Before answering the question, let’s remind ourselves that life insurance payouts are generally not considered as taxable income, as reviewed in detail in the article “Do beneficiaries pay taxes on life insurance payouts?”
There are a few exceptions discussed in the article, so feel free to check it out if you want to understand more about the taxation of life and disability insurance payouts.
Regarding the question of how life insurance is paid out, there are three common ways:
#1: Lump sum payout
As its name implies, the full dollar sum of the life insurance death benefit is paid in one lump sum, usually directly into the bank account of the beneficiary.
We’ll see shortly how that is handled in the case of more than one beneficiary designated in a life insurance policy.
With this option, the death benefit is not paid to the beneficiary in one lump sum but rather in a series of payments. This way, the beneficiary is ensured of a regular income.
The insurance company pays the death benefit in regular payments to the beneficiary. The interval and the total time frame are agreed between the beneficiary and the insurance company. For example, the payments can be monthly, paid over a period of ten years.
You might wonder what the benefit is of receiving regular partial payments instead of one lump sum.
The answer is that in this case, the insurance company usually invests the sum, which then earns interest for the beneficiary. So, in addition to receiving regular payments, the beneficiary also ensures that the sum will increase over time with the accumulated interest.
It’s important to note that in this case, the beneficiary usually has to pay tax on the accumulated interest from the investment of the death benefit payout.
#3: Asset account
This method is similar to method two. In this case, if the beneficiary doesn’t need the money immediately, she can arrange with the insurance company for the money to be transferred into an asset account.
Money in this asset account is then invested by the company and accumulates a return on the invested capital, i.e., additional money for the beneficiary. The beneficiary usually retains the right to be able to withdraw money from the asset account whenever needed.
Again, as with option two, the return on the investment is taxable, so you have to pay tax on the accumulated additional income.
As every situation is different, you should consult a financial and tax advisor regarding your specific case.
How is life insurance paid out among beneficiaries?
The policy owner, i.e., the insured person, designates beneficiaries in the life insurance policy.
There can be more than one beneficiary.
Life insurance policies can have more than one beneficiary.
In this case, the insured person specifies the percentage of the dollar amount of the life insurance death benefit that is to be allocated to each beneficiary. For example, a person with a husband and two children can specify a 50% payout to her husband and 25% for each of the two children.
Another important thing is that life insurance policies usually have primary and secondary (a.k.a. contingent) beneficiaries.
Life insurance policies usually have primary and secondary (a.k.a. contingent) beneficiaries.
The purpose is that if the primary beneficiary doesn’t survive the insurance policy owner, the percentage payout of the primary beneficiary is allocated to the secondary, contingent beneficiary. Again, as with the primary beneficiary, there can be more than one contingent beneficiary specified for each of the primary beneficiaries.
In this case, the policy owner specifies the percentage allocation for each of the contingent beneficiaries.
It’s important to note that there is generally no time limit for claiming a life insurance benefit. Even if you find out years later that you are a beneficiary of a life insurance policy, you can still submit a claim for your share of the payout specified in the policy by the insured person.
How can I know if I’m a beneficiary in a policy?
In general, life insurance companies don’t inform the beneficiaries, even if they know that the insured person has passed away.
Life insurance companies usually don’t inform the beneficiaries, even if they know that the insured person has passed away.
To find a solution to that major risk, many insurance policy owners store their policies in digital wallets with digital inheritance.
Digital wallets ensure that all a client’s documents and important information are securely stored in one place, with secure 24/7 access and encryption. These documents and information can be related to digital assets and accounts, insurance policies, etc.
Digital legacy planning services enable people to designate beneficiaries, and in the event of the death of the user, the digital inheritance service proactively notifies the beneficiaries about their designated assets so they are aware of the assets and know how to identify and locate them.
Digital inheritance services ensure that the beneficiaries will be proactively notified about their designated assets and will be able to identify and locate them.
Often, users also specify important information in their digital wallets about their life insurance policies and digital accounts. This information can be accessed by the beneficiaries through the digital inheritance services, ensuring that they’ll be able to locate and access the designated digital accounts and assets in the event of the owner passing away.