Life Insurance Payment Options
When you die, your beneficiaries receive the proceeds of your life insurance policy. The proceeds can be paid out in a number of different ways. Some life insurance companies allow you the option of dictating how these proceeds will be distributed. Generally, the beneficiary chooses how the death benefits are paid out.
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Types
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There are three ways to receive life insurance death benefits. First, a lump sum distribution may be made. Second, the insurance company may keep the death benefit proceeds and invest them. The interest generated from the investments is then paid to the beneficiary. The last way benefits can be paid is by annuity payments. Periodic payments are made to the beneficiary using an annuity contract. Payments extend for the life of the beneficiary or can be made for a set number of years.
Benefits
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The benefit of the lump sum distribution is that no taxes are due on the distribution. The benefit of the invested death benefit are that the death benefit never becomes depleted. Interest continues to be generated and paid to the beneficiary perpetually. The benefit of the annuity payment option is that taxes are lower than with the invested death benefit option and payments can be scheduled so that the beneficiary never runs out of money.
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Drawbacks
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The drawback to the lump sum amount is that the distribution is that the beneficiary must manage it. The drawback to the invested death benefit is that the investment is subject to taxation. Interest earned on the death benefit is considered investment income. This income is taxed at ordinary income tax rates and can be substantial if the death benefit amount is large. The drawback to annuity payments is that if you need access to more than the payment amount specified by the annuity, you can't.
Misconceptions
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A common misconception is that the lump sum amount is the only payment option available from a life insurance policy on death. While this may be a popular payment option, it is not the only one. Another misconception is that life insurance companies must always pay death benefits. While this is generally true, a life insurance company may refuse to pay a death benefit if it finds that any policy provisions were violated. For example, if the insured individual committed suicide within the first two years of the policy, the policy is void. Likewise, if the insured lied on the application for life insurance and the insurer finds out, the policy is void.
Considerations
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Understand your needs for life insurance. Make sure that, if you are the beneficiary of a policy, you choose the payout option that best suits your needs. If you are the policyholder and have a say as to how the proceeds are paid out, choose the policy payout that is best for your intended beneficiary. For example, does your beneficiary have a need for more income rather than a large savings? If so, choose the annuity payment option.
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