One way to ensure your family’s long-term, financial well-being is through a life insurance policy. In essence, life insurance protects your family’s financial future. It safeguards against potentially devastating financial burdens that could result if something happened to you or someone you depend on financially.
Unless you’re independently wealthy, a good financial plan probably includes protecting you and your family members with life insurance policies. Working with a financial planner or a life insurance provider, you can determine how much life insurance you and your family need. Once you’ve purchased a life insurance policy that is appropriate to your specific situation, ensure you add your beneficiaries to the policy. The insurance death benefit payout will provide peace of mind today and critical financial support when the time comes.
Consider the following scenarios to determine the appropriate type of life insurance and the amount:
- Replacing income for your family in the event of your death.
- Paying for final expenses, including family travel or medical costs.
- Settling debts, or relocation costs.
- Covering childcare costs that may arise from the loss of a parent.
- Setting money aside for future expenses such as college tuition.
Claiming the Death Benefit
When it comes time for your beneficiary to claim your life insurance death benefit, there will be several options to receive the payment. Knowing what they are in advance will help remove the pressure that is often felt when trying to decide during an already difficult time. Educate yourself and your family now to understand the choices and identify which one will be best for them. The decision can significantly impact your survivors’ financial future.
The most popular and common types of life insurance settlement options are:
Life annuities provide a monthly payment for the lifetime of the beneficiary. Payments stop when the beneficiary dies. The amount of the annuity is gender and age dependent — a younger beneficiary will receive a smaller monthly amount. Once selected, this settlement option cannot be changed. There may be a minimum net death benefit required to select this option.
Life Annuity 10, 15 or 20 Years Certain
Life annuities with a certain period provide lifetime monthly payments with a minimum of 120 payments (10 years), 180 payments (15 years) or 240 payments (20 years). As with other life annuities, the amount the beneficiary will receive is gender and age dependent — younger beneficiary, smaller monthly amount. But if the beneficiary dies before payments are complete, the remainder is paid to the beneficiary’s estate, unless otherwise specified. This settlement option cannot be changed.
If your beneficiary is unsure of their option or they may not need the insurance funds immediately, they may want to take an interest-only option. The life insurance death benefit is left with the insurance company, earning interest and the beneficiary will receive a monthly payment based upon a guaranteed annual interest yield. Typically, funds may be withdrawn as needed, which will reduce the life insurance principal and the interest payment. The beneficiary may select another settlement option at any time. Upon the beneficiary’s death, the balance of the principal is paid to the beneficiary’s estate, unless otherwise specified.
The most common option is to receive the insurance death benefit as a lump sum cash payment.
The following table shows the estimated payments for the options we outline for a 75-year-old female survivor receiving a $500,000 life insurance death benefit.
|Total Death Benefit
|Monthly Taxable Amount
|Life Annuity, 10 Years Certain
|Life Annuity, 15 Years Certain
|Life Annuity, 20 Years Certain
Based on an annual crediting rate of 4.00%
The life insurance death benefit is not taxable, only the interest earned on the death benefit amount is taxable and only if it is over $600 in a calendar year.
Because receiving a lump sum payout is the most common option, let us take a closer look at it:
Lump Sum Payouts: As the name suggests, a lump sum payout allows the life insurance beneficiary to receive the entire death benefit at once. Generally, it is not counted as taxable income (only the earnings on the death benefit is taxable and in rare cases would an estate tax come into play).
Pros: A lump sum payout is the most common life insurance payout by far because it gives the beneficiary the entire amount in one payment. It allows them to have full control over the money and can use it how they want.
Cons: Receiving such a large amount of money at once can be overwhelming. Work with a financial advisor who is a fudiciary. They will provide the beneficiary with the advice that best meets their needs. If you are putting the money in a checking or savings account, you might have to spread it across several accounts if you receive a large payout. Federal Deposit Insurance Corp. deposit insurance will cover only $250,000 per depositor, per FDIC-insured bank.
Retained Asset Account: You might have the option to leave the payout with the insurance company in an interest-bearing account. Typically, life insurance companies will provide you with a checkbook, so you can access the cash in the account. The insurer also might offer an interest income option, but you will be paid only the interest that is earned on the death benefit amount.
Pros: You do not have to worry about FDIC insurance limits if you leave a large death benefit payout with the insurance company, because the insurance company will protect the entire amount.
Cons: The interest rate the insurer provides might not be as high as what you can get with a high-yield savings account or by investing the money. Plus, the interest earned on the account will be taxable.
Life Annuity Payout: You may have the option to convert an insurance payout to an annuity. You’ll then get guaranteed payments for the rest of your life. The amount of the payment will be based on your age at the time you filed the insurance claim and the amount of the death benefit.
Pros: Lifetime income can be a good option if you’re worried about outliving a large lump sum payout. It’s a guaranteed income and you could get more than the policy’s death benefit amount if you live longer than the insurance company expected when calculating your guaranteed payments.
Cons: The younger you are, the smaller the payout amounts will be because they will have to be distributed over a longer period. There could be fees associated with this option and a surrender charge if you want to withdraw all the cash. Plus, when you die the balance of the life insurance benefit, Is left with the the insurance company.
Life Annuity with Period Certain: This option allows you to ensure that payments will continue to be made for a certain period even if you were to die. For example, if you opt for life income with a 10-year period certain and die in year three, beneficiaries that you designate will receive the residual amount of the death benefit.
Pros: If you die within a certain period, your beneficiaries will receive the remaining life insurance death benefit.
Cons: The payments will be lower than what they would be with a traditional life income option to compensate for the guaranteed payout period.
Specific Annuity Payout: This option allows you to receive a life insurance payout in installments. Unlike with a life annuity option, you can choose the period over which you want to receive payments and the amount of the payments. For example, if you received a $250,000 life insurance payout, you could choose to receive $25,000 a year for 10 years.
Pros: If you’re worried about spending a lump sum payout too fast, this option can give you more flexibility than the life annuity option because you can set the payout terms.
Cons: You still have less flexibility than you would with a lump sum payout. And any interest earned will be taxable.
Find Out Which Option Is Best for You
For more information about AAFMAA’s life insurance settlement options, an AAFMAA Member Benefits Representative can help. Call 888-541-0906, select option 2, then option 2 again; or email [email protected].