A life insurance death benefit is a sum of money that is paid out to a policy’s beneficiaries after the death of the insured. If there are multiple beneficiaries, the policy will state how much of the death benefit each person will receive – either a monetary amount or a percentage. If there is only one beneficiary, the full amount of the death benefit will go solely to the listed individual. While the policy owner normally has the option to dictate how they would like the death benefit to be paid out, beneficiaries often choose how they would like to receive the funds themselves.
There are several ways that a death benefit may be paid out:
- As a lump-sum payment. The beneficiary receives the full amount of the death benefit in a one-time payment.
- As installment payments. The beneficiary may receive payments for a certain amount of time or in a certain amount, until the funds run out.
- As interest-only payments. The life insurance company retains the funds and pays out periodic interest payments to the beneficiary. The beneficiary usually can make withdrawals at any time or convert their payments into installments.
- As an annuity. The beneficiary converts their death benefit into an annuity and receives payments for the remainder of their life.
A lump-sum payment is the best-known type of death benefit payment and is quite common. This type of payment is normally distributed tax-free, so the beneficiary owes no income taxes on the funds. If the beneficiary chooses another method of payment, the funds may earn interest. Any interest earned on the death benefit and paid to a beneficiary is subject to income taxes.
As the beneficiary of a life insurance policy, you will likely have full discretion over how to use the funds you receive from the death benefit. If you know that you are a loved one’s beneficiary, consider having a conversation while your loved one is still alive and ask about their wishes for the money. This can help provide guidance after your loved one is gone.
It may help to set the money aside while you are grieving so that, when it does come time to determine whether and how to spend, save, or invest the benefit, you can make better choices. Financial counseling can help you determine how to make the best use of the funds.
There are resources available to individuals who desire financial counseling. Members of the military and their families have free access to financial counseling on military installations through Personal Financial Management Programs at family support centers; they also can meet with financial counselors through Military OneSource. Outside of the military, you may also be able to access financial counseling through your bank or credit union, your employer, or your personal investment adviser.
What to Do with Death Benefit Funds
A life insurance payout can mitigate a major source of stress that often accompanies a loved one’s death: money worries. Ultimately, the decision of what to do with funds from a life insurance policy is personal and depends on your financial situation, your needs, and your goals. For example, you could consider the following.
- Settle immediate debts associated with death: When a loved one passes away, there are expenses that must be paid: funeral costs, burial or cremation costs, medical bills. These expenses can add up well into five digits, and money from a life insurance policy can lessen that financial burden. Remember too, that the insured’s personal debts must be paid along with any final income taxes.
- Pay off personal debts: If you have high-interest debt that is undermining your financial security, you could use a lump-sum benefit payment to pay down that debt, freeing you from the burden of interest that won’t stop growing until the debt is paid. Credit card debt and vehicle debt tend to have the highest interest rates, so paying down those types of debt may be most beneficial for your personal budget.
- Create (or bolster) an emergency fund: If you don’t already have an emergency fund, or would like your emergency fund to be larger, putting a portion of the death benefit into a high-yield savings account may be wise. The amount of money that should be in an emergency fund is unique to your situation, but experts generally suggest that you keep at least three to six months of living expenses in the account – enough to cover all of the bills and charges that you must pay, including your mortgage or rent, insurance, utilities, transportation, food, debt payments, and other anticipated expenses.
- Replace lost income or services: If the deceased regularly contributed to household income or provided services that will now need to be paid for (like childcare or household chores), you can use payments from the death benefit to replace their contributions. A lump-sum payment of the death benefit could serve this purpose, as could installment payments or annuity payments, depending on the amount of income needed.
- Invest: There are several ways that you can invest the money you receive from a life insurance death benefit. You could choose to invest in the financial market by putting money into a taxable brokerage account; you could open an IRA (provided you have earned income during the year); you could divert funds into a 529 Plan to provide for a child’s or grandchild’s future education; or you could go low-risk, and put funds into a Certificate of Deposit or purchase an annuity to earn guaranteed interest over time.
- Wait: If you have no immediate need for income (e.g., a funeral to pay for or debts that need to be paid as soon as possible), it may be best to wait before making any decisions. You can have the insurance company hold on to the funds (and receive interest-only payments) until you are ready to make a decision or you can take a lump-sum payment and put the funds into a high-yield savings account – leaving the funds accessible if anything comes up – until you have a more established plan.
At Navy Mutual, upon notification of a death, we may release 10% of a policy’s death benefit up to $10,000 to the policy’s beneficiaries for immediate use. After receiving all required claim documents, death benefit processing normally takes seven to 10 business days. If the deceased was a servicemember or veteran, our Education and Veterans Services team may be able to answer questions about survivor benefits that may be available.