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Lump sum benefits and life insurance

Caution is needed with this popular payout option

Most people shopping for life insurance do not pay much thought to how the benefit will be paid out.  In fact, the common benefit payout is the lump sum that comes to most people's mind.  Some people will make changes to this basic option but still...the lump sum is the default.  There are potential dangers to this option so let's take a closer and more thorough look at lump sum benefit payout.

I'm surprised it hasn't made into a reality show yet.  If we ever make the crossover from life insurance to reality TV, we will build a show around following the rise and almost certain fall of lottery winners.  It's almost tragic to watch.  On what should be a jubilant time for a lottery winner, it quickly spirals out of control and into a sea of misery.  After the 2 cent philosophizing about how people who have not earned money are not sufficiently ready to come into a large amount of money, this same scenario plays out every day with the proceeds from life insurance policies.  The lump sum life insurance benefit is even more dangerous since it's typically not subject to taxation.  So question is how will your beneficiaries handle receiving a lump sum of $250K, $500K, or even $1M in a fixed amount all at once?

Keep in mind that life insurance is there to replace lost income over a long period of time.  For example if you earn $50K and you want to cover 10 years, then we have a baseline of $500K term life insurance benefit to cover this period of time.  Now let's assume (rather pessimistically) that you pass away in year one and $500K is given in lump sum to your loved ones.  How would most people handle the sudden influx of $500K when they are used to receiving $50K a year.  Put yourself in their shoes.  A very responsible person would invest the $500K or an amount remaining after handling final expenses and transitional costs.  Let's say that leaves $450K.  Investment of this money might result is a certain amount each year...a percentage of what the family would have received had the insured not passed away.   Unfortunately, this isn't what usually happens. 

The first assumption is that the life insurance benefit isn't disputed by other family members and/or family friends.  Even if there is no dispute regarding whom the benefit goes to, people may start to come out of the woodwork.  It can be difficult not to give money away when a surviving spouse or dependent finds themselves in such a state of disarray.  So what can we do to avoid this type of situation associated with lump sum payout.

Depending on the carrier and plan, you have a lot of flexibility in how you can pay out the benefits to your beneficiaries.  It's probably a good move to contact us as a license life insurance broker to discuss various strategies for what you are trying to achieve.  For example, you pay the benefit out in installments to your beneficiary.  You can pay the benefit out at a certain attained age.  Age 18 (or 22) may be an option for a child dependent and you can even pay out the installments starting at a certain age.  This doubles your protection that the benefit will not be squandered away.  You could also have the benefit pay out at age 65 (when retirement kicks in) for a dependent spouse. 

There's almost no limit on the sophistication you can apply to the pay out of life insurance benefits to avoid the pitfalls of lump sum payment.  There's a whole world of trusts and estate planning tools that exceed the scope of this article and required a license professional to investigate.

The one thing you want to be careful of is not to create punitive payment options or unintended consequences.  It can be heartbreaking to have clients construct their payout in a way that creates the very hardships for his/her beneficiary that they were trying to avoid by having life insurance to begin with.  You want to protect your loved ones from themselves (that need this protection) while still providing the benefit of life insurance protection.




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