How life insurance pays out: beneficiaries and claims

A beneficiary is the person or entity you name to receive the death benefit. The Insurance Information Institute explains that a policy can have a primary beneficiary, who receives the benefit if they can be located after your death, and contingent beneficiaries, who receive it if the primary can't be found.

The Institute describes keeping those designations up to date as an important part of owning life insurance, since life events like a birth or adoption, marriage, or divorce can change who you'd want to receive the money. Naming beneficiaries clearly, with identifying details, also makes it easier for the insurer to locate them.

The process is usually straightforward. The Insurance Information Institute suggests getting several copies of the death certificate, then filing a claim with the insurer. An agent can help complete the forms, or beneficiaries can contact the company directly.

Insurers typically require a certified copy of the death certificate submitted with the policy claim. Once the claim is submitted, the Institute says a settlement should be issued shortly. Beneficiaries generally have choices for how proceeds are paid: a lump sum is one common option, but alternatives like scheduled income payments or interest-income arrangements may be available depending on the policy.

Life insurance proceeds are generally favorable on taxes. According to the IRS, proceeds you receive as a beneficiary due to the insured's death usually aren't includable in gross income, so beneficiaries typically don't report the death benefit as taxable income. One key exception: any interest paid, for example on benefits held or paid in installments, is taxable and should be reported.

Proceeds also tend to avoid probate. Because the benefit is generally paid directly to a named beneficiary rather than through the estate, it can bypass probate entirely. The Insurance Information Institute notes that if the benefit instead goes to your estate, probate proceedings could delay distribution and the cost could reduce what's available to your heirs. That's another reason naming a living beneficiary matters.

An insurer generally doesn't know a policyholder has died until someone notifies them, usually a beneficiary. Keeping loved ones aware of the insurer's name and where the policy is helps avoid delays. Most policies also include what's generally called an incontestability period: an early window during which an insurer can investigate and, in the case of a material misrepresentation on the application, potentially deny a claim or void the policy. That window is commonly two years, though the exact duration and rules vary by state and policy.

Sometimes benefits simply go unclaimed because a family doesn't know a policy exists. The NAIC offers a free Life Insurance Policy Locator that can help connect potential beneficiaries with lost policies and annuities. You submit the deceased person's information, participating insurers search their records, and if a policy is found and you're the beneficiary, the company contacts you directly.