How Is a Life Insurance Death Benefit Paid Out?

Dealing with the loss of a loved one is never easy. Alongside the emotional challenges, you may find yourself having to make legal and financial decisions.

And if your loved one had life insurance, you might wonder about settling the death claim. Here you’ll see the most common options offered by insurance companies.

How do life insurance payouts work?

When a financial advisor or family member reports a death claim to an insurance company, they provide basic information such as the insured person’s full name, the date and cause of the death and a certified death certificate. The company checks the policy to see who was named as the policy’s beneficiary. (If necessary, they look for the secondary or “contingent” beneficiary.)

The company has a contractual obligation to the named beneficiary. That means the information on the policy overrides an insured’s will or trust. A spouse or child isn’t always the named beneficiary.

The insurance company then sends a claim kit to the beneficiary regarding the benefit. The beneficiary can often choose to get a life insurance payout transferred into an investment account, as scheduled payments or simply as a lump sum—which can be a check, wire or direct deposit. The money will usually be available quickly, and it’s generally tax free.

Here’s more information on how each option works.

Transfer the money to an investment account

One option is to put the money directly into an investment account. Many financial companies—including Northwestern Mutual—can help you open an investment account and transfer the money directly to it. Investment accounts come in many shapes and sizes ranging from simple brokerage accounts to advisory accounts.

You might be inheriting a relatively large amount of money, which could produce significant returns over time if you invest it. Of course, you could also see a decrease in value if the market falls. So, this option might make sense if you won’t need the money for several years. It’s a good time to talk with a financial advisor about your goals so they can help you make the best decision for your money.

Take the lump sum

With a lump-sum distribution, you choose to receive all the money at once. Typically, you can have the insurance company either:

• send you a check,
• wire the money, or
• deposit it directly into your bank account.

Then you can do whatever you wish with the money. This option can make sense if you have an immediate need—for example, if you choose to pay off a mortgage, cover medical bills or pay down "bad debt” like a credit card balance. Even if you don’t need the money right now, there could be benefits to putting the windfall in the market all at once compared with investing it over time, a strategy known as “lump-sum investing versus dollar-cost averaging.” A financial advisor can help you weigh the pros and cons to each approach.

Create an income plan

But there may be benefits to receiving the money over time in different ways, which creates “passive income.” That’s money coming in without a lot of effort from you. It can be especially useful as retirement income. You also get to name your beneficiary(ies) for these plans. Here are some different types of income plans.

• Interest income plan. This option provides money to you without having to decide right away what you want to do with the full claim amount. As with a savings account, you receive interest on the full death claim. The interest can be paid to you or accumulate to grow the account. This allows you to make a claim without having to decide right away what you want to do with the larger death benefit. The interest is taxable at your ordinary income tax rate, although the death benefit is not. At any time, you can take some or all of the death benefit or switch to a different income plan with no fees charged.
• Period certain income plan. This plan allows you to create income for a set amount of time, say 10 or 20 years. The amount of each payment will be based on how long you want the money to last and will include interest earned on the remaining principal.
• Specified amount income plan. You can select a certain amount that you want monthly—such as $5,000 each month—and the insurance company will tell you how long your payments will last. (The process is different from an annuity, which specifies the length of time versus the amount of the payment.)
• Lifetime income plan. You can select a plan that will pay out for the rest of your life—or two people’s lives. If you specify two people, it pays out after the second person, often a spouse, dies. The amount you get will be based on your age (and the age of the second person if you select a joint income plan) at the time you begin taking payments, similar to how an income annuity works. You can also add “period certain” guarantees, which are options that ensure payments will last for you and a beneficiary for a certain amount of time, such as 10 or 20 years.

Use a mix of options

You could ultimately decide that you want to blend these options. For example, you could take one-third of your benefit as a lump sum to spend now and transfer the rest directly to an investment account.

What’s the average life insurance payout?

It’s natural to wonder how much money might be coming your way, but the answer to this question really varies by person. Life insurance payouts can be anywhere from a few thousand dollars to over a million dollars. It all depends on:

• the insured person’s financial situation;
• whether there are multiple policies, such as one through an employer and one purchased individually; and
• how many people are splitting the payout.

Talk with your advisor to choose the best option

As you plan for the years ahead, your Northwestern Mutual financial advisor can help provide clarity during a challenging time. They can help you understand your options and how to put the money to the best use. Your advisor might even identify potential opportunities or blind spots that might otherwise be overlooked—such as leaving a donation to charity.

Lifetime income plans have no cash value. Once issued, a lifetime income plan cannot be terminated (surrendered), and the death benefit proceeds placed into the income plan are not refundable and will be subject to limited or no withdrawal rights.
Portions of the payments from a lifetime income plan may be subject to ordinary income tax.