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How Life Insurance Payouts Work

Licensed Life Insurance Agent/Staff Writer
January 15, 2020

Life insurance payouts (also known as death benefits) are funds paid to your loved ones if you die while your life insurance policy is in force. Your beneficiaries must file a claim and provide a death certificate to the insurer, who will then review the information and issue benefits if everything is in order.

While the process of receiving a life insurance payout is often straightforward, there are a couple of possible hiccups or delays your beneficiaries may experience. It’s best to understand how life insurance payouts work and discuss that with your beneficiaries now so you can plan together.

Who gets a life insurance payout?

The payout will go to your primary beneficiaries first. If your primary beneficiaries predecease you, the payout will go to any contingent beneficiaries you've named. If there are no living beneficiaries, the payout will become part of your estate.

Learn more about how to choose and designate your life insurance beneficiaries.

How to start the life insurance claims process

Whoever you select as your beneficiary, they'll need to make a claim with the insurance company upon your death. The recipient will fill out a claim form and provide a death certificate. Some insurers also require the recipient to supply a copy of your policy, so make that easy for your loved ones to find. If your beneficiaries have trouble locating your documents, they may use the policy finder at the National Association of Insurance Commissioners (NAIC) to uncover any life insurance policies in your name.

How long does it take to get a life insurance payout?

A typical life insurance claim takes from 30 to 60 days. Insurers are legally bound to respond to a request within a specific period, which varies by state. Within that time, the company must either approve the claim, ask the claimant for more information, or reveal that it plans to investigate the claim before making a decision. If the company needs more information or chooses to investigate, the request could take months.

The best life insurance companies typically approve claims quickly, but every situation is different. How long your beneficiary’s claim will take—and whether they receive the entire payout—depends on several factors. That may include how long you’ve had your policy, the circumstances surrounding your death, and any living benefits you’ve received.

You’ve had your life insurance policy less than two years

If you pass away within two years of taking out a life insurance policy, the insurer may do more investigation than it would if you were a long-time policyholder. That's because most life insurance policies come with a two-year incontestability clause.

The incontestability clause allows the insurer to dispute information you’ve provided in the application or during your medical exam (or your medical records, if you bought a no exam life insurance policy). If the insurer finds any misrepresentations, it could deny your beneficiary’s claim or reduce the death benefit.

Your policy will likely have a suicide clause that lasts two years as well. If the insured person commits suicide within two years of buying a life insurance policy, the insurer may not pay the death benefit.

Incorrect information on your life insurance application

If the incontestability period has passed, but the insurer discovers misrepresentations in your application materials, your claim may not be denied. But your beneficiaries may not receive the amount spelled out in your policy.

Let's say you were 45 years old when you bought your coverage, but you accidentally wrote down 44 instead. All this time, you've been paying slightly lower premiums than you should have been. If the incontestability period has passed, your beneficiary may still receive a payout—but the amount will depend on your actual age of 45.

If you're tempted to fib a little to earn a better rate, know that lies on a life insurance application usually come back to bite you—or your beneficiaries.

Suspicious death with life insurance

If your passing is suspicious or authorities can't tell for sure how you died, this may delay a life insurance payout. That's because insurers won't pay the death benefit if the insured person died while committing a crime or if one or more of their beneficiaries murdered them. Until officials can rule out both possibilities, your loved ones may experience claims delays.

Accelerated death benefits for life insurance

Some life insurance riders (optional add-ons) can affect the payout your beneficiaries receive. An accelerated death benefit, for example, allows you to draw from your death benefit if diagnosed with a terminal or chronic illness. Any funds you withdraw while alive may drain your death benefit and result in a lower payout for your loved ones.

If you have an accelerated death benefit, make sure your beneficiaries know about it to avoid any surprises at an already difficult time.

Outstanding life insurance policy loans

If you have permanent coverage, such as universal life insurance, you may be able to borrow against your cash value. If you pass away before you pay back the loan, however, the insurer may subtract the outstanding balance from the payout.

Are life insurance payouts taxable?

Generally, life insurance payouts come to your beneficiaries tax-free. There are some exceptions, such as if you have a large estate or you have a life insurance policy for business reasons.

Whether life insurance payouts are taxed could also depend on how your beneficiaries choose to receive the payout. Long story short, if the payout remains in the insurer’s possession while earning interest, your loved ones may pay taxes on that interest.

Life insurance payout options

As the policyowner, you can select from several payout options and change your mind throughout your life. Or, you can leave it up to your beneficiaries. If you do choose a payout option, your beneficiaries won’t be able to change it later. Payout options are typically the same whether you have term life, whole life, or another type of life insurance.

Lump-sum life insurance payouts

A lump sum is a popular choice among beneficiaries because it’s a one-time payment in full. From there, your loved ones can use the payout for whatever they wish.

Interest-only life insurance payouts

If your beneficiaries aren't sure what to do with the life insurance payout, a reliable short-term option is interest only. The insurer will hold onto the payout while your loved ones take time to think about the next steps. As the money earns interest, the insurer may send it (minus any applicable taxes) to your beneficiaries.

Installment life insurance payouts

If you or your heirs want to spread out payments (for income replacement purposes, for example), you have several options.

Life-income payout

If your loved ones would prefer a steady income for life instead of one sizable, immediate payout, life income could be the right choice. Your beneficiaries will receive a regular payment as long as they live.

If the payout recipients pass away before your death benefit is exhausted, the insurer keeps the remaining balance. If they live much longer and exceed the death benefit, the insurer will continue those same payments anyway. In short, your beneficiaries may receive more or less than the death benefit you chose, depending on how long they live.

There are two types of life income. Single life is based on just one beneficiary. When this person passes away, the insurer will cease payments. If you have multiple beneficiaries, however, you can choose joint and survivor life. The insurer will continue payments until both beneficiaries pass away, usually with a reduced payment after the first death.

Fixed payouts

If you want to ensure your policy pays out every last cent no matter how long the recipients live, fixed payouts may be the right choice. You can set these payments up to ensure a specific regular income amount (fixed-amount payout) or a particular time length (fixed-period payout).

Once the insurer distributes all funds, the company will cease payments no matter how much longer your beneficiaries live. But if the recipients pass away first, the insurer will instead pay the recipient's next of kin until no funds remain.

Life with period certain payout

Life with period certain is a combination of the life income and fixed-period payout options. Your beneficiary will receive guaranteed payments up to a specific period, such as ten years. If they outlive that period, the insurer will continue payments for life. If your beneficiary dies first, the insurer will pay your beneficiary’s next of kin instead—but only up until the fixed period.

Debit account payout

While not common, some insurers will outfit your beneficiary with a debit card or checkbook linked to an account containing the life insurance payout. Your loved ones can withdraw funds as they choose until the account is drained, but they won't be able to add funds. These funds may collect taxable interest.

What your beneficiaries can do with a life insurance payout

There are no laws or rules that designate how your heirs may spend your life insurance payout. If you want these funds spent in specific ways, consider creating a will.

It’s also important to talk with your loved ones about your wishes. This conversation can help you and your family understand current financial liabilities (such as a mortgage) as well as any future obligations (such as college tuition for your kids). You can also use our life insurance calculator to help you remember all of your family’s financial obligations—and choose a death benefit payout that covers them all.

As your life evolves, so will your needs. Keep talking with your loved ones to ensure they have fewer things to worry about while grieving. These conversations may not be easy, but they’ll help your loved ones honor your life and continue living their own.

Life insurance payout FAQ

How long do you have to have life insurance before you die?

When you buy life insurance, your coverage begins as soon as you receive approval from the insurer, and you pay your first premium. If you pass away from a covered event or condition that very same day, your beneficiaries may receive a payout. The exception is in cases of suicide, which isn't covered for the first two years your policy is in force.

Does life insurance pay out if you don’t die?

It depends. Many people who have term life insurance outlive their coverage and don’t receive any payout when their policies expire. People who have permanent coverage such as universal life or whole life, however, don't have to worry about an expiring policy. Instead, these policies mature at a specific age. At maturity, you may receive a payout.

Learn more about term life vs. whole life.

Who gets life insurance if you don’t designate a beneficiary?

Without a designated beneficiary when you pass away, life insurance payouts typically become part of your estate. Your next of kin will likely receive the funds—but only after a delay and any creditors receive their share. If you properly name a beneficiary in your life insurance policy, however, the payout can’t be claimed by creditors and is less likely to be delayed. A beneficiary designation will even trump your will.

Is life insurance considered inheritance?

Many people use life insurance to leave their loved ones an inheritance, but the government doesn’t treat life insurance payouts the same as other kinds of inheritance. Your beneficiaries likely won’t pay taxes on the funds they receive from your life insurance, for example. And the income won’t affect your beneficiary’s ability to collect Social Security Benefits.

Written by
Kathryn Casna
Kathryn Casna is a licensed insurance agent and life insurance specialist who has appeared on The Simple Dollar and Best Company. On a weekly basis, she dives into complex life insurance topics to wring out genuinely useful information. When she’s not wrangling big ideas into easy-to-understand articles, Kathryn nerds out on budget-tracking spreadsheets and tries to coax her leash-trained cat to take outdoor adventures.