A Dubious Deal for a Death Benefit

EDITOR'S NOTE: This article was originally published in the May 2012 issue of Kiplinger's Retirement Report. To subscribe, click here.

If you're the beneficiary of a life insurance policy, you might be expecting to receive a simple check in the mail. But the insurance company may have another idea for the money. State regulators are taking a close look at "retained-asset accounts," where death-benefit proceeds are retained by the insurer but accrue interest for beneficiaries until they withdraw the money.

Insurers present these accounts as a prudent place to stash death benefits while survivors figure out what to do with payouts. But critics say the accounts pay paltry interest rates, place restrictions on survivors' access to funds and don’t provide the same protections as bank accounts.

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In some cases, the insurer offers the account to the beneficiary as an option. But many insurers automatically move the death benefits into retained-asset accounts unless a beneficiary specifically requests a lump sum or another payout option -- and that's a concern to some state insurance regulators. Last year, California passed a law requiring life insurers to get written declarations from beneficiaries on how they want to receive benefit payments. New York this year took a stronger stance, requiring life insurers to make a full payout to survivors unless beneficiaries specifically request otherwise.

The key point for consumers is "that they do in fact have options," says Peter Kochenburger, executive director of the insurance law center at the University of Connecticut School of Law. "Don't simply accept the option the insurance company provides."

Retained-asset accounts have been around since the early 1980s, but they have received more scrutiny in recent years as federal employees and others were commonly defaulted into these accounts. The Office of Personnel Management, which administers the Federal Employees' Group Life Insurance program, last year responded to concerns by requiring that most beneficiaries choose a payout option.

If your benefits have been placed in a retained-asset account, you'll typically receive a book of "drafts," which resemble checks and allow you to draw money from the account. If you don't want the account, you can write a draft for the full benefit amount and transfer the money to a bank or investment account.

Lower Rates and Fewer Protections

When weighing a lump-sum payout against a retained-asset account, one factor for beneficiaries is the interest rate on the account versus bank products and investment vehicles. MetLife, for example, is paying a guaranteed rate of 0.5% on its "Total Control Account" retained-asset accounts. The highest-yielding money-market bank accounts, however, yield roughly 0.9%.

And retained-asset accounts don't always offer the easy access of bank accounts or other cash vehicles. The drafts that allow beneficiaries to tap their money differ from checks: Instead of drawing money directly from a bank account, the draft requires the insurer's permission before the money can move where the beneficiary directs it. Retailers don't always accept the drafts. And there are often minimum withdrawal amounts, such as $200 per draft.

Retained-asset accounts, moreover, may not be fully protected if a life insurer goes belly up. The accounts are protected by state guaranty associations, which in most states provide coverage for death benefits up to $300,000. "If your policy is worth $1 million, you're not going to get $1 million from a guaranty fund," Kochenburger says.

A beneficiary who stashed $1 million in bank accounts at four different banks, however, could have Federal Deposit Insurance Corp. protection on the full amount, since the FDIC covers up to $250,000 per depositor at each institution.

Retained-asset accounts may still be valuable for some beneficiaries, particularly those who are dealing with an unexpected death and may be overwhelmed by receiving a large lump sum.

Yet insurance experts warn against leaving large sums in the relatively low-yielding accounts for a sustained period. Generally, says Jeffrey Stempel, insurance law professor at the University of Nevada, Las Vegas, "the better thing is just to get control of the money as soon as you can."