What Is the Option That Provides an Additional Death Benefit?

Life insurance is designed to provide financial security for beneficiaries after the policyholder’s death, but some policies offer additional benefits beyond the standard payout. These extra provisions can increase the total amount received under specific conditions, offering added peace of mind.

Optional Policy Provisions

Life insurance policies often include optional features that enhance the payout. These provisions, known as riders or clauses, allow policyholders to tailor coverage to their needs. Some of the most common options include accidental death riders, return of premium clauses, and supplemental term coverage.

Accidental Death Rider

This rider increases the payout if the insured’s death results from an accident. Often called “double indemnity,” it typically provides an additional benefit equal to the base policy’s face value, effectively doubling the total payout. Some policies offer a tiered structure where the payout varies based on circumstances, such as whether the accident occurred while traveling or at work.

Insurers define accidents differently, and exclusions apply. Deaths from high-risk activities like skydiving, racing, or intoxication-related incidents are often not covered. The cost of this rider depends on factors like age, health, and occupation. Those in high-risk jobs, such as construction workers or law enforcement officers, may face higher premiums or restrictions. Reviewing the policy’s terms ensures this rider aligns with the policyholder’s needs.

Return of Premium Clause

This provision refunds some or all of the premiums paid if the insured outlives the policy term. Primarily associated with term life insurance, some permanent policies also offer it as an add-on. If the insured dies during the coverage period, the death benefit is paid as usual, sometimes with an additional sum representing refunded premiums.

This clause functions as a form of forced savings, allowing policyholders to recover their investment if they outlive the term. However, policies with this option have significantly higher premiums than standard term life insurance. Insurers may also impose restrictions, such as requiring continuous coverage for a minimum number of years before any refund is available. Weighing the higher cost against the potential refund is important before opting in.

Supplemental Term Coverage

This option lets policyholders add temporary extra coverage to their base policy for a set number of years. It is often used to cover financial obligations like a mortgage or a child’s education, ensuring beneficiaries receive additional support during key periods.

Unlike a standalone term life policy, supplemental term coverage is attached to a permanent insurance plan or larger term policy, allowing flexibility in coverage amounts. Some insurers let policyholders convert this temporary coverage into permanent insurance without requiring a medical exam, which can be beneficial if health conditions change. The cost depends on age, health, and the length of the supplemental term. Comparing costs with standalone term policies helps determine if this option is worthwhile.

Payout Methods

Life insurance beneficiaries have multiple options for receiving the death benefit, each with different financial implications. The most common choice is a lump sum payment, which provides immediate access to funds for funeral costs, outstanding debts, or daily expenses. Since this payout is generally tax-free, beneficiaries can use the money without concerns about deductions or penalties.

For those who prefer structured distributions, insurers offer installment payments or annuitized options. Installment payouts divide the death benefit into fixed payments over a set period, such as 10, 20, or 30 years, helping prevent rapid depletion of funds and ensuring long-term financial stability. Some policies allow beneficiaries to choose whether payments include interest, which can provide additional income.

Annuity-based payouts follow a similar structure but are designed to last for the beneficiary’s lifetime, offering a predictable income stream. These arrangements can be useful for individuals who lack experience managing large sums of money or want guaranteed financial security over decades.

Another option is the retained asset account, where the insurer holds the proceeds in an interest-bearing account, and the beneficiary can withdraw funds as needed. This method provides liquidity while allowing the remaining balance to grow. However, interest rates on these accounts may be lower than other investment options, and some insurers impose withdrawal restrictions. Beneficiaries should compare returns before committing to this option.

Tax Considerations

Life insurance benefits are generally not subject to federal income tax when paid to beneficiaries, but certain situations can create unexpected tax liabilities.

One issue arises with the “three-party rule,” where the policy owner, the insured, and the beneficiary are three different individuals. In this case, the IRS may classify the death benefit as a taxable gift from the policy owner to the beneficiary. If the amount exceeds the annual gift tax exclusion of $18,000 per recipient in 2024, it may count against the lifetime gift tax exemption, currently set at $13.61 million.

Estate taxes can also apply if the policyholder retains ownership of the policy at the time of death. Under IRS rules, life insurance proceeds are included in the insured’s taxable estate if they had “incidents of ownership,” such as the ability to change beneficiaries or borrow against the policy’s cash value. If the total estate value, including the life insurance payout, exceeds the federal estate tax exemption of $13.61 million for 2024, the excess amount may be taxed at up to 40%. To avoid this, policyholders often transfer ownership to an irrevocable life insurance trust (ILIT), which removes the proceeds from their taxable estate, provided they survive at least three years after the transfer.

Policy loans and withdrawals from permanent life insurance policies have their own tax implications. Loans taken against the policy’s cash value are typically not taxable as long as the policy remains active. However, if the policy lapses or is surrendered with an outstanding loan, the borrowed amount exceeding the premiums paid becomes taxable as ordinary income. Withdrawals from a policy’s cash value follow the “first-in, first-out” (FIFO) rule, meaning the portion equivalent to the premiums paid is tax-free, while any amount exceeding the cost basis is subject to income tax.