Life Settlements and the Life Insurance Payout Toolbox
Selling the policy can be seen as just another way to get cash out of a policy.
There are many options available to life insurance policy beneficiaries in regard to how they can receive the proceeds of the policy. But one often-overlooked payout method can prove beneficial in some circumstances. Life settlements are, in effect, a useful addition to the list of life insurance payout methods.
Typically, payouts are mailed within a few days to a few weeks of the insurance company receiving the proper documentation, including a certified copy of the death certificate. However, this process could face delays if the life insurance policy was purchased within two years of the policyholder’s death. If that’s the case, it is customary for the insurance company to investigate for fraud, which could take several months.
While insurers will typically list the options you have for receiving the policy payout, they don’t always provide additional information about them. Understanding what’s best for your client’s particular situation — before choosing an option — is important.
Payout Options
Life insurance policy payouts are issued to the beneficiary within a few days or weeks or receiving a completed claim form, assuming there are no delays related to life insurance fraud investigations. Once the claim is approved by the insurance company, beneficiaries must choose how they will receive the funds. The following options are usually presented:
- Lump sum: A lump sum payout is the most popular choice but there can be drawbacks. For one, receiving such a large amount of money at once can be overwhelming for some, plus the FDIC insures only up to $250,000 bank balances per depositor. This payout choice may be best for clients with multiple bank accounts to spread out the payout if the amount is more than $250,000.
- Retained asset account: Some beneficiaries have the option of leaving the payout with the life insurance company, though the interest rate could be smaller than alternative depository institutions — and interest income will be taxed. Clients who don’t want to be bothered with FDIC insurance limits associated with traditional banks may opt for this route as the insurance company will protect the entire payout amount.
- Convert to an annuity: Converting the proceeds from a death benefit to an annuity for a payout that lasts a lifetime can help control the amount of money a beneficiary has access to at one time, as opposed to a lump sum. However, the younger the beneficiary, the smaller the payout amount since they will be distributed over a longer period of time. This option may be more appealing to clients within retirement age as it offers a guaranteed source of income without risk of losing money that can be inherent in other investment vehicles, such as the stock market.
- Fixed amount: Also known as specific income payout, beneficiaries can choose to receive a set amount each month or year over a selected period of time. Once the funds are depleted, payments cease. This option, like the retained asset account option, avoids the burden and risks associated with a lump sum payout. Keep in mind that any interest your client earns is taxable.
- Life income with period certain: This option allows your client to ensure payments are made even if they die. For instance, if the individual dies in the fourth year of a 10-year period certain, the beneficiaries they have listed will receive the payments for the remaining six years of that 10-year term. This option may suit clients older in age with beneficiaries in need.
- Life settlement: A policyholder can choose to sell their policy during their lifetime. Policyholders will receive a lump sum that is more than the policy’s cash surrender value, but less than its net death benefit. Life settlements are great for people who want cash now but might be unattractive for clients who want to maximize the death benefits payout to beneficiaries.
Since life insurance payouts usually involve large sums of money, the interest earned can accrue quickly, along with taxes owed. This is an often-overlooked point to consider when choosing which payout option works best for your client. That, among other reasons, is why a life settlement is another option that should be considered for clients.