What You Need To Know About Collecting Life Insurance Proceeds

A magnifying glass sits on top of a life insurance leaflet that instructs beneficiaries on collecting life insurance proceeds.

What You Need To Know About Collecting Life Insurance Proceeds

Life insurance allows people to leave money for those they love after they have passed away without needing to open a bank account, create a trust, or announce the amount of money in a Last Will and Testament. By taking out a policy and naming a beneficiary, you can ensure your spouse, children, or other loved ones are financially secure quickly and privately. Despite the ease and privacy of life insurance, there are some important things to know about collecting life insurance. If you have questions about ensuring your family receives your life insurance, or you are trying to collect life insurance proceeds and are having trouble, our knowledgeable Florida estate planning attorneys at Loughlin Law, P.A. may be able to assist you. Call (561) 677-8384 to schedule a consultation and learn more about life insurance death benefits.

Filing a Life Insurance Claim

One of the most important things to know about collecting life insurance is that the beneficiary must file a claim after the policyholder has died. The beneficiary is the only individual who can file the claim, which is one reason why minor children cannot be beneficiaries on a life insurance policy. Beneficiaries must have the policyholder’s death certificate and a claim form from the life insurance company that holds the policy. This requires determining who has the policy or policies, as the deceased may have more than one policy. There are many ways to find this information, including reviewing the deceased’s files and using the National Association of Insurance Commissioners’ (NAIC) Life Insurance Policy Locator. If beneficiaries use the NAIC locator, they should note that they will only be contacted if a policy is found that they are listed as the beneficiary on. If there are other policies with other beneficiaries, those individuals must conduct their own searches. Therefore, if the deceased may have had multiple policies but the family has no confirmation, they may need to perform multiple searches in the locator.

Once the policy or policies have been located, beneficiaries will fill out the claim form and submit it with a copy of the death certificate. They will also need the policy number, deceased’s date of birth, full name, date of death, location of the death, cause of death, and beneficiary name. The life insurance company will review the claim; the beneficiary will choose the payout form if approved. The beneficiary may need to file an appeal if the claim is denied.

Do I Report Life Insurance Proceeds as Taxable Income?

Life insurance proceeds are typically not included in the beneficiary’s gross income and do not need to be reported on their tax return. However, the Internal Revenue Service (IRS) does state that any interest received is taxable, and the beneficiary should report it as interest received. Depending on the chosen payout option, beneficiaries may not need to pay any taxes. If they select an option that pays interest, they should receive the appropriate tax documents to claim the interest on their tax return. Life insurance is also not subject to federal estate tax, and Florida does not have an estate or inheritance tax.

One instance where life insurance would be taxable is if the policy is surrendered for cash. If the policyholder surrenders the policy for its cash value, any proceeds that are more than the cost of the policy are taxable. The policyholder would receive an IRS Form 1099-R showing the total proceeds and taxable part of the proceeds. These numbers would be entered into lines 5a and 5b respectively on IRS Form 1040 or 1040-SR.

What Are the Payout Options?

Most life insurance policies offer different payout options for the life insurance proceeds. Different insurers might offer various options, so beneficiaries will need to confirm their options with the specific insurance company holding the policy. There are five standard payout options that beneficiaries may be able to choose from: lump sum, specific income, interest income, retained asset accounts, and converting to an annuity.

Lump Sum

Lump sum payments may be the most common option for life insurance proceeds. With this option, the beneficiary gets the death benefits all at once. Because this money is not taxed, the beneficiary can use all of the proceeds as they wish. They can spend it, add it to a savings or retirement account, or use it to pay off debts.

Specific Income

A specific income payout happens when the insurance company deposits the payout in an interest-bearing account that is taxable, and the beneficiary or beneficiaries are paid monthly installments over a set period. Because the life insurance proceeds are in a taxable account, the beneficiaries would receive a tax document each year. They must claim the appropriate amount on their taxes until they are no longer collecting life insurance from that policy.

Interest Income

With an interest income payout, the insurance company holds the principal of the death benefit and pays the beneficiary the interest earned on the principal. This payout option allows the beneficiary to make larger withdrawals upon request. One advantage of this payout option is that it lets the principal continue to grow and can enable the principal to act as an emergency fund for the beneficiary. However, because it is paying out the interest, the beneficiary must pay taxes on the money received.

Retained Asset Account

The retained asset account payout option is similar to a checking account. The insurance company holds the payout in an interest-accruing account, sends the beneficiary a book of drafts that are very similar to checks, and the beneficiary writes checks as needed. The NAIC indicates that this option is intended to allow the beneficiary or beneficiaries to have time to consider all of their payout options before choosing one while still being able to access the proceeds if they need to before making their final decision.

This can be a good option for beneficiaries who need extra time to consider which payout option is best for them, as it keeps the money secure and allows them to earn interest simultaneously. However, this option also means the beneficiary must pay taxes on the interest earned.

Convert To Annuity

Another option for collecting life insurance is to convert the policy to an annuity and receive guaranteed payments for a set period of time or the rest of the beneficiary’s life. This allows the remaining principal from the life insurance proceeds to continue earning interest even as the beneficiary receives payments. The longer the payout timeframe, the more interest the money will earn. As with other payout options, the beneficiary must pay taxes on the interest earned.

An estate planning attorney at Loughlin Law, P.A. may be able to assist you in determining which payout option is more suited to your circumstances. We may also be able to assist you in filing the claim or addressing any other issues with the life insurance company.

What Might Delay Collecting Life Insurance Payouts?

One of the reasons many people decide to get life insurance is the swiftness with which the beneficiary can access the life insurance proceeds. Once they receive a death certificate and file a claim form, the insurance company can approve and pay out the claim. However, in some instances, beneficiaries may find the payout delayed. There are several reasons this may happen, including:

  • Policy Lapse: If the policyholder failed to pay the premiums or if the policy was a term life policy and the term ended before the policyholder died, the claim may be denied.
  • Contestability Period: Many life insurance policies have a contestability period during the policy’s first two to three years. If the policyholder dies during this period, the insurance company may delay the claim as they review the application for any fraud that they can use to deny the claim.
  • Beneficiary Issues: Beneficiary issues such as missing or incomplete beneficiary information, a beneficiary filing the claim late (multiple beneficiaries on a policy must file their claims at the same time), or a beneficiary being changed just before the policyholder died may all cause the insurance company to delay payment as they try to confirm or correct the issues.
  • Material Misrepresentation: If the insurance company finds a misrepresentation in the application for life insurance that would have made a difference in accepting the risk and/or the rate the policyholder would have been charged, they can deny the claim.
  • Failure To Provide Necessary Documentation: A death certificate and claim form are often all that is needed to file a life insurance claim. However, if either of these documents or others requested by the insurance company are not provided, the company may not issue the payout until they receive the documentation.
  • Accidental Death or Other Exclusions: Many life insurance policies exclude accidental deaths. They also often exclude high-risk hobbies (such as skydiving) or careers (such as racecar drivers).

Is There Any Difference in Collecting Life Insurance Proceeds From a Term Life Policy Instead of a Whole Life Policy?

Term and whole life insurance are two of several types of life insurance policies. Term life is a policy that lasts for a set period of time, typically 10 to 30 years. Whole life is a policy that lasts for the entirety of the policyholder’s life from the purchase date as long as the premiums are paid. Whole life also allows the policyholder to borrow against the principal, while term life does not.

The process for filing a claim and choosing a payout option is generally the same for term and whole life policies. If the term of a term policy has already passed, there will not be a payout. Beneficiaries should carefully review term policies to ensure that they are current and not outdated, lapsed policies before filing claims. Additionally, because whole life allows the policyholder to borrow from the policy, if they had an outstanding loan against the policy’s cash value when they died, the death benefits would be reduced by the loan amount. A term life payout will be the amount promised in the policy, as the policyholder cannot borrow against the policy.

How Can an Estate Planning Attorney Assist You With Collecting Life Insurance?

If you believe you are the beneficiary of a life insurance policy, an estate planning attorney may be able to provide valuable assistance. If you can speak to the attorney who helped your loved one create their estate plan, you may be able to find out which insurance company is holding the policy or policies. Even if that is not an option, an attorney may be able to help you search for policies, get copies of the death certificate, fill out claim forms, and, if necessary, file an appeal if the claim is denied. If the life insurance proceeds payout is delayed, an attorney may be able to contact the insurance company and clear up any issues so you can collect the proceeds. If you have questions or are having difficulty collecting life insurance, Loughlin Law, P.A. may be able to assist you. Call (561) 677-8384 to schedule a consultation with one of our experienced Florida estate planning attorneys.

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