How Does Life Insurance Work When Someone Dies?

Life insurance serves as a financial safety net, providing monetary support to beneficiaries after the policyholder’s death. Designated individuals or entities receive a specified sum, known as the death benefit, offering financial security during a difficult time. Understanding the process of accessing these funds is important for beneficiaries, as it involves several steps from the moment of loss to the final disbursement. This guide explains how life insurance functions when a policyholder passes away, detailing the procedures for beneficiaries to receive financial support.

Initial Steps After a Death

Upon the death of a life insurance policyholder, the immediate priority for beneficiaries involves locating the policy documents and identifying the insurance company. Policy papers often contain crucial information, including the policy number and the insurer’s contact details. If physical documents are not readily available, checking financial records, employer benefits information for group policies, or consulting with the deceased’s financial advisor or attorney can help identify the carrier.

Promptly notifying the insurance company is an important next step in initiating the claims process. Many insurers have dedicated departments or online portals for reporting a death and beginning a claim. During this initial contact, beneficiaries will need to provide basic information about the deceased, such as their full name and date of death, and state their relationship to the policyholder. Identifying all named beneficiaries is also important, as the insurer will need to communicate with all individuals entitled to the death benefit.

Gathering Claim Documentation

Collecting the necessary documentation is a crucial phase before formally submitting a life insurance claim. A certified copy of the death certificate is required by life insurance companies to verify the policyholder’s passing. This official document is obtained from the funeral home or the vital records office in the state where the death occurred. It serves as legal proof of death and helps prevent fraud.

Beneficiaries often need multiple certified copies of the death certificate, as various institutions, such as banks or government agencies, may require them. Each copy incurs a fee, which can vary by state, ranging from $10 to $25 per copy. In addition to the death certificate, the original life insurance policy or its policy number is needed to verify the claim. While some insurers may accept a copy of the policy, having the original can expedite matters.

The insurance company will also require identification for the beneficiary or beneficiaries, which involves providing a government-issued ID and proof of relationship to the deceased. Claim forms provided by the insurer must be completed accurately, requesting details such as the beneficiary’s personal information, relationship to the policyholder, and chosen payout option. Completing these forms with the gathered documentation helps avoid delays in processing the claim.

Filing a Life Insurance Claim

Once all required documents are prepared, beneficiaries can proceed with filing the life insurance claim with the insurer. Most insurance companies offer several methods for submission, including online portals, mail, or in-person at a local office. Submitting the claim electronically through an online portal can be the fastest and most secure method, providing immediate confirmation of receipt.

When submitting by mail, it is advisable to use a method that provides tracking and delivery confirmation to ensure the documents reach the insurer. Regardless of the submission method, ensuring all forms are completely filled out and all necessary documents are attached is important. Incomplete paperwork is a common reason for delays in claim processing. Insurers begin processing a claim once they receive the certified death certificate and the completed claim forms.

The processing timeline for life insurance claims can vary, but many are paid within two weeks to two months after submission, assuming all documentation is in order. However, certain factors can extend this period, such as if the death occurred within the policy’s contestability period, which is the first two years of coverage. During this period, the insurer may investigate the claim more thoroughly, including reviewing medical records, to ensure there were no misrepresentations on the application. If delays occur, the insurance company should provide updates and explanations.

Benefit Payout Options

Life insurance benefits offer various disbursement options to beneficiaries, allowing flexibility in how the funds are received. The most common method is a lump-sum payment, where the entire death benefit is paid out as a single payment. This option provides immediate and full access to the funds, which can be useful for covering large expenses like mortgages or outstanding debts.

Other options involve receiving payments over time:

• Interest-only option: The insurer holds the death benefit while paying the beneficiary regular interest on the principal. The principal remains intact and can be paid out later, to a secondary beneficiary.
• Fixed-period installments: The death benefit, plus accrued interest, is paid out in regular payments over a specified number of years, such as 10 or 20. This provides a predictable income stream for a defined period.
• Fixed-amount installments: Regular payments of a specific dollar amount are made until the entire death benefit and any interest earned are depleted.
• Lifetime income option: Guaranteed payments are provided to the beneficiary for the remainder of their life, with the amount determined by factors like the death benefit and the beneficiary’s age.

Beneficiaries can choose the payout method that best aligns with their financial needs and goals at the time of claim.

Tax Considerations for Life Insurance Proceeds

Life insurance death benefits are received by beneficiaries free from income tax. This means the full face value of the policy, when paid as a lump sum, is not considered taxable income to the recipient. This tax-advantaged status makes life insurance a tool for financial planning and wealth transfer.

However, certain situations can lead to tax implications. If the death benefit is not taken as a lump sum and instead held by the insurer to pay out over time, any interest earned on the held funds becomes taxable income to the beneficiary. For instance, if a beneficiary chooses an interest-only option or installment payments, the interest component of those payments will be subject to income tax.

Life insurance proceeds can also be subject to estate tax if the policy is included in the deceased’s taxable estate and the estate’s value exceeds the federal estate tax threshold. For example, if there are no named beneficiaries, the proceeds may default to the estate and become part of the taxable estate. The federal estate tax exemption is $13.61 million per individual in 2024, meaning most estates do not owe federal estate tax. Some states also impose their own estate or inheritance taxes, which can have lower thresholds. Additionally, if a life insurance policy was transferred for valuable consideration, the “transfer-for-value” rule may apply, making a portion of the death benefit taxable as ordinary income. This rule applies when a policy changes hands for something of value, with certain exceptions for transfers to the insured, a partner, or a corporation where the insured is a shareholder or officer.