According to the Insurance Information Institute, insurance companies pay out billions of dollars in claims to policyholders annually. If you are filing an insurance claim, you may be presented with different payout options. What should you consider before choosing a payout option and what should your priorities be once you receive the funds? This article will take you through the basics of how to evaluate, choose, use and invest your insurance payout.
Evaluating Your Payout Choices
Depending on the type of policy and the nature of your claim, you may be presented with the following payout options:
- Lump Sum: With a lump-sum payout, you receive all of the funds you are entitled to in one payment.
- Advance Payment: You may be able to receive an advance payment on an insurance claim if you require money for immediate needs, such as safe housing, food and clothing after a natural disaster.
- Partial Payment Contingent on Certain Conditions: Your insurance company may provide only partial payment on your claim if certain conditions are met, such as if a qualified contractor is secured to do necessary repair work on insured property or assets.
If you are filing a death benefit claim as a life insurance policy beneficiary, you will most likely be presented with several additional payout options:
- Life Income: This option enables you to receive guaranteed, fixed monthly payments for the remainder of your life. The amount is determined by your age and gender, and payment will cease when you die (you cannot name a beneficiary to continue receiving funds from the policy after you die).
- Life Income Within a Certain Period: This life insurance payout option enables you to receive a guaranteed portion of the death benefit for life or a certain period of time (i.e., 10, 20 or 30 years), whichever is longer. The longer the period selected, the lower your annual payment.
- Joint and Survivor Life Income: Under this option, you can choose to have a guaranteed amount of income paid out over two or more lives, yours and another beneficiary you name. The death benefit payments would then be guaranteed until the last beneficiary dies.
- Interest Income: With this option, you can choose to have all or a portion of the death benefits remain with the insurance company to earn interest and then have that interest paid out to you monthly, quarterly, semi-annually or annually. You will want to know if your funds are earning a fixed rate of interest income or if the interest rate is variable; if the interest rate is variable, find out the minimum and maximum interest rates that you could earn on your investment. You may be allowed to withdraw up to a certain amount of principal under certain conditions.
- Specific Income: With this option, you can choose how much money you want to receive on what basis (i.e., quarterly, annually, etc.) until the death benefit is completely paid out. You can also name a secondary beneficiary to receive the remainder of the payments if you die before then.
Before you select a payout option, you'll want to make sure you have considered your financial needs and goals by answering questions such as the following:
- Do you need the entire sum to pay for claim-related bills or assistance?
- Are there conditions related to your claim that you will be able to satisfy within the required time period?
- If you can't access necessary claim-related assistance (i.e., contractors for repair work), could you delay the bulk of payment and just use nominal advance payment for immediate needs?
- What is your current and projected income, and how could this benefit supplement it to help you reach your long-term goals (i.e., retirement, paying for a child's college education, etc.)?
Once You Receive a Check
After your claim is approved, you will receive a check that might be the first in a series of payments. What should your priorities be for those funds?
- Claim-Related Expenses and Bills: If you have already incurred expenses related to your insurance claim (i.e., car repair bills for an auto insurance claim, home damage repair work for a homeowner's insurance claim, funeral costs for a life insurance death benefit claim, etc.), use the funds to pay those bills first. It's largely what the insurance was intended for in the first place.
- Claim-Related Debt: If you have put claim-related expenses on your credit card or taken out a loan to cover expenses while you were waiting for the payout, use the funds to pay off that debt so that you don't end up paying additional money in high interest and fees.
- Taxes: While insurance payouts typically aren't taxed, be sure to check the fine print on your claim check or policy. If you're unsure, speak with a representative at your insurance company, a financial advisor or tax attorney.
- Assistance Related to Claim: If you filed the claim for damage to your home, car or other property, make sure you use the funds for the purpose of making those repairs or renovations. It can be easy to view the insurance claim check as "free money" and use the funds for everyday items or other financial needs, but then you may find you don't have the funds necessary when help is available.
Options for 'Parking' Remaining Funds
You may not spend your entire payout at once. If you can't access needed assistance and don't want to deposit funds into a checking account where you may be tempted to dip into it, or you have additional funds remaining after paying bills and claim-related expenses, consider investment vehicles that may pay a small amount of interest while you evaluate longer-term investment options. Depending on how long it will be until you need to access your payout funds, you may want to park your money in:
- a money market deposit account
- a money market fund
- a high-yield bank account
- a short-term certificate of deposit, or CD
- U.S. Treasuries
- short-term bond funds
It's wise to take some time and get professional advice before making a financial investment. Before you choose to invest your payout, make sure you have determined the following:
- Your time horizon: The sooner you need your money, the less risk you will want to take with the money you have to invest.
- Whether your funds are insured by the Federal Deposit Insurance Corporation, or FDIC.
- How much interest you will be paid, and if the rate is fixed or variable (subject to change).
- What fees you will be charged, and if those fees will be automatically withdrawn from your account or if you will be billed separately.
- If you have the ability to withdraw or transfer money from the investment account.
- What penalties you could possibly incur if you change plans and want to withdraw money sooner than you originally planned.
If you are unsure of which payout option is most appropriate for your financial needs, goals, and tax status, consider getting professional help. You can ask questions and request information from the policyholder services department of your insurance company, a professional financial advisor, or possibly a tax adviser. Make sure you understand their fee schedule and ensure that they have experience working with someone in your particular situation.
The Bottom Line
Insurance policies are financial tools. Carefully consider your current financial situation, needs, and goals before deciding on a payout option. An investment or tax professional can be vital in determining the best options for both payouts and short-term investment options to manage your cash flow.