Americans buy life insurance for various reasons. Maybe it’s to provide an income for a spouse, pay off a mortgage or fund future college expenses. Or it could be to pay for a funeral and final expenses.
No matter your reason for buying life insurance, it’s important to name a life insurance beneficiary.

What Is a Life Insurance Beneficiary?

A life insurance beneficiary is a person or entity you select to receive the death benefit from your life insurance policy when you pass away.

The beneficiary is paid the death benefit because your life insurance policy is a contract between you and the life insurance company. That means the face amount of the policy goes to your beneficiary regardless of what your will, probate courts or family say.

You can choose more than one beneficiary, and you can choose how much of the death benefit goes to each person.

Life insurance policies can also be used to keep businesses, especially family businesses, afloat. In this case, a company could be named as the beneficiary because the so-called “key man” or rainmaker is no longer there.

The life insurance amount you can afford, and the nature of the policy, could affect who you’re likely to name as the beneficiary. For example, consider these types of life insurance.

• A term life insurance policy with a time frame of 30 years might suffice for seeing your children through college or maintaining a business.
• A small burial insurance policy would pay for your funeral.
• A universal life insurance policy may be an effective way for those with assets to pass them on to their heirs.

Whatever the need, it’s vital to choose the best beneficiary.

Primary vs. contingent beneficiary

A primary beneficiary receives the death benefit when the policyholder dies, but what happens if the primary beneficiary is dead or somehow can’t collect the death benefit? That’s when you need a contingent beneficiary, sometimes called the secondary beneficiary.

You can have one or more primary beneficiaries and one or more contingent beneficiaries. Here are the differences between primary and contingent beneficiaries.

• Primary beneficiary. Receives the death benefit when the policyholder dies.
• Contingent beneficiary. Receives the death benefit only if the primary beneficiary is unable to receive it, such as if the person already died or doesn’t want to handle the death benefit.

It’s wise to name at least one contingent beneficiary (in addition to a primary beneficiary) just in case. You could name family members, friends, charitable organizations, children or the guardians of your children if you were to die.

The policy’s death benefit goes to the policyholder’s estate if both the primary and contingent beneficiaries die before the policyholder.

Who Can be a Life Insurance Beneficiary?

You can name anyone as a life insurance policy beneficiary. Charities, trusts and estates can also be named as beneficiaries.

Keep in mind that some state laws may require you to name your spouse as your primary beneficiary, getting at least 50% of the benefit. In some states, you may be able to name someone other than your spouse as a beneficiary if you have documented permission from your spouse to do so.

How Do I Choose a Life Insurance Beneficiary?

Think of naming a life insurance beneficiary as a way to provide funds for who or what you want: your spouse, a favorite charity, a pet, your own funeral.

In most instances, policyholders focus on the ones who’ll most need the payment if they die. That is the person or persons most reliant on your income or savings.

Designating a beneficiary

There are two options when designating a beneficiary.

• Revocable. In this case, you can change who you want as beneficiary at any time during the life of your policy.
• Irrevocable. An irrevocable beneficiary can’t be removed from the policy or have their share of the death benefit changed without their consent. An irrevocable beneficiary must also be notified if you cancel the policy.

Deciding how the death benefit will be paid

There are also options when choosing how the death benefit is paid to beneficiaries.

• Per capita (by “head”). In this case, the amount is split equally between all beneficiaries, often the children.
• Per stirpes (by “branches”). This means that if a child predeceases the policyholder, his or her children—the branches—receive what would otherwise be shared among the living children. Per stirpes is a valuable tool for protecting grandchildren, particularly if they’ve lost a parent.

Setting up a trust

When it comes to protecting grandchildren, or even that pair of beagles who were your best friends during your later years, nothing works as well as setting up a trust for all, or at least some, of the money in your policy. With a trust, the life insurance proceeds automatically go into the trust and not the estate.

But if you decide to take this route, it’s critical to find good trustees. You might want to ensure that a young beneficiary doesn’t squander his inheritance on a Lamborghini and forget about college. You may also want to guarantee that a favorite charity receives the money needed to help end world hunger or just prevent the dogs from being taken to the pound.

A trust is a way to accomplish this. In a sense, it keeps your hand on the tiller of your financial ship even after you’re gone. An attorney can help you make a trust as part of an estate plan.

Think of it as one of the notable times in your life when you—and only you—get to decide what is the right choice. After all, this is a personal decision and you can do as you please.

Life insurance is a legal contract that can seldom be challenged, except under very special circumstances, and is even less likely to be overturned in court than a will. You may offend someone—or several people—with your choice of beneficiary, but what can they do about it? The truth is, unless you tell them ahead of time, they probably won’t find out they’re not your life insurance beneficiaries until you’re dead.

When to Update, Change, Add or Remove Beneficiaries

It’s a good idea to review your life insurance beneficiaries at least once a year to make sure you’re still comfortable with who you have listed. Divorce, marriage or the death of a loved one are all instances that may cause you to reconsider your beneficiaries.

While a life insurance policy is a contract, it’s important to remember that it’s not set in stone. It’s a living document—at least while the policyholder is alive—and its beneficiaries can usually be changed at any time with either a request form or online.

Your likes and dislikes can lead to change. For example, one child may step up to help during an illness or injury while another sits on the bench. Divorce and remarriage can also lead to change, particularly if there are new children to consider.

If you and your spouse are ending your marriage, it’s prudent to know how life insurance works during a divorce. A settlement might include a stipulation that one or both spouses maintain life insurance, especially if they’re going to owe alimony or child support.

Since your life can constantly change, and people can come and go, insurers recommend naming contingent beneficiaries. These are people or entities like charities that would receive the money if the primary beneficiary has died. This is something that should always be considered, especially if your spouse is a primary beneficiary and you are growing old together.

Life insurance death benefits aren’t typically taxed, which is one of the primary upsides to life insurance. Since life insurance death benefits can be in the millions of dollars, it’s a significant advantage to buying (and receiving) life insurance.

But there are other aspects to life insurance that won’t get past the taxman.

Is a Life Insurance Payout Taxable?

Life insurance death benefit payouts are usually not taxable. That means beneficiaries will receive the money without a tax burden hanging over their heads.

However, there are certain situations where a life insurance death benefit may be taxable. Here’s a look at when to prepare for a tax bill.

You are a life insurance beneficiary who receives interest on a death benefit

Most life insurance payouts are made in one lump sum right after the death of the insured person. But if a beneficiary chooses to delay the payout or take the payout in installments, interest may accrue. In that case, the interest paid to the beneficiary may be taxed.

The life insurance payout goes into a taxable estate

Most life insurance payouts are made tax-free directly to life insurance beneficiaries. But if a beneficiary was not named, or is already deceased, where does the life insurance death benefit go? It goes into the estate of the insured person and can be taxable along with the rest of the estate.

This could create a significant tax bill, especially considering both federal and state estate taxes may be applied. While federal estate taxes will not tax the first $12.06 million per individual as of 2022, state estate taxes can have significantly lower exemption levels.

Another possible unhappy scenario is that an estate is below the exemption level but a large life insurance payout to the estate pushes it above the exemption threshold into taxable territory.

This is avoidable by naming both primary and contingent life insurance beneficiaries and keeping those selections up to date.

The life insurance policy involves three different people

Life insurance death benefits can become a taxable gift in a situation where three people serve three different roles in connection with the life insurance policy. The positions include:

• The policyowner. This is the person who purchased the policy and is ultimately responsible for paying the premiums.
• The insured. This person’s life is covered by the life insurance policy.
• The beneficiary. This person receives the death benefit when the insured person dies.

For example, say a husband purchases a life insurance policy for his wife, and their son will be paid the death benefit. Suppose the wife (the insured) dies and the son (the beneficiary) receives the death benefit. In that case, the IRS considers the life insurance payout a gift from the husband (the policyowner) to the son. This is sometimes referred to as the “Goodman triangle” or “Goodman rule,” named after a decades-old court case regarding this issue (Goodman v. Commissioner of the IRS).

If this triangle exists, the policyowner may have to pay gift tax for the life insurance payout that exceeds federal gift tax exemption limits. In 2022, the annual gift exclusion is $16,000 per individual and the lifetime limit (known as a basic exclusion) is $12.06 million per individual.

To avoid tax implications from the Goodman triangle, limit insurance policy involvement to only two people: a policyholder who is also the insured and the beneficiary. A remedy to the example above is for the wife to be the policyowner and insured, maintaining the son as the beneficiary.

Is the Cash Value in a Life Insurance Policy Taxable?

If you have a cash value life insurance policy, you can generally access the money through a withdrawal, a loan or by surrendering the policy and ending it.

One of the reasons to buy cash value life insurance is to have access to the money that builds up within the policy. When you pay premiums, the payments generally go to three places: cash value, the cost to insure you and policy fees and charges. Money within the cash value account grows tax-free, based on the interest or investment gains it earns (depending on the policy). But once you withdraw the money, you could face a tax bill.

Money that’s withdrawn from cash value is generally made up of two parts:

If your life insurance policy is a “modified endowment contract,” or MEC, different tax rules apply and it’s best to consult a financial professional to understand tax implications.

Here are situations where cash value may be taxable.

You surrender the life insurance policy

There can be times when a policyowner no longer wants or needs the life insurance policy. You can take the surrender value of the life insurance policy and the insurer will terminate the coverage. The amount you receive is your cash value minus any surrender charge. You can generally expect to get a surrender charge within the first 10 or 20 years of owning the policy, and over time the surrender charge phases out.

You won’t be taxed on the entire surrender value, though. You’ll be taxed on the amount you received minus the policy basis, or the total premium payment you made on the policy. This taxable amount reflects the investment gains that you took out.

Say the premiums you’ve paid over many years add up to $38,000 and your total cash value is $45,000. The portion of the payout that would be taxed is $7,000, representing the investment gains.

You took out a policy loan and the life insurance ends

If you have a life insurance policy with cash value and take out a loan against it, the loan isn’t taxable—as long as the policy is in force. But if the policy terminates before you’ve paid the loan back, you could get a tax bill. For example, the coverage terminates if you surrender the policy or it lapses.

The taxable amount is based on the amount of the loan that exceeds your policy basis. Policy basis is the portion you’ve paid in premiums. Amounts “above basis” are based on interest or investment gains on cash value.

One way to access all your cash value and avoid taxes is to withdraw the amount that’s your policy basis—this is not taxable. Then access the rest of the cash value with a loan—also not taxable.

If you die with a loan against the policy, the death benefit is reduced by the outstanding loan amount.

You sell the life insurance policy

There’s a market for existing life insurance policies, especially cash value life insurance policies that insure people who are terminally ill or have short life expectancies. Transactions involving terminally ill policyowners are called “viatical settlements.” These involve an investor, such as a company specializing in buying policies, paying you money for the policy, becoming the policyowner and then making the life insurance claim when you pass away.

Viatical settlements are typically used as a way for patients to get money for medical bills, especially when selling a life insurance policy will mean getting more money than simply surrendering it for the cash value.

Fortunately, the IRS doesn’t treat any portion of what you receive for a viatical settlement as taxable. Under IRS code 101(g)(2), an amount paid by a viatical settlement provider is treated like a payment of the death benefit—and death benefit payouts are not taxable.

A life settlement is a similar transaction but involves a policyowner who is not terminally ill. In these cases, the IRS does not see the proceeds as a payment of death benefit. A portion of what you receive can be taxable.

Summary: When Is Life Insurance Taxable?

More than half of Americans have life insurance. And the primary advantage of having life insurance is that you can provide a death benefit to anyone you name as a beneficiary.

What Is a Life Insurance Death Benefit?

A death benefit is the amount your life insurance policy will pay to your beneficiaries if you pass away, as long as your policy is in force.

Who Gets the Death Benefit?

Life insurance beneficiaries are the people or organizations you’ve chosen to receive the death benefit from your life insurance policy.

A beneficiary could be:

• People, such as a spouse or your adult children
• Charities
• A trust
• A business

You can choose multiple beneficiaries for your life insurance policy and you can select how much of the death benefit goes to each. For instance, a business, an individual and a charity could all be named as beneficiaries on the same policy.

You can designate the percent of death benefit to each beneficiary, such as 80% to a spouse and 20% to a brother.

A policyholder can remove or add beneficiaries at any time.

How beneficiaries can use a death benefit

Beneficiaries can use money from death benefits however they choose. Beneficiaries often use this money for everyday bills like groceries and utilities, for larger debts like a mortgage or to put a child through college.

How Do Life Insurance Death Benefits Work?

A death benefit is typically paid in a lump sum to beneficiaries, but there are other options.

Death benefit payout options

There are several ways to receive a life insurance payout. Here are the usual death benefit payout options.

• Lump-sum payout: This type of death benefit is paid out all at once, rather than over a period of time. It is generally not counted as taxable income.
• Retained asset account: Beneficiaries might have the option to leave the death benefit with the insurance company in an interest-bearing account. You typically get a checkbook to access the cash in the account. Any interest earned will be taxable.
• Life income payout: You may be able to receive the death benefit in guaranteed payments for the rest of your life. The amount you receive in each payment will be based on your age when you file the life insurance claim.
• Life income with period certain: This option allows you to receive payments for a certain period, and for your beneficiaries to receive the remaining payments if you die before the period is up.
• Specific income payout: This type of death benefit is paid out in installments over time, such as 10% annually for 10 years. The portion of the benefit that has not been paid out generally earns interest for the beneficiary. Any interest earned over this period will be taxable.

Death benefits with different types of life insurance

Here is how the death benefit works with term life vs. permanent life insurance.

• Term life insurance: Term life insurance policies lock in level premiums for a set period, such as 10, 20 or 30 years. If you pass away while your term life policy is in force, your beneficiaries receive the payout. No death benefit will be paid if your policy expires and you’re still living.
• Permanent life insurance: Permanent life insurance is designed to stay in force for your entire life. If you pass away at any time, your beneficiaries will receive a death benefit—as long as your policy has not lapsed due to lack of payment.

There are certain circumstances in which a death benefit may be lower than the policy’s face value. For example, if you have life insurance with a cash value account and take out a loan without paying it back, this amount will be subtracted from the death benefit if you pass away.

Cash value accounts are savings or investment accounts that come with certain types of whole life insurance and accumulate value. Typically, if you don’t use the money in your cash value account before you pass away, the cash value reverts back to the life insurance company if you pass away.

How Much Is My Death Benefit?

The death benefit amount is based on the face value of the life insurance policy, with subtractions for any withdrawals you made from cash value or policy loans you didn’t pay back.

For example, you bought a $500,000 term life insurance policy, the payout to your beneficiaries will be $500,000. (Term life insurance does not have any cash value for policy loans or withdrawals.)

When deciding how much money you should provide to your beneficiaries, consider your reasons for buying life insurance. If you want to provide funds to replace your income for 10 years, you could choose a death benefit that closely matches your income multiplied by 10.

How Do Death Benefits Affect My Premium?

The size of your death benefit is one factor that affects how much you’ll pay in life insurance premiums. Other factors include the type of life insurance, your age, gender, health and whether you use nicotine.

The following examples show examples of premium payments for certain death benefit amounts.

Average annual costs for a variety of term life insurance amounts

Note that these examples are meant to be used for comparison. The most accurate way to see how much you’d pay for a certain policy is to compare life insurance quotes.

Types of Death Benefits

There are a few types of death benefits to consider when buying life insurance.

Fixed death benefit

This common type of death benefit is a set, unchangeable amount. For example, whole life insurance policies have fixed death benefits.

Some term life insurance policies have fixed death benefits, too, but other term life policies allow you to adjust a death benefit, such as lowering the amount.

Adjustable death benefit

Some universal life insurance policies allow you to adjust the death benefits amount (within certain parameters). You can choose a higher or lower death benefit over the course of the policy’s life. Doing so will change your premium payments.

Graded death benefit

With a graded death benefit, your beneficiaries won’t get paid the full death benefit if you die from a health condition within the first few years after buying the policy. Life insurance policies that don’t require a medical exam or ask a lot of health questions, such as guaranteed issue life insurance, commonly have graded death benefits.

How to File a Claim and Receive a Life Insurance Death Benefit

1. Call the life insurance company. The key to making a claim is to know which life insurance company holds the policy for the deceased person. You don’t need the policy number to make a claim. When you report the death to the life insurance company, the insurer can verify that you are a beneficiary on the policy.
2. File a claim and send a certified death certificate. Expect to be required to send a certified copy of the death certificate along with claim paperwork. You can typically get a copy of this document from the funeral home or medical professional who confirmed the death of the individual, or from a vital records office.
3. Fill out the insurance company’s required paperwork. The life insurance company can send you a claims form or direct you to it online.
4. Wait for the claim to be processed and paid out. There is typically no time limit for submitting a life insurance claim, but the sooner you file the claim, the sooner you will receive the death benefit.

Could a Life Insurance Claim be Denied?

There are situations where a life insurance claim could be denied, such as:

• You aren’t a beneficiary. In some cases a life insurance policyholder will change beneficiaries without informing the previous beneficiaries.
• The life insurance policy had lapsed due to lack of payment. If someone forgets or neglects to pay the premium, there’s typically a grace period. After that, the policy will lapse. If the insured person passes away while coverage is not in force, there is no death benefit payment. If the policy lapse was very recent—for example, because the policyholder was in the hospital and didn’t pay their bills—it may be possible for the beneficiary to pay the premiums due and then receive the death benefit.
• Fraud was involved. If an applicant purposely hides a medical condition or other relevant information from their life insurance company, their beneficiaries might not receive the death benefit. Most life insurance policies have a two-year contestability period during which a claim might not be paid on a death if there was fraud or misrepresentation on the life insurance application.
• The insured died from suicide. Life insurance policies generally do not pay out death benefits if a person passes away from suicide within the first two years after purchasing a life insurance policy.