Grieving the death of a loved one is the hardest thing in the world. The last thing you want to do in the middle of it is stress over money—and that’s why your loved one had life insurance.
But trying to collect on their policy can be confusing. If you’re like most people, you’ve got questions like: How do I claim the life insurance payout? When will the money get here? How will the money get here?
If you’ve experienced a loss—or you’re helping a loved one through their loss—we are so sorry. This situation is devastating, and it sucks. But when you understand how life insurance payouts work, you can get the money you need to take care of yourself and your family during this difficult time. So let’s get started.
How Long Do You Have to Claim Life Insurance?
We’ll be honest: Filing a life insurance claim is important, but it probably isn’t at the top of your to-do list immediately after a loss. (Unless you need the funds for end-of-life costs.) You need time to grieve before you can put one foot in front of the other and take steps toward the future. And that’s okay.
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There’s no time limit to claim life insurance, so you can file whenever you’re ready. That said, your loved one left this money to take care of their loved ones. There will be costs coming up that need to be paid, and the life insurance payout will help cover those costs. That’s the legacy this person left to you. So it’s best to honor their intentions and file the claim as soon as you can.
What Are the Payout Options?
Before you receive the life insurance payout, you’ll have to choose how you want to be paid. These are some of the most common options.
Lump sum payments are what they sound like: You get the entire payout all at once. We recommend this option because it’s the simplest. Plus, you can put the money to good use the minute you get it because a lump sum puts you in charge—not the insurance company.
With an installment plan, the life insurance company pays you a certain amount of money on a regular schedule (usually monthly, quarterly or yearly). And that money gets paid out over a certain period of time.
For example, let’s say Paul had a $750,000 life insurance policy. His wife Jody could ask the insurance company to pay her $75,000 a year for 10 years.
Unfortunately, there’s no more money after the 10 years end. That’s why some insurance companies offer installments that last “for the rest of your life.” But there are some huge flaws with lifetime installment plans.
For starters, the life insurance company is just guessing how much money to give you based on how long they think you’ll live. So if your loved one passes away when you’re 25, you might get a couple hundred dollars a month. That isn’t even enough to cover rent.
And regardless of your age, the reality is that life is just too short. If you pass away before you get the entire payout, then poof! It disappears. The insurance company will keep the leftover money, so you can’t even leave it to anyone else.
Some people try to get around this by choosing a period certain installment, which means the insurance company will keep distributing the payout for a set amount of time—say, 20 years. If you pass away in that time, it’ll go to the secondary beneficiary listed on the original policy. If they’re still alive, that is. If not, then you guessed it—the insurance company keeps the money.
This is why we recommend lump sum payouts. You take control of all the money at the very beginning. If you invest it wisely, there will be plenty for you to live on and leave your loved ones a large, lasting legacy. When you think about the long term, lump sum payouts beat installments hands down!
You can actually let the life insurance company keep the money and invest it for you. Then they’ll pay you the interest the payout is earning—but not the payout itself. No, we’re not making this up and, yes, it’s crazy!
With this option, you have no control over your own money. That’s nuts! The insurance company chooses how to invest it—and because they’re not you, they’re not motivated to make sure you come out ahead. Which means you can’t make the right investments to get maximum returns. Instead, you’re stuck with whatever crummy investments they make for you, while they keep the giant payout your loved one intended for you to use.
It’s way smarter to get a lump sum payout and invest it with the help of a qualified investing coach. They can teach you how to make the most of this money so you can live the life your loved one wanted you to have.
How Long Does Life Insurance Take to Be Distributed?
The short answer is, it depends. The life insurance company has to review the claim and confirm that the policyholder really did pass away before they’ll distribute any money.
States know families are counting on these payouts, so they set laws that limit how long the reviews can take. Most states allow up to 30 days—but of course, each state is different, so be sure to check the laws in your area.
Once the claim is reviewed, the life insurance company can deny, delay or approve it.
Life insurance doesn’t cover all situations—like if the policyholder quit paying, lied on their application or let the policy expire. In that case, you’ll get a letter stating that the claim was denied and why. Most companies will also refund the premiums your loved one paid up to that point.
If your claim is denied and you think it was a mistake, you may be able to contest it using the insurance company’s appeals process or—if they don’t have an appeals process—hiring a lawyer. Fortunately, denials are really rare, so it’s pretty unlikely that you’ll have to deal with this.
Claims can get delayed for several reasons. Usually it’s because the paperwork is incorrect or incomplete. In that case, the reviewer will ask you for more info. Once you send it to them, the claim will either get approved or denied from there.
Another reason claims get delayed is if the policyholder died within the two-year contestability period—which is the two years directly after they purchased the policy.
Insurance companies created the two-year contestability period because people planning to commit fraud or suicide are most likely to do so during those first two years. If your loved one passed away in either of those circumstances, the life insurance company will most likely deny your claim.
Unfortunately, the two-year window can slow things down even if your loved one passed away of natural causes and told the total truth on their application. It can take up to a year for the insurance company to investigate and approve your claim. We know—it’s complicated, and it sucks. If you have questions or concerns about a delay, contact your insurance agent.
Finally, claims can get delayed if there are extenuating circumstances, such as homicide. Then you may not get the payout until any criminal investigations are over.
The good news is that most life insurance claims get approved. You’ll typically get the payout within 60 days of the approval. And if your claim was straightforward and easy to review, the life insurance payout could be distributed in as little as 10 days.
Who Gets the Life Insurance Payout?
The life insurance payout will be sent to the beneficiary listed on the policy. If there’s more than one, each beneficiary has to submit their own claim. Then, the insurance company will pay each person or organization the amount the policyholder left them.
There are some rules for beneficiaries, so here goes:
First, we recommend that people tell their loved ones who the beneficiaries are and how much each person is getting ahead of time—that way there are no unpleasant surprises! But if your loved one didn’t do this, be aware that you are not legally entitled to know who the other beneficiaries are. The insurance company can’t tell you who else is getting money—or how much.
Even if you do know who the other beneficiaries are, you can’t file a claim for them. The only exception is if you’re a financial power of attorney for someone who is a beneficiary. Then you’ll need to talk to your insurance agent about how to access that money on behalf of the person you’re caring for.
And finally, if you’re a power of attorney or trustee, you can’t keep any of the payout for yourself—unless the policyholder left you an amount as payment for helping oversee their affairs. If they didn’t, then your sole responsibility is to manage that money for others.
Do You Have to Pay Taxes on Life Insurance Payouts?
Life insurance payouts are totally income tax free—so in most cases, you’ll get the full amount of the payout. But you might have to pay other types of taxes.
Estate taxes are pretty ridiculous: They’re basically the government’s way of swooping in and taking your money now that your loved one isn’t here to protect it—or you. You’ll have to pay estate taxes if the life insurance payout plus the rest of your loved one’s estate is worth more than a certain amount. In 2021, that amount is $11.7 million, so the good news is that the average person won’t have to pay these taxes.1
Income Taxes on Interest
If you take an interest-based payout, you’ll have to pay income taxes on that interest. And it’s similar if you’re on an installment plan. With installments, the money that you haven’t received yet is earning interest—so you’ll be taxed on that interest.
And that’s another reason we recommend taking the lump sum—it keeps you in control of your finances and it’s tax-free!
What Do You Do With a Life Insurance Payout?
There are a ton of things life insurance covers (and a handful it doesn’t). The important thing is that you have a plan. This is a lot of money—you have to tell it where to go, or else you’ll be wondering where it went!
First, take care of the Four Walls: food, transportation, shelter and utilities. You can use the life insurance payout to cover these basic needs and focus on your family, instead of rushing back to work to pay the bills.
When the Four Walls are taken care of, put the remaining money toward the Baby Step you’re working on. Depending on the amount of the payout, you’ll be able to get out of debt, save and invest, and give good gifts to the people and causes you care most about. Just make sure that you take care of yourself and your family first. That’s what this money is for.
And you can continue taking care of them with your own term life insurance policy. Your loved one left you money because they wanted you to live your dreams and have a beautiful life. And you can leave that same legacy for the next generation.
Get your free quote today, and our RamseyTrusted provider Zander Insurance will help you find the right policy. So, you can have peace of mind knowing your loved ones’ futures are set.