To start, let’s define death benefit: It’s the money – lump sum or otherwise – that gets paid to your beneficiaries if you die while your life insurance policy is in effect. Whether you’re buying life insurance, or you’re filing a claim on a life insurance policy, there are a few things you need to know about beneficiaries:
- A beneficiary needs to be specifically designated in the life insurance policy
- There can be more than one beneficiary – and in practice, there often is
- A beneficiary doesn’t have to be a person – it can also be an entity such as a charity, family trust, or even a business
An heir is not necessarily the same thing as a life insurance beneficiary
An heir is assumed, but a beneficiary is designated. This means that if a person dies intestate (i.e., without a will), his or her heirs are the people who may be legally entitled to inherit the deceased’s estate – their spouse, children, and so forth1. One or more heirs are usually named as beneficiaries on a life insurance policy, but they don’t have to be. In fact, there are many reasons for naming someone other than your spouse or children as beneficiaries, including:
- You want to leave money to care for other family members, such as parents or a sibling
- You could leave money to a family-run business to help ensure continuity of operations after you’re gone
- You decide to leave money to your grandchildren (instead of your children) as part of your tax strategy
Even though anybody can be named as a beneficiary, you may need permission from your spouse
The most common reason people buy life insurance is to help protect their family’s financial well-being. That’s why married people commonly designate their spouse as the only primary beneficiary, especially when their children are still at home. However, if you live in a state with common property laws, you must name your spouse as the only beneficiary unless you have his or her consent to name someone else. One more thing: underage children can’t ordinarily be named as beneficiaries; if you want to leave money to a minor, you may have to set up a trust to manage the financial payout until they become of age.
Beneficiaries can be changed
When you buy an insurance policy, you can designate each beneficiary as either revocable or irrevocable. When beneficiaries are irrevocable, it can be difficult to remove them from policies or change their share without their consent. For revocable beneficiaries, the change process is relatively easy and you don’t need permission (unless it’s your spouse and you live in a common property state). For example, with Guardian, a beneficiary change can be done online in a few minutes by going to GuardianLife.com and signing in or registering for an account. Other life insurance companies may require a phone call or ask you to fill out a paper form and send it back. An annual review with your agent or financial professional can be a great time to ensure your beneficiaries are up to date.
A life insurance death benefit can be divided up any way the policyholder wants
If you’re one of four beneficiaries, that doesn’t automatically mean you’ll get one quarter of the death benefits. The policyholder can allocate different percentages to different beneficiaries.
Beneficiaries can use the money any way they want
There are no stipulations or conditions on benefit payouts. You can take the lump sum and use it for living expenses if you need, but you can also use it for any other purpose, from education to retirement savings – or even going on vacation.
The payout may not be subject to taxes
Generally speaking, life insurance death benefits are exempt from income tax (which is one of the most important life insurance tax benefits). While the benefit is usually income tax-free, you should consult with your tax advisor if you receive a death benefit payment.
Sometimes, part of the benefit can be paid out before death
Many life insurance policies have an Accelerated Death Benefit rider (i.e., optional provision) which allows policyholders with a terminal illness to access part of the death benefit amount while they are still alive – usually to help pay for needed care2. The company may need Proof of Life Expectancy from a medical provider in order to accelerate the death benefit; sums paid out will typically reduce the amount disbursed to beneficiaries after death.
Under certain circumstances a death benefit may be decreased
While every reputable company has a long history of paying out insurance death benefits in full, there are some situations in which a death benefit may be reduced:
- If an Accelerated Death Benefit was provided (see above)
- If the policyholder willfully misrepresented his or her information during the application process to obtain lower premiums, the company can reduce the benefit amount accordingly – or in some cases cancel coverage altogether
- If there were outstanding loans against the cash value (this is typically not applicable to a term life policy with no cash value)
- If the policy had an adjustable death benefit (which can be a feature of universal life insurance policies designed for flexibility), the payout may be lower than the original coverage amount
Beneficiaries can be charities or other 501(c)(3) organizations
As a means of creating a legacy, some policyholders may choose to designate a charity or other organization as their beneficiary. On some products, a policyholder can even elect to use certain options like a charitable benefit rider, which automatically provides a payout to the charity of their choice above and beyond the beneficiary payout.3
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You might think that the only function of life insurance is to provide a payout when someone dies. But it can also provide money while you’re still living in certain situations. These payouts are often called living benefits.
“Companies typically offer some way to get at your money early,” says Byron Udell, CEO of AccuQuote, a national online life insurance agency. “Most people don’t even know they have the right.”
This right typically comes in the form of a life insurance rider called an accelerated death benefit. Most life insurance companies offer this benefit automatically with their policies, but not all do. So it’s important to find out whether the policy you’re considering or the one you have includes an accelerated death benefit.
It’s also important to understand how this benefit works if you need to use it.
What Is an Accelerated Death Benefit?
An accelerated death benefit lets you access a portion of your life insurance policy’s death benefit while you’re living.
Typically, you must be diagnosed with a chronic illness or terminal illness to trigger this benefit. You can then use the money to cover medical costs, long-term care costs or, truly, for whatever you want.
The AIDS epidemic sparked the creation of the accelerated death benefit concept, according to the National Association of Insurance Commissioners. It caught on about 20 years ago as lIfe insurance companies started offering accelerated death benefits for terminal illness in response to the growing life settlement market that allows individuals to sell their insurance policies to third parties, Udell says.
“Life insurance companies don’t like people shopping policies on the secondary market,” Udell says. So accelerated death benefits allowed policyholders to gain access to death benefits while living without having to sell their policies.
Most term and permanent life insurance policies now include an accelerated death benefit for terminal illness—often at no additional cost, Udell says. Accelerated benefits for chronic illness are more commonly offered as rider on permanent life insurance policies. Some insurers charge extra for this rider, but some do not. Read your insurance contract closely or ask your insurer if your policy includes benefits for terminal or chronic illness.
If you’re buying a life insurance policy, ask if these benefits are included or if you have to pay extra for them.
How to Access an Accelerated Death Benefit
How you access an accelerated death benefit depends on whether the benefit is for a chronic or terminal illness. It also will depend on the insurer’s requirements.
Accessing an accelerated benefit for terminal illness: To access the benefit, you’ll need a diagnosis from a medical doctor that you have a terminal illness, Udell says. Insurers typically require that you have a life expectancy of 12 months or less. Some allow a life expectancy of two years or less.
Accessing an accelerated benefit for chronic illness: To trigger a chronic illness benefit, a medical professional must certify that you have a chronic condition and cannot perform two of the six activities of daily living: bathing, continence, dressing, eating, toileting and transferring. You also can typically qualify if you have a permanent severe cognitive impairment and need substantial supervision.
How Accelerated Benefits Are Paid
There’s a lot of variation when it comes to how accelerated death benefits are paid. “Nothing is standard with this benefit,” says Nate Schelhaas, vice president and actuary of individual life at Principal Financial Group. “Every design is different.”
Some accelerated death benefits are paid in a lump sum. This is more common with a benefit for a terminal illness. Chronic illness payments are more likely to be monthly.
Some accelerated death benefit riders are straightforward because they pay a certain percentage of the death benefit, Schelhaas says. That percentage can range from 25% to 95% of the death benefit, depending on the insurer and policy.
And there can be a limit on the percentage of the death benefit that can be accessed monthly or annually for a chronic illness. For example, the insurer might allow you to receive a maximum of 25% of the death benefit per year up to four years.
Some insurers, such as Principal, use their own formula to determine the amount of accelerated benefits they will pay rather than a specified percentage of the death benefit. That formula may be based on your life expectancy at the time you want to access an accelerated death benefit, so it can be hard to pin down the specific amount you’ll receive until you actually need it.
Be aware that some insurers also charge an administrative fee or service charge to access an accelerated death benefit.
Once you start receiving an accelerated death benefit, you usually no longer have to pay your life insurance premium, Schelhaas says. In most cases, you won’t have to pay taxes on an accelerated death benefit payout.
Note that the death benefit that is paid to your beneficiaries when you die will be reduced by the amount you claim as an accelerated benefit. That’s why it’s important to carefully weigh whether it’s worth taking advantage of an accelerated death benefit before you do so.
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