There are a lot of questions when it comes to buying a life insurance policy. What options and riders are available? Will my premium go up? Are there any potential exclusions or loopholes? But fewer people concern themselves with distribution options from a life insurance policy. And that’s just as important as any other provision the policy holds. After all, it will determine how the benefits are distributed.
Here are some of the options that are available – you can choose the best one for you and your beneficiaries.
Lump Sum Option
Taking insurance proceeds in a lump sum is the simplest option, and probably the most common. It is exactly what the name implies, the entire face value of the benefit of the policy is paid out in a single payment at the time of the policyholder’s death. The proceeds can go to either a single beneficiary, multiple beneficiaries, or even to a charity or into a trust fund (the lump sum is the best option for a trust, particularly one that is created upon your death).
The advantage of this option is that your beneficiaries will have the greatest amount of money immediately, and probably when it is most needed. The disadvantage is that the money can also disappear quickly if your beneficiaries are not particularly skilled in managing the receipt of a large amount of money.
Fortunately, there are other distribution options you can consider that will prevent the policy proceeds from disappearing quickly after your death.
Life Income Option
We can think of this option as a “spendthrift provision”. It reduces the likelihood of the entire benefit being spent shortly after receipt, by parceling it out as income to the beneficiary or beneficiaries over an extended period of time.
This is a good option to use if the primary purpose of your life insurance is to provide support for your beneficiaries after your death. It will create a stable income source that will provide for them in your absence.
It is also an excellent option to use if you have minor children, a beneficiary who is disabled, a non-working spouse, or a spouse who may not be particularly savvy when it comes to handling money. Since the money will be distributed over many years, there will always be more money coming in subsequent years. Bad judgement in one or two years won’t doom your beneficiaries to poverty for life.
The life income option does one very significant limitation – if the beneficiary were to die before the proceeds are fully dispersed, the undistributed balance may be lost.
But don’t worry, there are still more options.
Fixed Period Option
You can also choose to have the policy proceeds distributed over a certain period of time, say five years, 10 years, or even 20 years. The insurance company will calculate the monthly or annual payments in such a way that the policy proceeds will be fully dispersed within that timeframe. And because income is accumulated on the unpaid balance, your beneficiaries will actually receive more than if the proceeds have been distributed in a lump sum.
This is an excellent distribution option if you want to provide income for one or more of your beneficiaries for a very specific time. For example, you may want to provide income for your spouse until he or she is eligible for retirement. Or you may want to provide a regular income for your minor children until they reach age of majority.
Fixed Amount Option
This is similar to the fixed period option, except that you are choosing a specific amount that you want dispersed to your beneficiaries for each payment installment. For example, you can choose higher payments at the beginning, and lower payments at the end, under the assumption that your beneficiaries will have less need for the extra income as they grow older.
The term of the distribution will be determined by how quickly the chosen payment depletes the policy proceeds.
Life Income With a Certain Period Option
This option is similar to the life income option, except that it distributes income only for a certain period of time. But unlike life income option, it enables you to continue having the proceeds distributed even if the primary beneficiary dies before the proceeds are exhausted. For example, should the primary beneficiary die before the distribution term ends, the income could be transferred and paid to another beneficiary.
Despite the death of the primary beneficiary, payments would continue to the secondary beneficiary for as long as the chosen term lasts. So if you choose a 20 payment term, and your primary beneficiary dies after 10 years, the secondary beneficiary will receive the payments for the remaining 10 years.
Interest Income Option
I’ve saved the best option for last! Under the interest income option, your beneficiaries can get the benefit of both an ongoing income and a lump sum payment.
Here’s how it works… The insurance company pays your beneficiaries the interest income on the policy principle for the term that you choose. The payments can be remitted monthly, quarterly, semiannually or annually.
All the while, the original principal balance remains constant. But at the end of the term that you choose, the principal balance of the policy will be paid out to your beneficiaries.
Let’s say that you have a $500,000 term life insurance policy. You choose to have your beneficiaries receive interest income for 20 years, after which the proceeds will be distributed to them. With an annual interest rate of say 3%, your beneficiaries receive $15,000 per year in interest income for 20 years. At the end of that time, the $500,000 face value of policy is paid out to them.
This provides your beneficiaries with both an ongoing income, and a lump sum when the interest income is no longer available.
So when you are shopping for a life insurance policy, give careful consideration as to how you want the proceeds to be distributed to your beneficiaries. You have a lot more control over this than you might imagine.
