The 5 Key Life Insurance Payout Choices

Beneficiaries can choose to settle with the insurer in a number of ways. These optional modes of the settlement include the following: 

1. Lump sum payment
2. leave the proceeds with the insurer and receive annual interest payments;
3. accept the proceeds in installments for a specified period of time (fixed years installments);
4. accept the proceeds in installments of a specified amount (fixed amount option); and
5. accept the proceeds as a life annuity (systematic liquidation of principal and interest) for the life of one or more persons.

Interest Option

Here, the insurer guarantees to pay at least a specified minimum interest rate which the insurer may increase by paying excess interest (also called a dividend extra interest or surplus interest) to keep the insurer competitive with alternative investments. The insurer and beneficiary agree upon payment intervals such as annually, semiannually, quarterly, or monthly, (unless the policyowner pre-selects the intervals). The insurer can give the payee the right to change to another settlement option and either a limited or unlimited right to take all or any portion of the principal. In some cases, the policyowner may select an interest beneficiary payout option that gives the income beneficiary no right to make a withdrawal of capital. In such cases, any benefit balance upon the income beneficiary’s death will pass to the payee’s estate or to a third party depending on the terms of the agreement. Generally, at the option of the beneficiary, someone other than the interest recipient may receive the principal. The policyowner or the beneficiary should always name a successor-payee to receive any amount remaining payable at the primary payee’s death.

Planners utilize this option as a temporary investment repository to give beneficiaries time to make a rational and studied decision on how to invest the proceeds. The interest-only option is also convenient if the beneficiary does not currently need income under one of the other options but is planning to utilize one of them at a later date.

Installments over a Fixed Period of Years Option

Under this option, the insurer makes payments in equal amounts over a specified period selected by the beneficiary. If the primary payee does not survive to the end of the payment period, the insurer will pay the balance of the payments to the contingent payee. The contract contains a table that shows the amount of the individual payments (usually per $1,000 of death benefits) that the insurer can make over various periods of time ranging from one to thirty years. Any extra interest the insurer pays will increase the amount of income it pays (rather than extend the period). This option is indicated where the beneficiary needs the largest possible guaranteed income over a relatively short and fixed period of time.

Fixed Amount Option

Payments under this fixed amount option are paid to the beneficiary (and to the beneficiary’s successor-payee after the original beneficiary’s death) for as long as the proceeds (compounded at a guaranteed interest rate) last. If the insurer pays excess interest, the period over which the insurer will make payments will increase accordingly (while the amount of each payment remains the same). Planners use this easy-to-explain option to augment Social Security benefits and other income.

After payments commence, beneficiaries generally can ask the insurer to commute any remaining unpaid installments under either the fixed years or fixed amount option (i.e., the beneficiary can choose to take the present value of the future stream of income in an immediately payable lump sum) or have the commuted value of the remaining unpaid installments applied under another option.

Life Income Option

Under this option, the insurer makes periodic payments over the lifetime of the beneficiary. The insurer essentially uses the proceeds to purchase (the insurer charges no commissions or other acquisition costs) a single-premium life annuity for the designated payee. That annuity then pays out to the named payee an income of a guaranteed amount for the payee’s lifetime. Beneficiaries can choose for the annuity to have a period certain guarantee—a guarantee that payments will continue for a selected period of years, regardless of whether the payee is alive or dead. The period-certain guarantees commonly run for ten-, fifteen-, or twenty- years, and sometimes longer.

The life income option can take one of four basic forms:

1. Straight life (annuity) income – Payments will last for as long as the payee lives and stop at the payee’s death. This provides the highest annual income of the four forms of life income because it stops when the payee dies.
2. Life income with period certain – The insurer makes payments for a period selected by the beneficiary. The insurer will continue payments to a contingent payee for the balance of the period if the primary payee dies before the period ends.
3. Life refund annuity – The insurer makes payments to the payee (and/or contingent payee) until the insurer pays an amount at least equal to the proceeds paid at the insured’s death.
4. Joint and survivor annuity – The insurer makes payments to two individuals as long as both are alive and then continues the same or a lesser amount for the life of the survivor. Beneficiaries may elect to take payments of a smaller amount that continue at the same level for both lives (until the second death) or to take payments of a larger amount that continue until the first of the two payees dies and then a lower amount to the survivor until the survivor’s death.

Planners should consider settlement options where the amount of insurance is relatively small and the cost of establishing a trust is relatively high. Some consider a settlement option the “poor man’s trust.” These optional modes of settlement do have a number of advantages including:

1. the insurer makes no separate or special charges;
2. no other commercial institution can pay a life income; and
3. the insurer guarantees both principal and a minimum rate of interest.

But planners should also consider the following downside costs and disadvantages: they may be able to get higher earnings from alternative investments;

1. a trust may prove more flexible; and
2. a trust may be more responsive to the beneficiaries’ needs and circumstances

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM