What is a Lump-Sum Payment?
How life insurance payouts work
If someone covered by life insurance dies, their beneficiaries can file a claim with their life insurance provider. At that point, barring any hurdles like investigations into misrepresentation, the insurer pays the policy’s death benefit to the beneficiary or beneficiaries.
The beneficiary might receive that money in a number of ways, but the most common is a lump-sum payment. In this case, the insurer pays all of the death benefit in a single deposit.
Beneficiaries may also have other options for receiving the death benefit. They may be able to establish an annuity to get periodic payments of a portion of the money, for example.
Pros and cons of a lump-sum payment
A lump-sum payment has long been the default option for life insurance payouts, but insurers have started to offer other options because these payments come with pros and cons.
The biggest con is the challenge in managing what is likely a very large sum of money. Setting up an annuity breaks the sizable amount into smaller distributions, which can help with cash flow and budgeting, ensuring that the beneficiary is provided for over a longer period of time.
The pro of a lump-sum payment is that it’s easy and tax-free. There’s no specialized account to set up and you don’t have to worry about any tax implications of the money. (With an annuity, you’re subject to taxation for any interest the money earns while sitting in the account waiting to be distributed to you.)
Additionally, a lump-sum payment can make adjusting to life without the insured easier. Getting all of the money at once means you can easily portion off an amount to cover their funeral expenses while still handling ongoing expenses. If you have any significant debts, a lump-sum payment also enables you to pay them off and avoid further interest accrual.