Life insurance is commonly used to provide an immediate source of funds for a surviving spouse or family member. As a financial planner working with those who lost a loved one, I've seen first-hand the impact an insurance policy can have on the surviving family. A life insurance death benefit helps the family carry on, maintain the family standard of living and provide immediate — and sometimes essential — funds to pay bills or provide a source for future expenses like college. Either way the impact can be enormous.
What most life insurance beneficiaries don't realize, however, is that there is more than one option available when it comes to receiving the insurance benefit. Though taking a lump-sum is the popular choice, insurance carriers do offer other death benefit claiming options. If you are the beneficiary of a life insurance claim, it's important to be aware of the other options, as one choice may be a better fit for your circumstances than the other.
Here's a brief overview of the initial steps to claiming a life insurance death benefit and three of the most common life insurance claiming options.
First things first
If you are the beneficiary of a life insurance death benefit, you will have to contact the life insurance company to start the claim process or reach out to your insurance agent for help. My Survivor's Checklist can help with getting organized. Most insurance companies pay benefits within 30-60 days of the date of a claim. However, if an insured passed away within two years of taking out the policy, the insurance company may delay paying to investigate the claim. This is called the "contestability clause."
Initially, the insurance company will need a copy of the death certificate and a claim form. Keep in mind, life insurance death benefits are income-tax free, and there are no penalties for taking the money out pre-59½, unlike in retirement accounts. There may or may not be an estate or inheritance tax depending on your relationship to the insured and the state in which you reside. A local estate attorney can help you understand your estate tax laws.
Before you complete the claim form, it helps to understand your claiming options. Generally, there are three:
A lump-sum payout is a popular choice and the default option of most carriers. You can have the proceeds paid to you via a check or direct deposit into a bank account. The advantage of taking a lump sum is you can use the life insurance proceeds to pay off a mortgage, pay other bills, give yourself a little cash cushion or invest in a brokerage account for future use. You have the ultimate control over the money.
The downside is you may spend all the money! When you lose a loved one, the grieving process may lead you to make emotional rather than rational decisions. Widows may find spending some of the life insurance money helps with the grief, though it is temporary. I've seen some widows take trips, buy a second house or purchase expensive gifts for the kids to make themselves feel better, without considering future spending needs.
If you have a history of burning through cash quickly or are not good with money, consider hiring a financial adviser to help with prioritizing and budgeting to make the lump sum last. For instance, I often am asked if a new widow should pay off the mortgage with the insurance proceeds. That may or may not make sense. Usually I find it may "feel" right to pay off the mortgage immediately, but logically — when you run the numbers — it may not make sense. A financial adviser can help you weigh the pros and cons.
If you are afraid of running out of money or you like the security of a reliable income stream month-to-month, then having the insurance company provide you an annuity instead of a lump sum is a possibility. Insurance companies can provide you a quote so you can see the expected annuity payout. The downside to taking an annuity is the income may not be enough, the income may stop on your death, or you may want some cash upfront to pay off the mortgage or pay for college.
If that's the case, a combination of a lump sum and annuity strategy may work. For example, you can take receipt of the death benefit via a lump sum, keep some money in the bank for large cash needs and purchase an annuity with some portion of the proceeds through the same or a different insurance company. This hybrid strategy ensures you have some cash available to meet your large one-time expenses and yet the annuity provides a monthly income stream to help with day-to-day expenses.
Another option involves keeping the life insurance death benefit at the insurance company and having installment payments paid to you. The insurance company holds the money for you in an interest-bearing account and can send you checks based on an installment schedule you decide. For example, you may request $5,000 a month. The insurance company will continue to send you installment payments until the account runs out. This differs from an annuity in the sense that an insurance company can guarantee annuity income for life, whereas installment payments run out when the principal account balance is used up.
The advantage to an installment payment is you can increase or decrease the income stream depending on your needs, whereas with an annuity you are usually locked into a fixed payment. An installment payment is good for those who are undecided about how to take a death benefit and need time to evaluate options. The payments can help cover some of the immediate bills while you decide how to best take and use the larger amount of money. A financial adviser can help you evaluate whether the interest rate on the interest-bearing account is competitive or whether a different strategy may produce more income.
Having a plan
The best option really depends on your needs and the type of person you are. If you are worried about running out of money, perhaps the annuity strategy will make you less anxious. If you want to pay off the mortgage and invest the difference for college or retirement, then a lump sum may be a good idea. It can also be some combination of the three. It's not unusual to see widowers take a lump sum with some of the death benefit and purchase an annuity with the balance to help meet day-to-day income needs.
It really depends on your situation. That's why a financial plan like my Survivor's Financial Plan is helpful in evaluating the options and helping you make the right choice.
For more financial planning insights for Widows and Widowers, please visit my website www.survivorplanning.com.
Investment advisory and financial planning services are offered through Summit Financial, LLC, an SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666. This material is for your information and guidance and is not intended as legal or tax advice. Legal and/or tax counsel should be consulted before any action is taken.
Investment advisory and financial planning services are offered through Summit Financial LLC, an SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666. This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not a guarantee of future results. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Links to third-party websites are provided for your convenience and informational purposes only. Summit is not responsible for the information contained on third-party websites. The Summit financial planning design team admitted attorneys and/or CPAs, who act exclusively in a non-representative capacity with respect to Summit’s clients. Neither they nor Summit provide tax or legal advice to clients. Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local taxes.
Michael Aloi is a CERTIFIED FINANCIAL PLANNER™ Practitioner and Accredited Wealth Management Advisor℠ with Summit Financial, LLC. With 21 years of experience, Michael specializes in working with executives, professionals and retirees. Since he joined Summit Financial, LLC, Michael has built a process that emphasizes the integration of various facets of financial planning. Supported by a team of in-house estate and income tax specialists, Michael offers his clients coordinated solutions to scattered problems.
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