- Life insurance policies provide your loved ones with money after you die to support them.
- Beneficiaries are the ones who get the life insurance benefit and they can be family or friends.
- Payment options include lump sum payments and installments, and are usually processed in at most 30 days.
Life insurance is a contract between you and an insurance company. You pay for the policy on a regular basis and in exchange, when you die, your beneficiaries get money. Those funds can go to your burial costs and to supporting those who depend on you.
We’ll explain more below.
Inside this article
How does a life insurance payout work?
When you die, either your beneficiary or the insurance agent on the policy will reach out to the insurance company to inform them of your demise.
The insurance carrier will log your death and send paperwork to your beneficiary, which must be completed and returned, along with proof of death, generally in the form of a death certificate. The insurer will review the paperwork, do the due diligence to verify the beneficiaries are who they say they are and pay the claim, says insurance planning consultant Michael Staeb.
While most claims are paid within 30 days, there are exceptions. These include suicide, homicide and death from an excluded clause, like a pre-existing condition. If the insured died by homicide, ie, you are killed, the beneficiary will usually receive payment once they've been cleared of fault, ie, they didn’t do it. If the insurance company suspects fraud, they will withhold payment while they verify the claim.
What are payout options and which is the best?
Most people take payments via lump sum, or all at once, says Staeb. They usually receive the money by check or an electronic funds transfer.
Alternately, beneficiaries can take regular payments over a specified period of time. This creates a recurring income stream in which your beneficiary receives a monthly check until the benefit is depleted.
The best option is the one that's right for you, Staeb says.
“If they need all of it at once, they should take all of it at once,” he adds, crediting Suze Orman for her wise words on lump sum payments.
Orman’s philosophy is to take the lump sum so insurance companies don't earn interest on your money. She then advises beneficiaries to spend what they need to satisfy immediate debt obligations and save the rest.
Your beneficiaries have just experienced a major emotional loss.
“Don’t make big financial decisions while you are still going through that,” says Staeb.
Is a life insurance payout taxable?
In general, no, life insurance payouts are not taxable.
However, there are two situations when you might pay taxes on a life insurance payout: if you take installments and if the deceased was wealthy enough to trigger estate taxes.
The federal estate tax threshold is more than $12 million for 2022. Life insurance payouts become taxable when the deceased’s estate is worth more than this threshold.
While not all states have an estate tax, those that do tend to be lower than the federal estate tax. For instance, Washington state's estate tax kicks in at $2.19 million.
Installment payouts can also be taxed, according to MassMutual. It’s worth checking with a tax professional before you agree to recurring monthly payments.
What do you do with a life insurance payout?
Honestly, whatever you want.
It’s very much a personal decision. MassMutual lists common ways people use life insurance payouts:
Pay off debt
Build an emergency fund
Buy an annuity
Invest in the market
Create a college fund for your children or grandchildren
Gift money to a favorite cause
Frequently Asked Questions
Does life insurance actually pay out?
Yes. Exceptions may include death from suicide, excluded condition or illegal activity. Check your policy carefully.
What is the average life insurance payout?
The average life insurance payout is around $600,000, according to Randy Jones Insurance Services. Haven Life puts the average figure a little higher at $618,000, which represents the average purchased face value of a life insurance policy.[3,4]
Is life insurance paid in a lump-sum?
It can be, but there are other payout options as discussed above.