What are Settlement Options?
In life insurance, the settlement options are the choices the beneficiary has to receive the payout from the life insurance policy when the insured dies.
Common life insurance settlement options
A life settlement is the amount of money that a policy’s named beneficiaries receive when the insured passes away. It’s equal to the policy’s death benefit, minus any relevant deductions. If the insured used part of the benefit while they were alive (e.g., toward an activated long-term care rider) or had an outstanding loan against the policy’s cash value, that amount will get subtracted from the death benefit before the policy’s settlement gets distributed.
The beneficiary or beneficiaries have choices as far as how they’ll get the remaining money. These settlement options vary from insurer to insurer, but common ones include:
Lump-sum payment. This is the most common settlement option. With this choice, the beneficiary receives the entirety of the settlement in one lump sum.
Interest-earning accounts. With this option, the beneficiary leaves the money with the life insurance provider, which puts the money into an interest-earning account. This then functions like a savings account, with the beneficiary receiving interest payments periodically. They can withdraw the money when they need it. The beneficiary may receive a checkbook to make withdrawals against the account, in which case the settlement option is called a retained asset account.
Annuity. In this case, the money gets held in an interest-earning account but gets distributed to the beneficiary periodically, usually as a certain amount at prespecified times (e.g., annually). Annuities can be structured to pay a fixed amount periodically until the death benefit is exhausted, or to provide lifetime income. In that case, the annuity provider calculates how much the beneficiary should receive in each payment period based on their life expectancy.
Lump-sum payments aren’t subject to income taxes. With interest-earning accounts and annuities, the death benefit isn’t taxable, but earned interest is.