Written by Heather Larson
After an insured’s death, payments to the beneficiary usually arrive within 30-60 days if no legal issues or disputes arise. Most commonly, the heir chooses to receive a lump sum equal to the face value of the life insurance policy. However, after a loved one’s passing, the family may still be grieving and the designated beneficiary may not want to make major decisions regarding life insurance payouts until he or she is emotionally prepared to face that. Insurance companies have recognized this and now offer other options besides a lump-sum payout. Financial goals, such as paying off a mortgage, sending kids to college, or caring for a special needs family member can also play a part in how life insurance payouts are structured.
So, who decides on the best payout method for the beneficiary?
“Generally speaking, the beneficiary chooses the payment structure, but in rare cases the policyholder can select the payment method,” says Catherine Theroux, spokesperson for LIMRA, an insurance and financial trade association in Windsor, Connecticut, that has been in business for 101 years.
“When a loved one dies, you’re dealing with so much to start with that you may not also want to manage a large sum of money,” says Theroux.
Because of that mindset, some life insurance carriers began offering payments to the beneficiary spread out over a period of time—usually from 5-40 years.
Here are 3 payout options which might suit your circumstances and financial needs.
1. Income Stream Payments
“This option comes in either monthly or yearly payments,” says Theroux.
Theroux notes that taking the money in regular disbursements makes sense when your beneficiary is a special needs child and supporting that child is the goal for the policy. This would also be a time where the policyholder pre-selected the payout method. A trust can be set up so the child receives equal payments over time.
Getting paid in installments could also cancel out inflation. For example, a daughter benefits from her father’s $1 million policy and he specified she gets paid in 10 equal annual installments. After the first yearly payment of $100,000, she earns interest each of the following years on the remainder. So, in the second year, she’ll receive another $100,000 plus the interest on $900,000 and so on until the money runs out. That interest may cancel out any inflation.
Depending on the carrier’s requirements, the beneficiary could receive a combination of equal payments and a large sum.
2. Single Lump Sum Payout
More often, the heir receives one payment equal to the face value of the life insurance policy. Under some circumstances, that might not be the optimal solution. As mentioned before, the loved one may already be under extreme stress and not have the ability to make wise decisions on how to use the money. Or let’s say the policyholder named a teenager as beneficiary. He or she has no money handling experience and suddenly is presented with $250,000+ policy. That can easily go awry.
Valid reasons to select the lump sum option relate to the goals of the policy. If the policyholder meant for the entire policy to cover final expenses, pay off debt or a mortgage, and/or to replace the income provided by the deceased or any combination of these, the benefactor needs all the money at once.
In the case of a high-value policy, just withdrawing the interest might meet the beneficiary’s needs.
3. Draw the Interest Only
A third payout method, used less frequently, allows the beneficiary to withdraw the interest only and leave the principal of the life insurance policy intact. This option works well if the goal of the policy is to fund a college education. Then the living spouse can draw down the interest until the child reaches college age.
Two heirs can benefit from this method, also. The first beneficiary receives interest payments until his or her death, then a second beneficiary can claim the original amount of the policy.
Whatever method of payout you choose, talk it over with your insurance agent or lawyer to make sure it meets your goals for this life insurance policy.
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