Life insurance is a very common asset that figures into many people's long-term financial planning. Purchasing a life insurance policy is a way to protect your loved ones, providing them with the financial support they may need after you die. You may have young children who need money for their education, or your spouse may need income to pay off the mortgage and other debts you've accumulated as a couple.
To effectively incorporate this tool into your portfolio, you must understand how and when life insurance payouts are delivered to your beneficiaries—the people you nominate to receive the benefits of your policy after you die. This includes understanding how quickly benefits are paid and designing the policy with the payout option that works best with your estate planning.
- A life insurance company should be contacted as soon as possible following the death of the insured to begin the claims and payout process.
- Many states allow insurers 30 days to review the claim, after which they can pay it out, deny it, or ask for additional information
- Life insurance benefits are typically paid within 30 to 60 days of the filing of a claim, but delays can arise—if the insured dies within the first two years of the issuance of a policy, for example.
- Payout options include lump sums, installments and annuities, and retained asset accounts.
Filing a Claim
The life insurance company should be contacted as soon as possible following the death of the insured to begin the claims process. Because everything is done online these days, you may be able to file a claim through the insurance company's website. For companies that continue the hard copy tradition, you may need to initiate the claim over the phone or in writing by requesting a claims package. No matter how you end up filing, the company normally requires paperwork and supporting evidence to process the claim and payout.
As the beneficiary of the insurance policy, you may be required to provide a copy of the insurance policy along with the claims form. You must also submit a certified copy of the death certificate, either through the county or municipality or through the hospital or nursing home in which the insured died.
“The death certificate has to be submitted to the insurance company address listed in the policy along with a statement of claim, which is sometimes called a request for benefits, signed by the beneficiary,” says retired insurance lawyer Luke Brown.
Policies owned by revocable or irrevocable trusts must ensure that the insurance company has a copy of the trust document identifying the owner and the beneficiary, adds Ted Bernstein, owner of Life Cycle Financial Planners LLC.
When Benefits Are Paid
Life insurance benefits are typically paid when the insured party dies. Beneficiaries file a death claim with the insurance company by submitting a certified copy of the death certificate. Many states allow insurers 30 days to review the claim, after which they can pay it out, deny it, or ask for additional information. If a company denies your claim, it generally provides a reason why.
Most insurance companies pay within 30 to 60 days of the date of the claim, according to Chris Huntley, founder of Huntley Wealth & Insurance Services.
“There is no set time frame," he adds. "But insurance companies are motivated to pay as soon as possible after receiving bona fide proof of death, to avoid steep interest charges for delaying payment of claims."
Life Insurance Policies: How Payouts Work
There are several possible situations that may result in a delay in payment. Beneficiaries may face delays of six to 12 months if the insured dies within the first two years of the issuance of the policy. The reason: the one- to two-year contestability clause.
"Most policies contain this clause, which allows the carrier to investigate the original application to ensure fraud was not committed. As long as the insurance company cannot prove the insured lied on the application, the benefit will normally be paid," says Huntley. Most policies also contain a suicide clause that allows the company to deny benefits if the insured commits suicide during the first two years of the policy.
Payments may also be delayed when homicide is listed on the insured's death certificate. In this case, a claims representative may communicate with the detective assigned to the case to rule out the beneficiary as a suspect. The payout is held until any suspicion about the beneficiary's involvement in the insured's death is clear. If there are charges, the insurance company can withhold the payout until charges are dropped or the beneficiary is acquitted of the crime.
Delays to payouts may also arise if:
- The insured party died during the course of illegal activity, such as driving under the influence.
- The insured party lied on the policy application.
- The insured omitted health issues or risky hobbies/activities like skydiving.
Insurance companies can delay payment for six to 12 months if the insured party dies within the first two years of the policy.
You can also help decide how your death benefit will be paid out after you die. Talk to your insurance agent or company to determine the best option for you and your situation. Here are a few of the payout choices available to you and your beneficiaries.
Since the inception of the industry more than 200 years ago, beneficiaries have traditionally received lump-sum payments of the proceeds. The default payout option of most policies remains a lump sum, says Richard Reich, president of Intramark Insurance Services, Inc.
Installments and annuities
Modern life insurance policies have seen a monumental improvement in how payouts can be delivered to the policy's beneficiaries, says Bernstein. These include an installment-payout option, or an annuity option, in which the proceeds and accumulated interest are paid out regularly over the life of the beneficiary. These choices give the policy owner the opportunity to select a pre-determined, guaranteed income stream of between five and 40 years.
"For income-protection life insurance, most life insurance buyers prefer the installment option to guarantee the proceeds will last for the necessary number of years," says Bernstein.
Beneficiaries should remember that any interest income they receive is subject to taxation. You may end up better off with the lump sum rather than installments, as you'll end up paying more in taxes on the interest if the death benefit is fairly high.
Retained asset account
Some insurers offer beneficiaries of large policies a checkbook instead of a lump sum or regular installments. The insurance company, acting as a bank or financial institution, keeps the payout in an account, allowing you to write checks against the balance. Such an account would not allow deposits but would pay interest to the beneficiary.
The term for this is accelerated death benefit. (For related insight, take a closer look at accelerated benefit riders.) Traditionally, life insurance policies will only pay out at the time of the policyholder’s death. Talk with your insurance agent about whether this option makes sense for you.
"Some life insurance companies have designed policies that allow their policyholders to draw against the face value of the policy in the event of a terminal, chronic or critical illness. These policies enable the policyholder to be the beneficiary of their own life insurance policy," says Bernstein.
The Bottom Line
Life insurance policies provide both policyholders and their loved ones peace of mind that financial difficulties may be avoided in the event of a person’s death. To expedite the claims process, and avoid errors and delays, Reich stresses that accuracy is essential when submitting any documentation or communicating with the life insurance company.
"A person’s life insurance agent can help make sure that the claim form is filled out correctly and help answer questions throughout the process," he says.