How does a life insurance payout work?

Many life insurance policies pay out as a lump sum once the beneficiaries' claims are approved. However, depending on the insurer, beneficiaries may also have the option of a life insurance annuity or even a retained asset account. Here's how the life insurance payout options work:

  • Lump sum payout

    A lump sum payout disperses your full portion of the death benefit tax-free via a check or directly into your bank account. If your payout is larger than $250,000, you might consider splitting the deposit between multiple accounts. The FDIC only insures deposits up to $250,000 per depositor, per insured bank.

  • Annuity payout

    A life insurance annuity provides a steady income stream to the beneficiary. The insurer pays out the death benefit regularly over a set timeframe, while they keep the remaining amount in an account that earns interest until it's fully paid out. This life insurance payout option isn't always available, and interest earned on the remaining death benefit may be subject to taxation.

  • Retained asset account

    Some insurers can hold onto your life insurance payout in a retained asset account, so you can withdraw funds as needed. The account operates much like a checking account — you can withdraw your balance at any time, and it's interest-bearing. Any interest earned may be subject to taxation, but the original payout remains tax-free.

When you file a life insurance claim, ask the insurer about your life insurance payout options. Every situation is unique, so you should also consult with a financial advisor regarding the potential tax implications of your payout choice.

How is life insurance paid out among beneficiaries?

The life insurance policyholder will have named at least one or more primary life insurance beneficiaries. They may have also named contingent beneficiaries. And in rare cases, there may be no beneficiary still living. Here's how each situation would affect the life insurance payout after the death of the insured:

Beneficiary type Payout
One primary beneficiary Payout Only this person, charity, or trust can claim and receive the policy's payout.
Multiple primary beneficiaries Payout The policyowner will have designated a percentage or dollar amount for each beneficiary. Each needs to file a claim for their portion of the death benefit and choose their payout option.
Contingent beneficiary(ies) Payout If all primary beneficiaries have passed away, the payout may be claimed by any contingent beneficiaries. If multiple contingent beneficiaries are named, each must file a claim for the portion designated to them by the policyowner.
No beneficiary Payout If no primary or contingent beneficiary is living when the insured passes, the death benefit will be paid out to the insured's estate. It will go through the probate process and may be subject to claims from lenders before it's distributed to the insured's heirs.

There's technically no time limit to claiming life insurance. Starting the process sooner rather than later can help the life insurance payout process go smoothly. If you're managing a loved one's affairs after they pass, notify all known life insurance beneficiaries so they can start their claim with the correct insurer. And if you have a policy of your own, remember to regularly review your life insurance so you can avoid passing away with no living beneficiaries.