Life Insurance Settlement Options
- Find out how the most common life insurance settlement options work, including their advantages and disadvantages and how to access funds before you die.
Choosing between life insurance settlement options is an important decision because it determines how and when your beneficiaries can access the death benefit. Below, you can find out the advantages and disadvantages of common life insurance settlement options.
What Are the Five Settlement Options for Life Insurance?
There are several life insurance settlement options, and understanding how they work can help you choose the right settlement option for your beneficiary.
1. Lump-Sum Payment
Most people choose a lump-sum payout as their preferred life insurance settlement option. After your beneficiary's claim is processed, they will receive the entire death benefit in a single transaction. Your death benefit won't usually be subject to tax unless it was invested.
The primary benefit of choosing a lump-sum settlement is that it allows your beneficiary immediate access to the entire sum and lets them spend it however and whenever they wish. It may not be the best option if you're concerned that your beneficiary won't manage a large payout responsibly. Choosing a payout option that supplies your beneficiary with smaller, regular payments could be a better bet if you want to prevent them from spending the death benefit too quickly.
2. Life Income
A life income settlement is also known as a life annuity. It lets you convert the death benefit to fixed, regular annuity payments for the rest of your beneficiary's life. The insurer guarantees an annual annuity amount based on the beneficiary's expected lifespan and the death benefit amount. Therefore, payments will usually be smaller for younger beneficiaries because the death benefit is spread over a longer period.
The primary advantage of a life income settlement is that it provides your beneficiary with a lifelong income stream and prevents them from using up the money too fast. As the income is guaranteed, your beneficiary could end up receiving more than the death benefit's value if they outlive the insurer's life expectancy estimate.
However, life income settlement agreements tend to be inflexible. This could cause problems if your beneficiary suddenly has an urgent need to access the funds because they may not be able to request additional withdrawals or change the settlement type. It's also difficult to estimate the annuity payment amount at the point of choosing a life income settlement, so it can be hard to know if it will be sufficient to meet your beneficiary's needs.
3. Fixed Amount
Unlike a life income settlement, a fixed income settlement lets you specify the amount of money your beneficiary receives each month. They will continue to receive payments until the death benefit and any cash value runs out.
Fixed income settlements can be a good option if you want to discourage your beneficiary from spending the entire death benefit all at once, but they may be allowed to change the payment amount after you pass away. However, this may be advantageous if your beneficiary has a specific reason to need more money or only requires the income for a finite period.
4. Fixed Period
Like a fixed amount settlement, a fixed period settlement spreads the death benefit payments out. However, it shares the payments over a set period instead of guaranteeing a certain amount until the money runs out. This could be a good option if you wish to ensure that your beneficiary can keep up with their mortgage payments because you can set the fixed period to end when the mortgage will be repaid.
A further advantage of a fixed period settlement is that you can nominate a contingency beneficiary. A contingency beneficiary is a person who will receive the payments if your primary beneficiary dies during the fixed period, ensuring that the death benefit goes to a loved one instead of the insurer keeping it. However, the payments may be lower than a life income settlement. This is because guaranteeing a payout period is generally more expensive for insurers.
5. Interest Income
An interest income settlement lets the insurer retain the death benefit and invest it so that it earns interest. The interest is then paid to your beneficiary to provide a regular income. Your beneficiary can usually request cash withdrawals if they need access to a larger sum.
You may wish to consider an interest income settlement if your beneficiary isn't used to managing money because it balances the need for a regular income against investing for their future financial security. However, they'll have to pay tax on the interest earned, and it may not yield as much interest as it would if your beneficiary received a lump sum and invested it themselves. It's wise to ask your insurer to explain how they would invest your money if you chose an interest income settlement and provide a projection of the estimated monthly income it would yield.
What Is Interest Accumulation?
If your beneficiary doesn't require a regular income or lump payment because they have sufficient income of their own, interest accumulation may be a suitable option. In that case, your insurer holds the death settlement on their behalf and invests it, letting the cash value grow. Therefore, it functions in a similar way to a savings account. Your beneficiary can then withdraw funds when they need to.
However, it's essential to discuss with your insurer how they plan to invest your funds. If your beneficiary is financially savvy, they may achieve better growth by receiving a lump sum settlement and reinvesting the money elsewhere.
How Are Life Insurance Settlement Options Paid?
When the insured party dies, the beneficiary must submit a paper or online claim to receive the death benefit. They will need to provide copies of the policy document and death certificate. After the claim is processed, the insurer transfers the death benefit in a lump sum or in a series of payments depending on the settlement option chosen.
Can I Cash Out My Own Life Insurance Policy?
Alternatively, you could surrender the policy and receive a lump payment from the insurer, but this will likely be significantly lower than the amount you paid in. Alternatively, you could sell your policy for cash to a third party in a transaction known as a life settlement, which usually pays more than surrendering the policy. However, bear in mind that selling or surrendering your policy means you forfeit any death benefit for your beneficiaries and lose any remaining coverage.