Life insurance protects your loved ones from the financial risk of being without your income when you die. If you’re covered, the insurance company pays your beneficiaries (the survivors you selected in your policy agreement) a sum of money called a life insurance death benefit.
The death benefit is the main purpose of a life insurance policy; it's essentially what you're paying for when you sign up for life insurance coverage. If you buy a $500,000 life insurance policy, that means, with some rare qualifiers, the carrier will pay that money in its entirety as a $500,000 death benefit to your beneficiaries if you die while the policy is active. The amount of coverage you need is the largest factor in determining your premium payment, so make sure not to buy more than you can afford.
Your beneficiaries can use the death benefit to pay their bills and finance their lifestyle when you are no longer around to contribute an income. There are no restrictions to its use, which can cover anything from taking a vacation, buying stocks, and even paying taxes.
How much is a death benefit?
The life insurance death benefit payment is equivalent to the amount of coverage you purchased when you signed up for your life insurance policy. It can range from a few thousand dollars to millions of dollars, but the exact amount you should purchase is contingent on your own personal needs.
When purchasing life insurance coverage, take into account all the financial expenses you help cover. That could mean payments on an auto loan, for example, which keep the car from being repossessed if your loved ones can't continue paying the bills.
In fact, any loan debt that your surviving spouse (or anyone else) had co-signed will become his or her sole obligation when you die.
The death benefit should be large enough to cover a variety of situations, including end-of-life expenses like the cost of a funeral, or the cost of college tuition if you have dependents. It's common for someone with two dependents and a spouse to need well over a million dollars in coverage.
When do you receive the death benefit payment?
Although the death benefit is paid to the insured's beneficiaries upon death, it doesn't always happen automatically. The life insurance company doesn't always know when the policy owner has died, so the beneficiary must alert them by filing a claim.
Take these steps to receive the death benefit payment:
Find the insured’s policy document. If you can't find their life insurance policy in their home or digital records, also check the National Association of Insurance Commissioners' Life Insurance Policy Locator Service, which searches a database of known policies.
Fill out a claims form, also known as a “request for benefits.”
Provide a death certificate to the deceased’s insurance agent.
Once the provider confirms the policy holder’s death and approves the claim, you will be paid the death benefit.
When is the death benefit paid?
Once you file a claim, you may receive the death benefit in as little as one to two weeks, but it could take as long as 60 days if the life insurance company needs more time to review the claim.
Delays may be caused by a suspicious death that occurs during the contestability period, which lasts for two years after the policy is put in force. During this time, the life insurance carrier reserves the right to dispute any death benefit claim.
How is the death benefit paid?
Most people choose a lump sum payment, usually in the form of a check or a direct deposit into their bank account, which is listed on the claim form.
Others may choose to convert the death benefit into an annuity, depositing the death benefit payments into an investment account from which yearly annuity payments are made to the beneficiary until the money runs out.
Can the death benefit amount ever decrease?
If you lied about or misrepresented any personal or medical information during the application process to obtain a lower premium rate, the life insurance company may find out when you die and decrease the death benefit.
The policy holder is expected to tell the complete truth about his or her medical history and lifestyle, including any illnesses and risky hobbies, when signing up for an insurance policy. The life insurance company will use that information along with your coverage needs to determine the cost of your premium payments.
If the insurance company discovers false information, they may reduce the death benefit by the amount in premiums that you would have paid had you represented yourself truthfully. The carrier may even cancel your policy altogether and deny your beneficiaries the death benefit that you had been paying through your life.
Adjustable life insurance
Another way the death benefit may change is with an adjustable life insurance plan. True to its name, under this type of insurance plan you can adjust the death benefit amount as your needs change.
Cash-value life insurance
Unlike term insurance, cash-value life insurance comes with an investment-like component that gains value over the years. This will increase the death benefit if you don’t access the cash value while alive.
Is the death benefit taxable?
The death benefit is generally not taxable if you paid your premiums using after-tax dollars.
However, it may be taxable in certain circumstances:
If you have an employer-sponsored plan, or group life insurance, or if you paid your premiums with pre-tax dollars.
If you put your death benefit in a trust, such as when the beneficiary is a child. Payments to the child for his or her expenses may be taxed as the child's income.
If you opted for a permanent life insurance policy with a cash-value component, such as whole life insurance. Any gains you make from the cash value may be taxable if you withdraw them as cash. Check with your financial planner to confirm.