Once a person dies, their life insurance inheritance will go to the policy beneficiaries. Whether you are one such beneficiary, or looking to get a life insurance for yourself, understanding how life insurance works is important.
In this article, we are examining how life insurance works, and what tax and financial obligations the beneficiaries will have to face.
Knowing how these work will give peace of mind to the insured person and allow the beneficiaries to move on with the insurance inheritance without issues. Read on to find the ins and outs of life insurance payout after death.
How Does Life Insurance Work?
Life insurance is perhaps the most popular long term financial planning tool. The insured person pays a monthly premium in exchange for a sizable lump sum upon the insured person’s death.
Upon the insured person’s death, the people who are listed as beneficiaries of the policy are eligible to inherit that lump sum, which is also known as life insurance payout, life insurance inheritance, and death benefit.
There are several different types of life insurance, with varying degrees of coverage. The most common and usually the most inexpensive type of life insurance is term life insurance. Term life insurance provides coverage for a set amount of time. The monthly premium stays the same for the duration of the insurance, and if the insured person dies during that time, the insurance triggers.
An insured person can upgrade their term insurance into a permanent life insurance. This provides universal coverage until the end of the insured person’s life. The insured person can adjust the monthly payments, which in turn affect the insurance payout after their death.
Collecting a Life Insurance Payout
In order for the beneficiaries to claim the life insurance inheritance, they must follow certain steps. After the death of the insured person, the beneficiaries must file a claim and present two documents to the life insurance company. Those two documents are the original death certificate and the life insurance policy.
Depending on where the insured person died, the beneficiaries will have to contact different authorities for the death certificate. If the insured person died in a hospital or a nursing home, that institution must issue the death certificate.
The beneficiaries don’t have any time limit to file the claim and submit the documents. In most states, insurance companies get a month to verify the papers before releasing the funds.
Upon verification, the life insurance company will release the funds to the accounts of the beneficiaries according to the specifics of the policy. Note that life insurance inheritance is not part of the insured person’s probate estate.
In case the insurance company denies the claim, beneficiaries might have to provide additional information.
Alternative Life Insurance Payout Options
In addition to a lump sum insurance payout, insurance companies are now offering a range of alternative life insurance payout options depending on the insured person’s policy.
The most common alternative payout method is pre-death benefits. With pre-death benefits, the insured person is eligible to claim a portion of their life insurance payout while they are still alive. This sum becomes available in case of serious illness or injury.
Another common alternative is life insurance installments. Installments work by paying the beneficiaries a monthly sum until the total cost of the insurance payout has been repaid. This ensures that beneficiaries will have a steady stream of income in their balance, instead of a sizable sum of money.
Life insurance policy holders can also specify for their life insurance payout to be withheld until the beneficiary is of a certain age. They can also set up an annuity payout. With annuity, the payout is withheld and interest is paid out periodically to the beneficiary.
Life Insurance Payout Complications
There are many reasons for an insurance company to deny the claim or delay payment. If the insured person did not die a natural death, the insurance company might require additional information about the nature of their death. The most common such complication is when the insured person was the victim of a homicide.
Another reason for delayed payment is the contestability clause. Most life insurance policies have such a clause, which triggers if the insured person died less than two years after the policy was signed. The contestability clause protects the insurance company in case of fraud.
Taxes and other Obligations Related to Life Insurance Payout
A life insurance payout does not burden the income tax of the beneficiaries. This is also true for the estate and inheritance tax. Life insurance payout work that way because they are essentially paid out after the insured person’s death, so the money was never technically in their possession.
In some states, beneficiaries will have to pay a percentage of the payout as state taxes.
Note that in case of installment or annuity payouts, beneficiaries will have to pay an income tax on the income made after the insured person’s death.
Finally, if the insured person had any outstanding debts, these will not carry over to their life insurance payout. Inheritance beneficiaries might inherit some or all of the insured person’s debt, but this will not be deducted directly from the life insurance payout.
Now That You Know How to Collect Life Insurance Payout after Death…
Knowing what to do with life insurance payout after death can save you a lot of time and hassle. Here at Insurdinary, we strive to offer informative articles on insurance and financial products and services.
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