Life insurance proceeds are received tax free if you are the beneficiary of the policy. After the insured individual dies, you must make a claim for the benefits. After that, you have a multitude of choices to make in regard to what you do with the death benefit. There are no restrictions on how you spend or save it.
Pay Down Debt
When you receive your life insurance death benefit proceeds, you may spend the death benefit. Paying down your personal debts may relieve you of some stress or anxiety you are experiencing over your finances. Also, you may need to pay off any debts that you shared with the deceased insured person. For example, if you were a co-signer on a loan and the loan agreement stipulates that the creditor may come to you for the collection of the debt if the primary borrower dies, then you will be responsible for the repayment of the loan.
Pay Funeral & Burial Costs
You may need to pay funeral costs and burial costs with the death benefit. If you are the spouse of the deceased, then this will be a practical necessity if there are no other sources of funds that can be used to pay for the funeral and burial (or cremation). Depending on how much the death benefit is, the cost for the funeral and burial may deplete some or all of the death benefit.
Save or Invest
You may save or invest the death benefit proceeds. Life insurance death benefits may be left with the insurance company to accumulate interest in the insurance company's general account, or they may be invested with another brokerage firm. The insurance company's general account consists of bonds and bond-like investments. Because of this, the interest earned on the death benefits will be based on whatever the investments return. You may also invest the money into a retirement account or a regular brokerage account. If you are investing in a retirement account, like an IRA, you must follow the contribution rules for the particular retirement account you use.
Buy a New Contract
You may purchase a new life insurance policy on yourself with the death benefit proceeds. When you do this, you may purchase an immediate annuity contract. The immediate annuity policy makes guaranteed payments. These payments last for your entire life or for a set period of time. Either way, these payments may be used to pay the premiums on a new life insurance policy. In this way, you are "recycling" the death benefit and are able to pass your relative's money on to your own beneficiaries.