There are two types of life insurance payouts:
- Death Benefit: The first type is a death benefit payout from a life insurance policy. I.e., the payout that life insurance makes when the policyholder dies.
- Surrendering A Policy: The second type of payout occurs when a whole life insurance policy owner no longer needs their policy and chooses to “surrender” (sell) it back to their life insurance company. The policy owner then receives a cash payment equal to their cash value minus surrender fees.
In this guide, we’ll review eight different ways you can structure your life insurance payout.
For those in a hurry, see below a table that summarizes each of the eight payment options, namely the way in which they are paid out and whether the beneficiary has the option to withdraw funds off-schedule.
|Settlement Option||Payment Schedule||Early Withdrawals Allowed?|
|Lump Sum Payment||The beneficiary receives the proceeds immediately and in one payment||N/A|
|Interest Income||The beneficiary receives interest only||Yes, full or partial withdrawals allowed at any time|
|Interest Accumulation||The beneficiary does not receive any payments (until they proactively withdraw)||Yes, full or partial withdrawals allowed at any time|
|Fixed Period||Payments are divided over a fixed number of years.||Yes, full or partial withdrawals allowed at any time|
|Fixed Amount||Payments are made in fixed amounts until the proceeds have been paid in full.||Yes|
|Life Income||Payments are structured to last the entire lifetime of the beneficiary||No|
|Life Income With Period Certain||Payments are structured to last for a set period that is based on the life expectancy of the beneficiary||No|
|Joint and Survivor Life Income||Payments are structured as an annuity that pays out for as long as one beneficiary is living (i.e., the payment amounts are based on the life expectancy of the beneficiary expected to live the longest)||No|
1. Lump Sum Option
The first life settlement option is the lump sum option.
With a lump sum payment, the beneficiary receives the full proceeds immediately and in a single payout.
This gives them control over how to allocate the policy proceeds — e.g., for debt paydown, living expenses, or investment in the markets.
The risk of the lump sum payment option is that the beneficiary spends the money too quickly.
The purpose of life insurance is to cover future financial obligations, such as tuition expenses for children or income for retirement, and if the beneficiary spends the money prematurely, the policy’s intent may not be realized.
2. Interest Income Option
Under this second life settlement option, the life insurance company holds the policy proceeds in an interest-bearing account and makes interest payments to the beneficiary each month.
The original proceeds are kept in the account until withdrawn by the beneficiary, which he or she can do at any time.
3. Interest Accumulation Option
The third of these life insurance settlement options is to leave all of your policy proceeds with the insurer, including interest earned.
The earned interest accumulates and grows alongside the original sum and is reduced only when the beneficiary makes withdrawals, which he or she can do at any point.
This can be particularly attractive because your money inside a life insurance account grows tax-free. If you were to receive the death benefit in a lump sum payment and then invest it, you would have to pay both capital gains tax and income tax when you withdraw the money.
4. Fixed Period Option
Under the fixed period option, the beneficiary receives the death benefit over a specific period of time (e.g., 20 years).
As with all of these options, the death benefit would sit in an interest-bearing account and would grow by the interest earned and decrease by the amount of the fixed payments made to the beneficiary.
This may be a good idea if you have regular payments (e.g., mortgage payments) that need to be made AND the interest you are earning on the death benefit exceeds the interest you are paying on the debt. The two timeframes can be matched such that your monthly death benefit payment goes to monthly payment on the debt that you owe.
5. Fixed Amount Option
Under the fixed amount settlement option, the policy proceeds are paid out in fixed amounts until both principal and interest have been fully paid out to the beneficiary.
Note that, with this option, the beneficiary can increase or decrease the payment amount (or changes settlement options entirely) at any time.
6. Life Income Option
The sixth of these life insurance settlement options, as its name suggests, is to receive payments for the rest of your life. You can think of this as a life annuity.
The payment amount is set based on the beneficiary’s age and estimated life expectancy.
This option prevents the beneficiary from spending the policy proceeds prematurely. And instead, it guarantees them lifetime income for living expenses, debt paydown, and similar expenses.
Note that once the beneficiary chooses this option, he cannot change his mind nor can he make early withdrawals.
7. Life Income With Period Certain
With this option, the policy proceeds are converted to an annuity, which pays the beneficiary for a set period that is based on the beneficiary’s life expectancy.
Payments continue for that period of time whether or not the beneficiary lives. Any remaining funds go to a designated second individual or to the beneficiary’s estate.
8. Joint And Survivor Life Income
This final life insurance settlement option is typically used by couples.
Payments are structured as an annuity that pays out over the lifetimes of both individuals. Any amount remaining after the second spouse dies goes to a designated third beneficiary, usually a child of the couple.
The Tax treatment Of Settlement Options
An important factor to consider when choosing a settlement option is how the payments you receive will be treated for tax purposes.
For the most part, beneficiaries do not have to pay income tax on death benefit payouts. However, interest earned on the death benefit is taxable as ordinary income.
The Bottom Line
Many life insurance concepts are easier than they seem at first glance.
However, for life insurance settlement options, there is real complexity here, and therefore, it may be best to speak with a life insurance agent before choosing an option.
We would be happy to serve that function too, so if you have any questions, please don’t hesitate to leave a comment here or email us at firstname.lastname@example.org.
The GetSure Team