How do life insurance payouts work?

Have you ever wondered what exactly happens when a life insurance policy pays out? As someone considering life insurance, it's natural to have questions about how the process works after the unfortunate event of a death. While no one wants to think about that possibility, understanding how life insurance payouts are handled can help provide peace of mind that your loved ones will be taken care of financially.

Here’s everything you need to know about the steps involved when a life insurance claim, including notifying your insurer of the death, to assisting with paperwork and receiving the payout.

Understanding life insurance payout options

Upon your death, your beneficiary or beneficiaries will need to file a claim with the insurer that carries your life insurance policy.¹ After the claim is approved, the beneficiary gets to select how they’d like to receive their life insurance payout. These payout methods can support the beneficiary’s individual needs.

Lump-sum payout

A lump-sum payout is the most common type of life insurance payout; it may be a good choice for beneficiaries who need immediate access to funds to cover expenses and financial obligations.² This could include funeral costs, outstanding debts or ongoing living expenses.

However, this option can also be risky if funds are not properly managed. Additionally, if the payout exceeds $250,000, it may be necessary to place the funds into multiple accounts.

Annuity payout

An annuity payout is a life insurance payout option where the beneficiary receives periodic payments rather than a lump sum. These payments can be monthly, quarterly, semiannually, or annually and continue for a predetermined amount of time or until the funds are exhausted.³

An annuity payout may be best for individuals who are concerned about managing a large sum of money all at once. However, it's important to note that the annuity payout method may result in a lower total payout compared to a lump sum.

Retained asset account

A retained asset account, also known as a retained death benefit or settlement option, is essentially a checking or money market account set up by the insurance company in your name.⁴ Instead of receiving a lump-sum payout, your beneficiaries will receive a checkbook or debit card linked to this account.

When the insurance company receives the death benefit claim, they deposit the funds into this account. Your beneficiaries can then access the money as needed, similar to a regular checking or savings account. They also have the option to leave the funds in the retained asset account and earn interest on the balance. This method may be a good option for beneficiaries who are not comfortable managing a large lump sum of money.

How is life insurance paid out to beneficiaries?

When it comes to deciding the beneficiary of your life insurance policy, there are several options available:

• One primary beneficiary is an option available when you want to designate a single individual to receive the payout upon your death. This person can be anyone: your spouse, child, friend or even a charity.
• Multiple primary beneficiaries can also be selected. For example, if you have two children and would like them to receive an equal share of the payout, you can list them both as primary beneficiaries. You can also allocate a specific amount or percentage to each beneficiary with this option.  
• Contingent beneficiaries are people who are designated to receive the payout in case your primary beneficiary passes away before you do. This is a crucial consideration, especially if your primary beneficiary is older than you or has any health issues.
• No beneficiary receives a payout if you do not designate any beneficiary. If your designated beneficiary passes away before you and there is no contingent beneficiary listed, the payout will go to your estate. This means that the money will be distributed according to your will or state laws.

How to file an insurance claim

The first step to filing a life insurance claim is to contact the insurance company. This can usually be done by phone or through their website. The beneficiary will need to have all the necessary information on hand, such as your policy number and the date of death.

Once they have notified the insurance company, the beneficiary is provided with a claims packet. This may include forms that need to be filled out and documents that need to be submitted, such as a death certificate. For any additional questions your beneficiary has, there are online resources available.