How much does life insurance pay out?
This question gets right to the heart of the discussion about life insurance: How well will my loved ones be taken care of after my death?
While simple in concept, the payout from a life insurance policy has quite a few twists and turns that are critical to understand.
We will cover the components of a payout and the factors that impact how much insurance you should purchase to fill in critical financial gaps for your family after you are gone.
How is the life insurance payout calculated?
Often referred to as the face amount or death benefit, the payout is typically based on the amount of life insurance you purchased to take care of your primary beneficiary at your death.
There is some elbow grease on your part to determine how much life insurance you need. The life insurance company, through its underwriting process, will ultimately determine the amount of coverage it is willing to offer you. In most cases, these competing interests meet at a place that is acceptable to both parties.
The following four factors are, in my humble opinion, the most critical to determining the right payout amount to meet your surviving family’s needs. Think of these as the 20% of factors that impact 80% of the calculation for the potential lump sum payout amount:
- Lost Income. What will be the income gap left for your surviving spouse after you are gone?
- Children at Home. A study by The Brookings Institution in 2022 estimated the cost to raise a child born in 2015 to be $310,605. Additionally, are there any children with special needs?
- Business Continuity. If you own a business, how will your death impact its ability to adequately support your family?
- Large Debts. Whether a mortgage, education, credit cards, final expenses, or other significant obligations, will your survivors be able to cover these expenses?
Types of life insurance payouts
There are two broad types of life insurance coverage: term life insurance and permanent life insurance. Each impacts the payout differently.
Term Life Insurance Policy
This is the most simple and straightforward type. It covers a specific period of time, usually 10, 20 or 30 years. If the policyholder dies during the term, the insurance provider pays the face amount of the insurance policy to the beneficiaries.
Term insurance typically has the lowest insurance rates.
Permanent Life Insurance Policy
This type is designed to cover you for your entire life. This coverage comes with higher costs for two reasons: the typically longer time the insurance is in force and a cash value component.
There are several variations of permanent insurance, such as whole life insurance, universal life insurance, and others. These types of policies have different features that can impact payouts:
- Cash value growth may be influenced by interest rates and market risk.
- Whole life policies may pay dividends, which increases the policy payout.
- The policyholder can take loans against the policy’s cash value buildup. If you die before the loan is repaid, that amount will be deducted from the payout.
What factors will determine how much insurance you can buy?
Insurance companies do not always approve the amount applicants request. Along with the information below, some policies may require a medical exam:
- Age
- Health (Current and Past)
- Height and Weight
- Gender
- Occupation
- Risky Hobbies
- Family Health History
- Use of Nicotine and Marijuana
- Substance Abuse
- Driving Record
- Criminal History
- Credit Score
To increase your chances of being approved at the lowest possible rates, focus on the things you can control: a healthy lifestyle, no use of tobacco products, no risky hobbies like skydiving or rock climbing, good credit, and no criminal history.
How does the claim process work?
Filing a claim for life insurance can be challenging. Add to that your loved ones are doing it at one of the most stressful moments in their lives. Here’s the process most insurance companies use:
- Certified Copy of Death Certificate. You may need 10-15 copies or more, depending on your situation.
- Notify Insurance Company. Do this as soon as possible.
- Complete Claim Form, Required Documents. Provide everything they request to ensure the process moves quickly.
- Beneficiary Information. Get detailed information about the beneficiaries, including names, addresses, and Social Security numbers.
- Processing. Be patient. The company may conduct an investigation if required.
For the amount of time the payout process takes, a claim that has no issues or additional questions from the company can be paid within two to four weeks. In my experience, this is about average. Anything longer than two months generally means the insurance company has found more significant issues.
For payout options, a tax-free, lump sum payment shortly after the death is the most common form of payment. You can also leave the money with the insurance company to be paid in installments, typically referred to as a retained asset account, or convert the payout to an annuity to be paid out for the rest of your life.
These are all issues to be discussed with a licensed insurance agent or financial advisor to ensure you apply for the right amount of insurance and set your family up for success in the event of your death.
