Even if you’re convinced that buying life insurance is the right call to protect your loved ones, you still have a lot to figure out. Just knowing you want a policy isn’t enough. You also need to understand how the money it gives your loved ones after you pass away — your death benefit — will be paid out to them. Can they expect a lump sum payment, or do they get the money in installments? If it’s the former, is a lump sum life insurance payment taxable? Clearly, there’s a lot to consider.
But first, what is a lump sum in term insurance or whole insurance? A lump sum life insurance payout means the people you’ve named in your policy to get your death benefit (your beneficiaries) get that money in one batch. So say, for example, that you have a policy with a death benefit of $500,000. When you pass away, if your policy provides a life insurance lump sum payment, your beneficiaries would get all $500,000 in one fell swoop.
But before we get into lump sum life insurance benefits, there’s another type of lump-sum life insurance we should quickly discuss: single-premium life insurance.
Can you pay a lump sum for life insurance?
While a lump sum is usually discussed when it comes to the end of a policy in regards to the death benefit payout, there’s a chance it might enter the conversation on the frontend, too. Some people wonder: Can whole life insurance be paid up in one lump sum? Can term insurance?
In some cases, you can pay a lump sum for your policy to lock it into place. This is called single-premium life insurance, or prepaid life insurance. Generally, if a policy has a lump sum life insurance premium option, it will be a whole, or permanent, policy, meaning it stays in force for your lifetime.
A lump sum premium life insurance policy can save you from having to budget for recurring premiums through the years, but it usually means coming up with a large amount of money to pay the policy in full. For most people, it’s not the best option for their cash flow.
Now that you know when a lump sum might apply to a life insurance policy premium, let’s get into the much more common use of lump sum in life insurance: the death benefit payout.
Is life insurance paid out in a lump sum?
Traditionally, yes. As the life insurance market has evolved, more and more options have come into play —like an annuity plan that pays out the death benefit in installments. But a life insurance lump sum payout is the most common way a death benefit is disbursed, and many life insurance providers consider it the default option for their policies. Because it’s such a common option, you can easily find both lump sum term life insurance and lump sum whole life insurance.
But is life insurance paid in a lump sum automatically? No. In order to collect a lump sum life insurance payout, the beneficiaries named in the policy will need to file a claim. In other words, the life insurance provider won’t track them down and hand them a check. Usually, to file that claim, they will need both the policy and the death certificate.
From there, assuming there are no hiccups like an investigation into the cause of death, beneficiaries can usually expect to receive the lump sum payment for life insurance in about 30 to 60 days.
What to do with a lump sum life insurance payout
Then, the question becomes what to do with lump sum life insurance payout. The beneficiaries can use that money however they wish. In most cases, the beneficiaries use at least a portion of the death benefit to pay for funeral expenses (if they don’t have burial insurance).
Beyond that, some common uses for a life insurance lump sum payout include:
- Paying off their mortgage
- Paying off other debts, like a car loan or credit cards
- Putting it into a 529 savings account for their children’s college education
- Planning a vacation to a location they know their deceased loved one always wanted to visit
- Setting up an emergency fund
- Paying for home repairs
- Paying estate taxes
- Donating to charitable causes
Beneficiaries can also take that payout and work to grow it. They could put it into a high-yield savings account or invest it, for example, to further set themselves and their dependents up for financial success in the future.
All told, once the lump sum is paid out, the beneficiaries can do anything with that money.
That can be both a blessing and a curse. While it provides immediate financial relief — especially if the beneficiaries depended on the now-passed individual’s income —it can also be a challenge. If the death benefit was supposed to stretch for a certain period of time (say, until the kids graduate college), the beneficiary then has to make sure that money is managed responsibly over the years.
In other words, life insurance with a lump sum at the end might not be the best option for all situations. That’s why you might want to decide between a life insurance lump sum or annuity.
Is it better to take an annuity or lump sum?
As an alternative to a life insurance lump sum payout, some insurance providers offer policies with a death benefit annuity. This basically means that rather than getting all of the death benefit at once, a structured installment plan begins once the claim is approved. At that point, the beneficiary starts receiving a set portion of the death benefit at regular intervals until the entire benefit is paid out.
Is it better to choose a life insurance payout lump sum or annuity? That depends on your loved ones’ situation. If you know you will be leaving them with a sizable amount of debts, a lump sum can help them clear those and avoid paying interest. But if financial planning is an added challenge you don’t want to leave behind, structured payments might be the better option for your loved ones.
If you want help deciding between a life insurance lump sum or payments, our team here at Sproutt is available. With our expertise, we can walk you through the pros and cons of your options.
Is a lump sum life insurance payment taxable?
Maybe you decide a lump sum is best for your loved ones. Or maybe you already have a life insurance policy with a lump sum payout. Either way, you probably want to know if the lump sum life insurance payment is taxable. That lump sum life insurance benefits tax could leave your family with a lot less than you had planned, after all.
Good news. The IRS says that “generally, life insurance proceeds you receive as a beneficiary due to the death of the insured person aren’t includable in gross income and you don’t have to report them.” With the IRS’s go-ahead there, beneficiaries don’t need to worry about including the lump sum life insurance payout in their annual tax filings. And that means they generally don’t need to pay a lump sum life insurance benefits tax.
That said, there are some instances when a life insurance lump sum is taxable. Specifically, any interest earned on that money can be taxed. Let’s say your beneficiary takes the life insurance lump sum payment and puts it into a high-yield savings account. Although the initial lump sum payout isn’t subject to taxation, any interest earned in that account is. To be fair, though, any interest you earn on any bank accounts, certificates of deposit (CDs), money market accounts, many types of bonds, etc. is taxable, per the IRS. So it’s not really the lump sum life insurance that’s taxable, it’s the interest — as would be the case with pretty much any other interest-earning account.
Long story short, is a life insurance lump sum taxable? Generally, no. But if you plan to earn interest on that lump sum, be prepared to both report that interest to the IRS and to pay taxes on it.
What about annuities?
Life insurance annuities are a bit of a different animal. Usually, the death benefit stays with the life insurance provider and they’re the ones to dole out the benefit in installments over time. To make the payments to the beneficiaries on the agreed-upon schedule, they keep that money in a designated account.
The good and bad news is that the account in which they keep the death benefit is usually an interest-earning one. So that means the beneficiary can expect a little upside from the portion of the death benefit they haven’t yet received. But it also means that they’re earning interest on that death benefit and — you guessed it — that interest is taxable.
That said, because the earned interest there (as with the high-yield savings account) is a perk of the death benefit, taking a little off the top for taxes probably won’t feel too painful. The beneficiary still gets the full death benefit, and they only need to worry about paying taxes on any interest they earn over and above that.
To recap the life insurance lump sum tax vs. annuity debate, here’s a quick table:
The death benefit payout is what makes a life insurance policy such a powerful tool for safeguarding what matters most to you and leaving a legacy. If you want help learning about life insurance — including choosing the right amount of death benefit and whether to leave it as a lump sum or annuity — we’re here. Don’t hesitate to contact our team of life insurance experts at Sproutt today. At the end of the day, whether your loved ones receive your death benefit as a lump sum or in installments, it can make all the difference for their financial wellbeing after you’re gone. With money to help them transition to life without you, they don’t have to stress about replacing your income, managing your debts, or covering the cost of your funeral.