Death Benefit

What Is a Death Benefit and How Does It Work?

When the insured or annuitant dies, a death benefit is paid to the recipient of a life insurance policy, annuity, or pension. Death payments from life insurance plans are not taxed, and named recipients often get the death benefit as a lump-sum payment.

The policyholder has control over how the insurer distributes death payments. For example, a policyholder may specify that half of the benefit is paid out immediately after death and the other half is paid out a year later. In addition, instead of getting a lump sum payout, some insurers offer beneficiaries a variety of payment choices. Some recipients, for example, can choose to utilize the funds of their death benefit to start a non-qualified retirement account or to have the benefit paid in installments. The treatment of death benefits from retirement accounts differs from that of life insurance policies. It's possible that the death benefits from these accounts will be taxed.

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TAKEAWAYS IMPORTANT

• When the insured or annuitant dies, a death benefit is paid to the recipient of a life insurance policy, annuity, or pension.
• Beneficiaries must provide proof of death as well as verification of the deceased's coverage to the insurer.
• Life insurance policy beneficiaries are exempt from paying ordinary income tax on their death benefits, however annuity beneficiaries may have to pay income or capital gains tax on their death payments.

Death Benefits: An Overview

At the time of application, individuals who are insured under a life insurance policy, pension, or other annuity product with a death benefit enter into a contract with a life insurance carrier or financial services provider. A death benefit or survivor benefit is guaranteed to be paid to the named beneficiary under an insurance contract as long as the premiums are paid while the insured or annuitant is alive. Beneficiaries might choose to receive death benefit proceeds in the form of a lump-sum payment or a series of monthly or annual payments.

Life insurance policy beneficiaries are exempt from paying ordinary income tax on their death benefits, however annuity beneficiaries may have to pay income or capital gains tax on their death payments. In either scenario, proceeds received through life insurance or annuity death benefits skip the time-consuming and frequently costly process of probate, allowing survivors to receive payouts on time. Probate is the legal process of examining a will to see if it is genuine and valid. In most policies and accounts, however, if the policyholder does not name a beneficiary, the proceeds are paid to the insured's estate, which may be probated.

Requirements for Payout of Death Benefits

The procedure of getting a death benefit from a life insurance policy, pension, or annuity when an insured individual or annuitant dies is simple.

Beneficiaries must first determine which life insurance firm has the policy or annuity of the deceased. There is no common repository for policy information, such as a national insurance database. Instead, it is the obligation of each insured to educate beneficiaries about their policy or annuity. Beneficiaries must fill out a death claim form, which includes the insured's policy number, name, Social Security number, and date of death, as well as payment preferences for the death benefit monies.

Beneficiaries must submit death claim forms and a copy of the death certificate to each insurance company with which the insured or annuitant had a policy. A certified death certificate with the reason of death is required by most insurers. If a policy or annuity has numerous beneficiaries or survivors, everyone must complete a death claim form in order to receive the corresponding death benefit.

Death Benefits in Retirement Plans Have Changed

The SECURE Act, passed by the United States Congress in 2019, introduced improvements to retirement plans, including death benefits from inheriting an IRA.

The SECURE Act did away with the so-called "stretch provision" for IRA recipients. Previously, an IRA recipient may defer the necessary minimum distributions from the account for as long as they wanted. Stretching out the distributions ensured a consistent revenue stream while also reducing the tax burden.

Non-spousal beneficiaries must distribute all money in an inherited IRA account within ten years of the owner's death beginning in 2020. The new regulation does have some exceptions, such as for marriages. Other changes were made as a result of the SECURE Act, in addition to the ones listed below. Investors should consult a financial adviser to review the new retirement account rule changes and their selected beneficiaries.