What Happens to Your Life Insurance Policy When You Die?

No one likes to think about what might happen if they die, especially those of us whose dependents rely on us financially to maintain their standard of living, or for those of us who provide an essential caregiving service to our loved ones that they simply cannot do without. Life insurance is purchased as a means of insuring one’s life, meaning it will offer coverage for a range of different expenses that your left-behind loved ones could be faced with if you should pass unexpectedly.

Life insurance is there to protect you, your loved ones, and their standard of living in the event of your premature death. Whether you have purchased a term life policy for 10, 20, or 30 years, or even a permanent life insurance policy, dying while your coverage is still active means your policy will “kick in.”

In this policy, we’ll go into what happens to your life insurance policy upon your death, explaining the death benefit payout, how beneficiaries are named, and how life policy payouts can be used to cover your outstanding debts and obligations. For further questions, reach out to an Excalibur Defender.

The Death Benefit Payout

Every life insurance policy is designed to “kick in” upon the insured’s death – so long as that insured did not die as a result of an uninsurable risk. Here’s a quick guide to how the death benefit works.

How is the death benefit paid out?

Whenever someone purchases a life insurance policy, they are intended to “name a beneficiary” – usually a family member, a loved one, or a spouse. That person will be the intended recipient of a lump-sum payment, otherwise known as the death benefit. They could be a family member, a loved one, a spouse, etc. The payment that they receive, the death benefit, is supposed to help them cover expenses that you would have otherwise been around to cover/or that wouldn’t have existed without your absence. This means funeral costs, outstanding debts, or even just ongoing living expenses.

Is the death benefit payout tax-free?

Generally, yes. The tax benefit payout is generally not deemed as income and is therefore not subject to any federal income tax. That being said, should the beneficiary choose to invest the death benefit upon receiving payout, interest or earnings that are generated by that investment would likely be subject to taxes. Note as well that different life insurance policies have different payout options. Some payments are received as a lump sump, whereas others will be provided the option to remain with the insurer to accumulate interest.

To best understand your policy and its options, be sure to discuss yours with both your broker and your beneficiary so that you and your loved ones are clear on the terms of your policy.

Naming Beneficiaries

One critical component of any life insurance policy, whether that is term or permanent, is naming beneficiaries (and also knowing how to update them, if need be.)

How do you name beneficiaries?

Beneficiaries, as mentioned previously, are the intended recipient of the death benefit payout. They are the person or even entity who is titled as receiving your death benefit in the event you should pass away unexpectedly. It’s critical on your part to name a beneficiary in order to ensure that all your wishes are adequately carried out and that your loved ones are looked after properly. Without naming a beneficiary in your wake, that death benefit may then be paid to your estate. This can result in taxes, delays, and lofty legal fees.

How do you update your beneficiary designation?

If, for whatever reason, you’re looking to change your beneficiary designation, you will need to contact your insurer and fill out a form. Some policies and insurers will have an option to update your designation virtually or through an online web portal. Upon updating your beneficiary, make sure you always provide the full name, their relationship to your, and their address. Just in case, have a backup beneficiary in mind, just in case your beneficiary ends up predeceasing you or cannot receive the death benefit for whatever reason.

Covering Debts and Obligations

We would never want to leave our debts and obligations behind to our loved ones, but unfortunately a premature death may mean that we have not fully paid off mortgages, credit card debt, or student loans. Life insurance is one option to pay off your current debts and obligations.

Can life insurance be used to pay off debt?

Yes, absolutely. Your debts, unfortunately, do not disappear upon your passing. They will become the responsibility of your estate instead. If you have any outstanding debts, like car loans, mortgages, credit card balances, etc., your estate will likely need to use assets (such as your death benefit) to pay off those debts. Life insurance can be a great strategy to do this, saving your loved ones from having to dip into their savings or sell their assets to settle your outstanding obligations.

Note, of course, that some creditors could make claims against your death benefit in order to satisfy any outstanding debts. If you owe money to creditors upon your death, they could be entitled to a portion of your death benefit payout – depending on regulations/terms of your policy. To avoid this from happening, you will need to rename a revocable living trust as your beneficiary. They can ensure your assets are distributed accordingly to your desires, and it offers protection against creditors.

Always consult with a financial advisor to determine what strategy is best for paying off your debts and obligations upon your death. After all, we want to make sure our loved ones are secure in the event of your passing, and that they won’t be saddled with the added weight and stress of having to pay off your debts when you are no longer around.

Conclusion

Yes, albeit a morbid topic, knowing what happens with your death benefit upon your passing is an important thing to be aware of. Life insurance is a great asset to have, especially as it can help protect your loved ones, secure their standard of living after your passing, and even help to pay off your debts and obligations so no one that you love is saddled with those payments.

Give Excalibur Assurance a call to discuss more about our offerings for life insurance, how it can be of benefit to you, or request a free quote to get started right away.