Life Insurance Settlement Options [2022]
- Rikin Shah | Licensed Life & Health Insurance Agent
- Updated: January 15, 2023
Life insurance riders, incontestability periods, death benefits — life insurance loves overly complicated jargon. And “life insurance settlement options” are no different.
Settlement options are a beneficiary’s options for how to receive their payout from a life insurance company.
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 payout type occurs when an individual “surrenders” (sells) their whole life insurance policy 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.
Life Settlement Options: Summary Table
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.
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 allocating 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. If the beneficiary spends the money prematurely, the policy’s intent may not be realized.
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The original proceeds are kept in the account until withdrawn by the beneficiary, which they can do at any time.
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 they 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.
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 the monthly payment on the debt you owe.
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 change settlement options entirely) at any time.
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 or make early withdrawals.
Life Income With Period Certain
With this option, the policy proceeds are converted to an annuity, which pays the beneficiary for a set period 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 the beneficiary’s estate.
Joint And Survivor Life Income
Couples typically use this final life insurance settlement option.
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
When choosing a settlement option, an important factor 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.
Life Settlement Option FAQs
Who will select the settlement option in this case?
Upon the death of the insured, the beneficiary will file a claim with the insurance company. At this point, the insurer will notify the beneficiary of the settlement option. In most cases the beneficiary can accept the option the policy owner selected or change it to one that he/she feels fit his/her needs.
What is surrender value?
Surrender value is the amount that a policyholder receives from the life insurer when he or she decides to terminate a policy before its maturity period. Suppose the policyholder decides on a mid-term surrender; in that case, the sum allocated towards the earnings and savings would be provided to him.
What is guaranteed life annuity?
A guaranteed annuity—also called a year’s certain annuity or a period certain annuity—pays out for a certain period and continues to make payments to a beneficiary or estate after the annuitant’s death.
Conclusion
Many life insurance concepts are more straightforward than they seem at first glance.
However, 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 [email protected]
Warm Regards,
The GetSure Team