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If you or a loved one have life insurance, you may be curious about this and wonder, how are life insurance death benefits paid? And are they taxed? Here's an overview of the rules and payout process to help you understand how this aspect of life insurance could meet your individual needs.
What Is a Life Insurance Death Benefit?
When someone buys a life insurance policy, it will list a death benefit. It could be a few thousand dollars, hundreds of thousands or even millions. While the policyholder is alive, they pay premiums to stay covered. Provided the policy is in force, when the insured dies the insurer will pay the death benefit to the beneficiary — the person or organization that the policyholder chose to receive the death benefit.
How Is the Death Benefit Determined?
Upon signing up for life insurance, the policy owner will decide how much death benefit coverage they wish to buy. This will be listed in their initial insurance contract. Over time, this value can change. Some contracts allow the policyholder to add more coverage in the future, increasing their death benefit.
Certain types of life insurance policies, such as whole life, can also increase the death benefit over time as the policyholder pays premiums. These policies can build cash value, which is money that the policyholder can take out while they are alive through either a loan or withdrawal. However, if money is taken out of the cash value, this may generate an income tax liability, reduce the account value as well as the death benefit, and may cause the policy to lapse.
The owner of the policy — generally the person paying premiums — can see the exact value of the death benefit through their most recent account statement. They also likely can access this information through the insurer's website.
If you don't own the policy but want to know the exact amount, you would need to ask the policy owner for this private financial information while they are alive. This applies even if you are the beneficiary.
How Does the Payout Process Work?
When the person insured passes away, their beneficiary must file a death benefit claim. As a beneficiary, you'd be expected to submit a copy of the insured's death certificate along with a short form. The claim form will require details such as the policyholder's contact information, SSN and policy number. The life insurance company will pay the death benefit to the beneficiaries within a month.
A big advantage of life insurance is it can pay out the death benefit more quickly than property left through a will. Life insurance benefits generally do not have to go through probate, the legal process where courts review a person's will to distribute their property. This can take up to a year and sometimes longer.
As the beneficiary, you can choose to receive the death benefit as a single lump-sum payment. The insurer could give you other options, too, such as splitting the payment into installments over time. You could also choose for them to hold onto it for a year, only paying you interest, to allow you time to grieve and plan.
How Are Life Insurance Death Benefits Taxed?
The IRS generally does not charge income tax on life insurance death benefits. This makes insurance policies a tax-efficient way to create an inheritance.
In 2024, someone can pass on $13.61 million in property, including the value of their insurance death benefit, without owing estate taxes.1 It's only if they leave more property behind that this tax applies. Some states also charge estate taxes at a lower threshold. You would need to check with your state's laws to see if the death benefit could be taxed.
If you have questions or concerns about a future life insurance death benefit, consider speaking with a financial professional before the policyholder passes away. That would give you both more time to figure out your financial plan, especially if you need to consider how life insurance death benefits are taxed.
Sources
- Estate Tax. Internal Revenue Service. https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax.
