Those purchasing life insurance do so to help care for their loved ones after they are gone. The death benefit payment that follows the death of an insured party is meant to help surviving family members transition to their new lives, or provide an additional layer of security for the future. It is important to understand the death benefits of life insurance if you are considering purchasing a policy.
There are different types of life insurance policies, with the two most common being term life insurance and whole life insurance. Though the basic confines of death benefits share a common denominator, both the amount and the method of the payments will differ based on the specifics of your chosen plan.
How Does a Death Benefit Work?
Assuming that the policyholder has been current with their premiums until their death, the beneficiaries are slated to receive a death payment.
The amount of the death benefit is defined when the policy is purchased. This is also known as the face value. In general, the value of the death benefit is directly related to the premiums that are paid by the policy holder.
In order to receive the death benefit, the beneficiaries must submit a claim. As part of this process, the beneficiaries must provide proof that the policyholder has died. The insurance company will then review the claim and evidence that the policyholder has indeed passed away.
The companies will then work to process and deliver the payment, unless they suspect foul play or fraud was committed (i.e. the policy holder was dishonest about any pre-existing health conditions). Barring any issues, payouts are usually executed within a month.
How Are Death Benefits Awarded?
Death benefits are awarded in a variety of ways. Usually, the recipient will have the choice of how to receive their allotted share.
Lump-sum payments are often disbursed to the beneficiaries, wherein the entirety of the death benefit will be paid at one time. This is the most popular option.
However, some policies offer other methods to receive death benefit payments. These include receiving payments via installments for a set period of time, or until the entirety of the death benefit has been paid.
The death benefit could also be paid as an annuity. Annuities are guaranteed payments at regular intervals throughout the beneficiaries’ lifetime, either fixed or variable. Both installment payments and annuities can be useful strategies for those looking to spread out their benefits over the years. In the case of an annuity, those with the ability to choose this option can gain a guaranteed source of income for the rest of their lives.
What Are the Tax Implications of a Death Benefit?
The tax implications of the death benefit depend on the way in which the monies are disbursed. Lump sums are generally paid without incurring any tax liabilities, which can be a good reason to choose this option.
Installment payments and annuities, however, can have a tax component. The money that remains with the insurance company will accrue interest over time, and these gains are taxable income.
If the life insurance is part of the policyholder’s estate, this could also trigger a tax obligation if the total value exceeds the Federal estate tax threshold. The Internal Revenue Service publishes the estate tax threshold numbers for each tax year on its website.
How Do Death Benefits Differ Between Term and Whole Life?
There are several key differences between term and whole life insurance, including the amount of time that the policy remains in force.
For term life insurance, the benefit is paid out if the policyholder dies during the predefined timeframe. If they pass away after the insurance has expired, there will be no death benefit.
For whole life insurance, there is no expiration date. Whole life insurance policies have a cash value, that policyholders can borrow from while they are still living. If the policyholder has borrowed money from the cash value portion of the life insurance fund (and did not repay this sum), the death benefit that will be passed along to their heirs will be decreased.
Term life insurance has no cash value, so the death benefit will not erode. As long as the policyholder has remained current with the payments and the individual passes away during the policy’s term, a death benefit will be paid to the plan’s beneficiaries.
Conclusion: Planning for Every Contingency
Insurance exists to plan for every contingency. When it comes to auto, home, or health insurance, hopefully, there will never be a need to fully activate the insurance as both you and your assets continue humming along without incident or illness.
Life insurance, on the other hand, addresses an inescapable eventuality. Providing a death benefit for your family can help them cope with life in your absence. As you think about life insurance, it is important to understand how the benefit is passed on to your beneficiaries.
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