Death Benefit

When the insured or annuitant dies, the death benefit of a life insurance policy, annuity, or pension is paid to the beneficiary. Death benefits from life insurance policies are not subject to income tax, and named beneficiaries typically receive the death benefit as a lump sum payment.

The policyholder has the ability to direct how the insurer pays the death benefits. For example, a policyholder may specify that half of the benefit is paid immediately after death and the other half is paid a year later. In addition, some insurers offer beneficiaries different payment options rather than a lump sum. Some beneficiaries, for example, choose to use their death benefit proceeds to open a non-qualified retirement account or to have the benefit paid in installments.

Death benefits from retirement accounts are treated differently than death benefits from life insurance policies, and they may be taxed.

Understanding Death Benefits

Individuals who apply for a life insurance policy, a pension, or another annuity with a death benefit enter into a contract with an insurer. The contract guarantees a death or survivor benefit to the named beneficiary as long as premiums are paid while the insured or annuitant is alive. Beneficiaries can choose to receive death benefit proceeds as a lump sum or as a series of regular payments.

Beneficiaries do not pay ordinary income tax on death benefits received, whereas annuity beneficiaries may pay income or capital gains tax on death benefits received. In either case, proceeds paid through life insurance or annuity death benefits avoid the time-consuming and often costly probate process, resulting in timely payments to survivors.

Probate is a legal process that examines a will to determine its authenticity and validity. However, if the policyholder does not name a beneficiary, the insurer will pay the proceeds to the insured's estate, which may be probated.

Requirements for Payout of Death Benefits

Receiving a death benefit from a life insurance policy, pension, or annuity is a simple process.

Beneficiaries must first identify the life insurance company that holds the deceased's policy or annuity. There is no national insurance database or other central location where policy information can be found. Instead, it is each insured's responsibility to share policy or annuity information with beneficiaries. Beneficiaries must complete a death claim form after identifying the insurance company, providing the insured's policy number, name, Social Security number, date of death, and payment preferences for the death benefit proceeds.

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. The majority of insurers require a certified death certificate that includes the cause of death. If a policy or annuity has multiple beneficiaries or survivors, each must complete a death claim form in order to receive the applicable death benefit.

Changes to Retirement Plan Death Benefits

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

The SECURE Act repealed the so-called stretch provision for IRA beneficiaries. Previously, an IRA beneficiary could spread out the account's required minimum distributions over their lifetime. Stretching out distributions provided a steady income stream while also helping to spread out 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. There are, however, some exceptions to the new law, such as spouses. Other changes were implemented as a result of the SECURE Act, in addition to the ones listed here. Investors should consult with a financial professional to review the new rule changes for retirement accounts and their designated beneficiaries.

What are the tax implications of death benefits?

Death benefits from a life insurance policy are not subject to ordinary income tax. Estate taxes may still be imposed. Beneficiaries of a death benefit annuity may be required to pay income or capital gains tax on the payout.

What if you think you're a beneficiary of a death benefit?

Do not rely on your insurance company to inform you! Determine whether or not you are named as a beneficiary before the policyholder dies. If you believe you are owed a benefit, the National Association of Insurance Commissioners' Life Insurance Policy Locator Service may be able to help.

Beneficiaries must submit death claim forms to insurers along with a copy of the death certificate. If a policy or annuity has multiple beneficiaries or survivors, each must complete a death claim form in order to receive the applicable death benefit.