace the income. A life insurance benefit can temporarily replace income until you find another source of revenue, such as a job.
Fortunately, there are a lot of payout options suited to meet this need. For example, you can ask for monthly installments over a few years to give yourself time to find a new source of income.
The estate is everything the deceased owned at the time of death. When the inheritors receive that estate, the government taxes it. Of course, you don’t have to use your life insurance to pay for those estate taxes. But it’s common practice for those preparing their estates to leave insurance money to pay for these taxes. Please keep in mind that federal estate taxes only apply to estate worth above 11.4 million dollars (i.e. tax on 0.6 million of a 12 million estate), and most states have similar thresholds.
One of the most common reasons people take out insurance policies is to cover significant debts if they pass away prematurely. Paying off significant debts is a heavy burden, especially for individuals dealing with the loss of a loved one.
Now that you know what costs you may have to prepare for, it’s time to learn how to find outstanding debts.
In some cases, it will be obvious which debts you should pay off. For example, if the only debt you have is a mortgage and your spouse specifically arranged for you to pay it off with a life insurance benefit, then the decision is clear.
However, sometimes you may not know what debts the deceased had. Things can also get muddled when different parties give you conflicting advice, and you’re not sure what to do.
Here’s what you need to know:
Before you pay off the deceased’s debts, you should understand that you’re not obligated to use your life insurance benefit to do so.
One of the significant advantages of a life insurance payout is that it’s not part of the deceased’s estate. That means the government, lawyers, and family members cannot legally demand that you use your payout to cover the deceased’s debts.
Some may try to get you to use your benefit that way, but there is no legal right or obligation to do so, and this can be considered illegal harassment.
Keep in mind you still have to pay off debts that you jointly owned with the deceased, such as a co-signed loan or jointly owned bank account with an overdraft fee.
You don’t necessarily have to use your insurance payout to cover these debts, but you will have to pay them sooner or later. It’s worth considering paying these necessary amounts since an insurance payout is often large and can conveniently wipe out entire debts.
It’s essential to research any state or local laws that may apply to your circumstances because they differ depending on your location.
For example, there are nine community property states, which means these states view most property as jointly owned by married couples. These states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
Always research thoroughly before making any significant financial decisions.
If you don’t know what debts the deceased had, the easiest option is to talk with the executor of the estate. The executor (or sometimes a lawyer) is the person in charge of the deceased’s estate.
This person’s responsibility is to sell off the estate to pay any debts, then divide the inheritance to the appropriate parties. The executor has access to all of the personal information of the deceased, including outstanding debts.
If the executor cannot answer your questions, they can often point you in the right direction.
If you’re unsure of which debts you should pay and not pay, it never hurts to get a professional opinion. A lawyer can help you navigate any tricky circumstances if you feel that an insurance company or the executor is misleading you.
Another powerful resource is a financial advisor who can help you prioritize which debts to pay off first and help you plan for economic sustainability.
The aftermath of the death of a loved one is a difficult season, and that’s exactly why people take out life insurance policies. You can use your insurance benefit to take care of financial burdens, but you have to know-how.
You can use this article as a guide to choosing a payout option, planning for costs, and finding outstanding debts. Then you can feel more organized and less stressed about what to do next.