We’ve all dreamed of coming into a large sum of money. You imagine all the ways you’d spend a million dollars and think how much better your life would be. But what if you did get a large sum of money but it came at a great cost? This is what life insurance is all about.
But what is it like getting a life insurance death benefit and how does it actually work? What should you actually do with a life insurance benefit? We chatted with personal finance experts to find some answers.
Life insurance death benefit amounts can vary depending on the policy. Generally, life insurance payouts aren’t taxable unless you earn interest.
Emily Guy Birken, author of End Financial Stress Now received a life insurance death benefit in 2013 after her dad passed. During a time of grief, it can be difficult to do almost anything—but luckily the process of claiming her death benefit wasn’t too difficult.
“I was pleasantly surprised at how easy it was to get the life insurance payout. Based on life insurance in pop culture, I thought it would be a more drawn-out or emotionally draining process,” she says.
In order to receive the life insurance payout, Birken says she had to fill out paperwork, sign documents and send in the death certificate. It took her about two to three weeks to receive the payout. In general, this process can often take between 30 to 60 days.
When it came to actually getting the life insurance payout, Birken was offered a couple of options. “The insurer offered us the option of receiving the full amount in either a check or direct deposit, or keeping it in their interest-bearing account, which is what my sister and I both opted to do,” explains Birken.
Choosing to keep it in the interest-bearing account was a strategic move and one that helped her manage her spending.
“I chose to keep the payout in the insurer's interest-bearing account because it gave me a better rate than my savings account at the time, and I wasn't quite ready to invest the money,” notes Birken.
Her sister made the same choice because she knew it would force her to think carefully about her spending decisions, Birken says, “whereas keeping it in her bank accounts (savings or checking) would allow it to simply become part of her spending.”
Note that taking this option—leaving the death benefit in the insurer’s interest-bearing account—does mean that the interest is taxable, whereas the benefit itself typically isn’t.
Keeping it in an interest-bearing account is a safe bet, but it may make more sense to invest the funds (if you’re ready).
“Upon the death of a loved one, we encourage the beneficiary to receive the proceeds directly. This allows the beneficiary to pay final expenses and evaluate where the remaining proceeds should be allocated,” explains Jim Kirk, Financial Advisor at Rocky Mountain Financial Solutions.
“If the beneficiary already has a comfortable savings account balance and has a long-term time horizon for investing,” he says, “then investing is a better option for long-term growth than an interest-bearing account. Albeit, taking on more risk.”
If you are someone’s beneficiary and that person passes away, you could suddenly have a good chunk of money coming your way. This money can help deal with the loss of income that that person would have contributed, pay for funeral costs and manage day-to-day life while adjusting to a new reality.
“The purpose of a life insurance benefit is to replace the value of the insured who has died. In receiving a life insurance payout, the best use depends on what the coverage was designed to replace,” notes Kirk.
“For example, with a young family, the life insurance payout is best used to pay the bills for living expenses or to pay off debt the family has incurred,” he says. This includes debts incurred by the person who passed away, which in some cases will not be forgiven even after their death. “It could even be set aside to pay for the kids' college tuition.”
You want to look at your short-term needs as well as your long-term goals. Daniel R. Hill, Certified Financial Planner at Hill Wealth Strategies, likes to look at the big picture and assess where you are currently with the income loss, current debt, retirement and charity. (Here's how to bequeath to a charity in your will.)
He says, “I like to sit down with my clients and review the amount of income that has been lost. This is done to either maintain their current lifestyle or to re-evaluate and restructure their lifestyle for both the immediate and long-term.”
There are many different things you can do with a life insurance payout. Look at the big picture to identify how the funds can support you now, in the near future and in the long term. Hill recommends that, in order of priority, you:
Replace the income or financial contribution you would have received for your daily expenses from the person who passed away.
Establish an emergency fund.
Pay off high-interest debt.
A financial advisor might be able to help you get more specific. “For example, if the proceeds are provided to a family who is debt-free and the surviving spouse is still able to work, funding a college education account and increasing retirement savings may be the priority,” Kirk illustrates.
On the other hand, “Maybe the surviving spouse is a stay-at-home parent and carrying mortgage and credit card debt. For this family, it may be in their best interest to pay off the debt and use the remaining funds to support day-to-day living expenses.”
Of course, if you are feeling financially stable and don’t need this money for your immediate expenses, you might even consider making a charitable contribution in honor of the person who passed away.
Dealing with the loss of a loved one is tough. You can decide to wait a while before choosing how you want to use the money. Being in a good mental space can offer clarity and ensure you’re using the money in ways that support your family and lifestyle. But how long should you wait to figure it out? “I do not believe there is a one-size-fits-all answer,” says Hill.
One way to help reduce the emotions involved with making financial decisions during this time is to work with a financial professional.
“Part of the planning I do for clients is to run updated scenarios, with the top industry software, of their financial position including the proceeds. This removes the emotions of planning and allows the family to make the best decisions, taking into account multiple options with their proceeds,” explains Kirk.
Dealing with such a loss is devastating yet this is also an incredible last benefit from someone you loved. But don’t be surprised if the process of figuring out how to use it becomes emotional.
“I struggled emotionally with receiving this money. Even though I intellectually knew that Dad intended it to be a gift with no strings attached, I felt like it would be a betrayal of my grief if I did anything enjoyable with the money,” explains Birken.
It’s a tough situation. In the end, it’s your money to use in ways that can make your life easier and support your family going forward. We feel confident saying that’s probably what your loved one would want for you.
Fabric exists to help young families master their money. Our articles abide by strict editorial standards.
Fabric by Gerber Life exists to help young families master their money. Our articles abide by strict editorial standards.
Information provided is general and educational in nature and is not intended to be, and should not be construed as, financial, legal, or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. We make no warranties with regard to the information or results obtained by its use, and disclaim any liability arising out of your use of, or reliance on, the information.
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