What to Do If You Are a Life Insurance Beneficiary

Life insurance serves as a financial safety net, providing a death benefit to designated individuals upon the policyholder’s passing. This benefit helps cover expenses and maintain financial security for loved ones during a challenging time.

Understanding Beneficiary Designations

A beneficiary in life insurance is the person or entity chosen to receive the death benefit when the insured individual dies. Policyholders can name multiple beneficiaries, which can include family members, trusts, or even charitable organizations.

Beneficiaries are categorized as either primary or contingent. A primary beneficiary is the first in line to receive the death benefit. If a primary beneficiary cannot receive the proceeds, the benefit then passes to the contingent, or secondary, beneficiary.

The method by which proceeds are distributed among multiple beneficiaries can be defined using “per stirpes” or “per capita” designations. “Per stirpes,” meaning “by branch,” ensures that if a named beneficiary dies before the policyholder, that beneficiary’s share passes to their direct descendants.

Conversely, “per capita,” meaning “by heads,” distributes the death benefit equally among the surviving beneficiaries at the same generational level. If a beneficiary predeceases the policyholder under a “per capita” designation, their share is divided among the remaining living beneficiaries, rather than passing to their heirs. The default distribution method for many policies is per capita unless per stirpes is explicitly stated.

If no beneficiary is named on a policy, or if all named beneficiaries predecease the policyholder, the life insurance proceeds become part of the deceased’s estate. This can lead to the funds being subjected to probate, a legal process that can delay the payout and potentially reduce the amount received by heirs due to associated costs. Regularly reviewing and updating beneficiary designations is a step to ensure the policy proceeds are distributed efficiently and as intended.

Steps to Claiming Life Insurance Benefits

Notifying the insurer about the death can be done through a phone call or by visiting their website. Providing the policy number and the deceased’s information can help expedite this initial contact.

A certified copy of the death certificate is a document required by all insurance companies to process a claim. Beneficiaries should obtain several certified copies from the funeral director or the local vital records office, as photocopies are not accepted. This document verifies the death.

Along with the death certificate, beneficiaries will need to complete the insurer’s specific claim form. These forms are available on the insurance company’s website or can be mailed directly to the beneficiary. The claim form requires details such as the policy number, information about the deceased, and the beneficiary’s contact and identity information.

Submission of the claim form and supporting documents can be done via mail, an online portal, or in person at some insurer offices. It is important to keep copies of all submitted documents for personal records. Some insurers may request additional information or documentation during the review process, which should be provided promptly to avoid delays.

After submission, the insurance company processes the claim, which takes between two weeks and two months. However, this timeline can be extended if the death occurred within the policy’s contestability period, the first two years of coverage. During this period, insurers may investigate the circumstances of death to ensure no misrepresentations were made on the application.

Tax Treatment of Life Insurance Proceeds

Life insurance proceeds paid to a beneficiary upon the death of the insured are not subject to federal income tax. This exclusion applies to the face amount of the policy, as outlined in Internal Revenue Code Section 101.

However, exceptions exist where life insurance proceeds may become taxable. If the beneficiary opts to receive the death benefit in installments rather than a lump sum, any interest earned on the proceeds held by the insurer before distribution is considered taxable income. This interest portion must be reported by the beneficiary.

The “transfer-for-value” rule is another exception. If a life insurance policy is transferred from one owner to another for valuable consideration, a portion of the death benefit may become taxable. The taxable amount is the proceeds exceeding the consideration paid for the policy and any subsequent premiums.

Regarding estate taxes, life insurance proceeds are included in the deceased’s taxable estate if the estate is the beneficiary or if the policyholder retained “incidents of ownership” in the policy at the time of death. Incidents of ownership can include the right to change beneficiaries or borrow against the policy.

Federal estate tax applies only to estates exceeding a certain threshold, which for 2024 is $13.61 million. If the total value of the deceased’s estate, including life insurance proceeds, surpasses this amount, the estate may be subject to federal estate tax. Beneficiaries do not directly pay estate taxes; these are paid from the estate’s assets.

Some states impose their own inheritance or estate taxes, which may apply regardless of the federal threshold. The tax implications of life insurance proceeds can be complex, and this information is general in nature. Consulting with a tax professional is recommended for specific situations.

Receiving and Managing the Life Insurance Payout

Beneficiaries have several options for receiving life insurance payouts, with the lump sum being common. A lump sum payment provides the entire death benefit in a single, immediate payment, giving the beneficiary full access to the funds. This option is preferred for its simplicity and the ability to address immediate financial needs.

Alternatively, beneficiaries can choose from various settlement options that provide payments over time. These include interest income options, where the insurer holds the principal and pays out only the interest earned. Fixed period installments distribute the principal and interest over a set number of years, while fixed amount installments pay a specified sum until the entire benefit is exhausted.

A life income option, similar to an annuity, provides guaranteed payments for the beneficiary’s lifetime, with the amount determined by factors like the death benefit and the beneficiary’s age. Each payout option carries distinct advantages and disadvantages, such as immediate liquidity versus a steady income stream or potential interest accumulation.

For minor beneficiaries, direct payment of life insurance proceeds is not permitted. In such cases, the funds may be held by the insurance company in an interest-bearing account until the minor reaches legal age, 18 or 21 depending on the jurisdiction. A legal guardian or a trust established for the minor may be required to manage the funds until that time.

Upon receiving life insurance proceeds, engaging in sound financial planning is recommended. This can involve consulting with a financial advisor to determine the best use of the funds, whether for debt repayment, investment, or long-term financial security. Thoughtful management ensures the death benefit serves its intended purpose effectively.