A life insurance death benefit is the amount of money that is paid out to the policy’s beneficiaries after the policyholder’s death. It’s usually paid as a tax-free lump sum and it can be spent however and whenever the beneficiaries want.
The right thing to do with the death benefit will depend on your current expenses, including housing, bills, or childcare.
If there’s anything left over after you’ve covered those costs, you can invest the rest and save for retirement or future expenses. Work with a financial professional to make a plan for the money that fits your needs.
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What to do with a lump sum life insurance payout
Usually, when someone dies, they leave behind financial obligations, like a mortgage to pay off or children to raise. If a loved one named you as their life insurance beneficiary it’s likely because they wanted you to help cover those costs or because your finances were intertwined. Your financial responsibilities will dictate how you should use the money from a life insurance payout.
You’ll probably have immediate costs, like funeral expenses, medical bills, and paying off debt. But the money is often also intended for longer term provision, including everyday cost of living and children’s education expenses.
Certified financial planners can help you build a personalized strategy for how to handle the lump-sum payment. Each advisor will have their own approach, so speaking to multiple people will help you find the right strategy.
“If you come into a lump sum of money, sit down with a certified financial planner, not [just] an investment advisor,” says Karen DeRose, founder of DeRose Financial Planning Group. “An investment advisor can only invest your money. A CFP can do both. They can first come up with a plan to figure out how much of this money you need every month — or if you don’t really need the money and it needs to be invested for your retirement.”
How you spend the payout from a life insurance claim ultimately comes down to your financial needs.
A young surviving spouse may need the money to support a child, whereas an older spouse may simply use the payout to support their retirement. A licensed financial professional can help you make a plan for your payout.
Immediate expenses
Outstanding debts
When you pass away, shared debts such as mortgages often fall on the shoulders of family members left behind. If someone co-signed your student loans, the responsibility of that debt falls on the co-signer. The life insurance payout can be put toward the remaining balance.
Medical expenses
Final medical expenses can be exceedingly high. Depending on the state, family members of the deceased might be responsible for any medical bills left unpaid before their death. The death benefit can go toward those costs or any future medical bills you might incur.
Final expenses
The average funeral costs $8,000. The life insurance payout can cover the costs of burial or cremation, including items like caskets and urns, and any other funerary expenses.
If there’s money left over after you’ve covered all your expenses, save and invest the rest for the future — putting it, for example, in a high yield savings account.
Long-term expenses
Monthly bills & everyday expenses
Everyday expenses add up. For example, the average cost of caring for a newborn in Wisconsin, is $12,567 per year. [1] The average Green Bay resident spends $349.06 on utilities and $1,075 on rent each month. [2]
Whether you’ve lost a primary breadwinner or a stay-at-home parent, you’ll need to replace their contributions to your household. The life insurance payout can cover groceries, bills, house cleaning services, and more.
Childcare or dependent care
Parents spend about $294,869 raising a child through age 18. [3] If the policyholder left behind any children or grandchildren, the death benefit can be put toward daycare, school tuition, after-school programs, or any other necessities.
The death benefit can also provide for aging parents or any other dependents.
College tuition
The median cost of attending a private nonprofit university in 2021 to 2022 was $27,940. [4]
One way to save for future college costs is by putting a portion of the death benefit payout into a 529 college savings account. The earnings on 529 investments are tax-deferred and any withdrawals won’t be taxed as long as they go toward qualifying education expenses.
→ Learn more about what is covered by life insurance
How is the death benefit paid out?
Life insurance money can be paid out in a few ways:
Lump sum: You get the entire death benefit in one tax-free payment. This is the default way to receive a life insurance payout and what most people stick with.
Annuity: You’re paid in yearly installments over a set period until the money runs out. An annuity can be an option if you have fewer expenses to cover immediately — it allows you to earn interest over time. But annuities can be complicated — and you’ll pay taxes on the gains in interest.
Retained asset account: The insurance company holds the money in an account that earns a small amount of interest. Similar to a personal savings account, you make withdrawals whenever you need. This is the least common option.
Who can claim a life insurance payout?
The only people who can collect the death benefit payout are the people listed as beneficiaries on the life insurance policy.
Regardless of your relationship with the policyholder, if you’re not listed on the policy, you can’t claim the death benefit. Creditors and debt collectors also have no access to the payout.
If the primary life insurance beneficiary dies, then the payout goes to the contingent beneficiary, also known as secondary beneficiary.
If none of the beneficiaries included in the policy outlive the policyholder, a court decides who gets the insurance money, and the payout can go to creditors or next of kin.
Is the life insurance payout taxed?
Lump-sum life insurance payments are untaxed, but interest earned on annuities or retained asset accounts is taxable.
You may pay additional fees on an annuity that you wouldn’t pay on other traditional investments, so taking the payout as a lump sum and then creating a separate investment portfolio often gets you more bang for your buck.
→ Learn more about taxes and life insurance
How long does it take to get the death benefit?
Depending on the policy and circumstances of the policyholder’s death, it can take one week to two months to be paid the life insurance proceeds. Providing the correct documentation from the get-go speeds up the claims process and minimizes your waiting time.
To claim the life insurance death benefit, the first thing you’ll have to do is submit a claim to the life insurance company.
Filing a claim requires the deceased’s name, date of birth, policy number, and cause of death.
You’ll also need documents like the death certificate and proof of your identity.
→ Learn more about submitting a life insurance claim
Can a life insurance company refuse to pay out the death benefit?
While a life insurance policy pays out for most causes of death, there are rare situations when the payout could be delayed or denied.
For example, if you lie on your initial application or stop paying your premiums and let your policy lapse, your insurance company could either pay only part of your benefit or deny the claim and only refund the premiums you paid into the policy.
