What Is a Death Benefit?
A death benefit is a payout to the beneficiary of a life insurance policy, annuity, or pension when the insured or annuitant dies. For life insurance policies, death benefits are not subject to income tax and named beneficiaries ordinarily receive the death benefit as a lump-sum payment.
The policyholder can structure how the insurer pays the death benefits. For example, a policyholder may specify that the beneficiary receives half of the benefit immediately after death and the other half a year after the date of death. Also, some insurers provide beneficiaries with different payment options instead of receiving a lump sum. For example, some beneficiaries elect to use their death benefit proceeds to open a non-qualified retirement account or elect to have the benefit paid in installments.
Death benefits from retirement accounts are treated differently than life insurance policies, and they may be subject to taxation.
- A death benefit is a payout to the beneficiary of a life insurance policy, annuity, or pension when the insured or annuitant dies.
- Beneficiaries must submit proof of death and proof of the deceased's coverage to the insurer.
- Beneficiaries of life insurance policies receive the death benefit payment free of ordinary income tax.
- Annuity beneficiaries may pay income or capital gains tax on death benefits received.
Understanding Death Benefits
Individuals insured under a life insurance policy, pension, or other annuity that carries a death benefit, enter into a contract with an insurer at the time of application. Under the contract, a death or survivor benefit is guaranteed to be paid to the listed beneficiary, so long as premiums are paid while the insured or annuitant is alive. Beneficiaries have the option to receive death benefit proceeds as a lump-sum payment or a continuation of regular payments.
Beneficiaries receive the death benefit payment free of ordinary income tax, while annuity beneficiaries may pay income or capital gains tax on death benefits received. In either case, proceeds paid through life insurance or annuity death benefits avoid the cumbersome, often costly, process of probate, ultimately leading to timely payments to survivors.
Probate is a legal process whereby a will is reviewed to ascertain if it's authentic and valid. However, for most policies and accounts, if the policyholder does not name a beneficiary, the insurer pays the proceeds to the estate of the insured, which may be probated.
While not subject to income tax, life insurance death benefits may be subject to estate tax.
Requirements for Payout of Death Benefits
The process of receiving a death benefit from a life insurance policy, pension, or annuity is straightforward.
Beneficiaries first need to know which life insurance company holds the deceased's policy or annuity. There is no national insurance database or other central location that houses policy information. Instead, it is the responsibility of each insured to share policy or annuity information with beneficiaries. Once the insurance company is identified, beneficiaries must complete a death claim form, providing the insured's policy number, name, Social Security number, and date of death, and payment preferences for the death benefit proceeds.
Beneficiaries must submit death claim forms to each insurance company with which the insured or annuitant carried a policy, along with a copy of the death certificate. Most insurers require a certified death certificate, listing the cause of death. If multiple beneficiaries or survivors are listed on a policy or annuity, everyone is required to complete a death claim form to receive the applicable death benefit.
Changes to Retirement Plan Death Benefits
In 2019, the U.S. Congress passed the SECURE Act, which made changes to retirement plans, including the death benefits from inheriting an IRA.
The SECURE Act eliminated the so-called stretch provision for beneficiaries who inherit an IRA. In the past, an IRA beneficiary could stretch out the required minimum distributions from the account over their lifetime. Stretching out the distributions provided a stable income stream and helped to stretch out the tax burden.
Starting in 2020, non-spousal beneficiaries must distribute all of the money in an inherited IRA account within ten years of the owner's death. However, there are exceptions to the new law, such as spouses. There were other changes implemented–besides the ones listed here–due to the SECURE Act. It's important for investors to consult a financial professional to review the new rule changes to retirement accounts and their designated beneficiaries.
What are the tax implications of death benefits?
Death benefits under a life insurance policy are paid free of ordinary income tax. Still, estate taxes may be levied. Beneficiaries of an annuity with a death benefit may pay income or capital gains tax on the payout.
What if you think you're a beneficiary of a death benefit?
Don't rely on the insurance company to tell you! Try to find out before the policyholder dies whether or not you're named as a beneficiary. This database may have an answer if you think you are owed a benefit: the National Association of Insurance Commissioners' Life Insurance Policy Locator Service.
Beneficiaries must submit death claim forms, with a copy of a death certificate to insurers. If multiple beneficiaries or survivors are listed on a policy or annuity, everyone is required to complete a death claim form to receive the applicable death benefit.
The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.