Life Insurance Settlement Options: Ways to Receive a Life Insurance Benefit

A life insurance policy can help provide a death benefit for your beneficiaries if you pass away. Not everyone realizes there are multiple life insurance settlement options for how a beneficiary could receive the benefit if the time comes.

Your policy should specify which options your beneficiary can choose from. If you have a life insurance policy or are the beneficiary on someone else’s policy, it’s helpful to know the following insurance settlement options.

What Is a Life Insurance Death Benefit?

Just to make sure we’re on the same page, when we talk about a death benefit, we mean the money your beneficiary can claim if you pass away. This is the amount you choose as a “face value” when you purchase the policy.

With a term life policy, you have coverage for a specific duration of time (e.g., 20 years). If you outlive the term of your policy, your coverage ends, and no one claims the benefit. You’d need to set up a new policy to continue coverage. Some people only want life insurance to cover a specific period in their life, such as the years when they’re raising a family; after that, they will go without life insurance, convert their term policy to whole life insurance, or set up a different policy.

Term life is a popular option because policies typically offer lower premiums than permanent life insurance for the same face value. In other cases, some people prefer ongoing coverage. Permanent life insurance, such as whole life insurance, don’t expire as long as you stay up to date with premium payments. Some permanent policies “mature” once you reach a very advanced age (e.g., 100 or even 121), at which point the benefit would go to you rather than directly to your beneficiary.

Life Insurance Settlement Options

These are some of the most common options for how a beneficiary might choose to receive a benefit from the life insurance company when they file a claim.

Lump Sum Payment

A beneficiary can choose to receive the death benefit as a lump-sum, one-time distribution. This is a popular default choice because of its simplicity and convenience. There are no restrictions on how to use money from a death benefit, and the proceeds will generally be tax free. Your beneficiary can save, invest or use funds for final expenses or any other expenses they wish.

Interest Only

With this option, the life insurance company holds onto the principal amount of the death benefit and pays the interest to the beneficiary. The beneficiary can typically claim a partial or full withdrawal of the principal funds whenever they want. The insurance company keeps the money in a retained asset account, which is not covered by FDIC protection but is covered under the state’s insurance guaranty fund.

Bear in mind that while the principal amount of a life insurance death benefit isn’t included in your gross income and is generally exempt from income tax, interest earned is taxable.

Fixed Period

One alternative to receiving a life insurance benefit as a lump-sum payment is to have the insurance company pay proceeds over a particular length of time. The amount of time varies depending on the insurer and policy details, but it may be possible to continue receiving installments for 20 years or more. The simplistic version of this might be to say, “Pay me every month for the next ten years, whatever amount that comes out to.”

This can be a helpful option for people who may find it overwhelming to manage a large lump sum or who prefer a predictable installment schedule. Keep in mind that the funds in the insurance company’s account will earn interest, so the beneficiary receives installments with both principal and interest funds, meaning a portion of the installment is subject to taxes.

Fixed Installment

Another way a beneficiary can receive a life insurance benefit is through fixed installments. Like fixed period, this involves receiving several payments over a span of time. The difference is that a fixed installment option is based on a specific amount per payment, rather than a specific length of time. The simplistic version of this might be to say, “Pay me $5,000 per month, however long it lasts until the money runs out.”

Annuity Payment

Some life insurance policies offer an option to structure a death benefit to provide lifetime benefits, such as through an annuity. There are several options for how to structure the payments, such as “life only” (receiving payments for the rest of your life) or “period certain” (receiving payments for a specific, guaranteed term).

This option can offer dependable payments for ongoing income. For some people, receiving smaller installments on a predictable schedule is easier to manage financially than handling a six- or even seven-figure lump sum. The beneficiary may have limited access to the funds (i.e., they may not be able to reverse the decision and take a larger partial or full withdrawal later). Depending on how the option is structured, if the beneficiary passes away early, they may not receive the full value of the original death benefit.

Frequently Asked Questions

The time after losing a loved one can be challenging, both emotionally and in terms of handling various logistics. Here are some common questions and what to expect when making a life insurance claim.

How Long Does It Take to Receive a Life Insurance Settlement?

The time for an insurance company to process a life insurance claim can vary, but in many cases, you can expect to receive the benefit within 60 days, and often within a few weeks of making the claim. It can be helpful to have a death certificate as well as the insured person’s name, Social Security Number and policy number to help the process go as smoothly and efficiently as possible.

In some cases, processing a claim may take longer, such as if there is missing information or if the insured person’s death happens within the contestability period.

Is a Life Insurance Benefit Taxable?

The principal money in a life insurance benefit is generally not subject to taxes, although interest earned on the money is taxable.

Does a Life Insurance Settlement Go Through Probate?

No, a life insurance settlement typically does not go through probate if it’s going to a named, living beneficiary.

If the main and contingent beneficiaries on a policy are all deceased, or if the insured person named their estate as the beneficiary, then the benefit may have to go through probate.

Can I Choose the Settlement Option for My Beneficiary?

Typically, the beneficiary will choose a settlement option that works for them. It is also common for many life insurance policies to default to a single, lump-sum payment.

In certain cases, a policyowner may wish to restrict which settlement options their beneficiary can receive (e.g., if they’re concerned the beneficiary cannot be financially responsible). Some insurance providers may allow options such as designating a trust as the beneficiary. It may be helpful to discuss these and other options with a financial representative or estate attorney, as limiting settlement options may involve some complexities and may not be available with every policy.