What is a life insurance death benefit?

Life insurance death benefit is one of the most commonly used phrases in the life insurance industry. Coincidentally, it is also the main reason that most people will purchase a life insurance policy. However, as simple as it appears to be, most consumers can’t distinguish between death benefit, face amount, or cash value when looking at their policies.

The death benefit, which is the life insurance money that your beneficiaries will collect upon your passing, has many implications and can be varied based on the policy type, outstanding loans, and the way in which it is paid to them. These things all come down to the terms of your life insurance policy.

What is a death benefit?

Life insurance death benefit is the sum of money an insurer pays to beneficiaries upon your death, provided the coverage was in force at the time of the event. The death benefit amount is determined when you first buy the policy and, in many instances, is equivalent to the face amount or face value of insurance.

However, just because the amount of coverage you bought (face amount of life insurance) is declared on the application, it doesn’t mean your beneficiaries will receive that amount upon your death (death benefit).

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When is the death benefit not equal to the face amount?

Let’s find out the difference between face amount vs. death benefit. So what is the face value of a life insurance policy? The face amount is the initial amount of money stated on the life insurance application when you first buy the policy and is intended to be paid as a death benefit to your heirs. The death benefit is the actual amount the carrier pays your beneficiaries, and you can tack on additional benefits with riders.

Typically, the contract’s face amount or face value is the death benefit your recipients will collect, however, there a few cases in which the death benefit does not equal the life insurance face value (face amount).

1. Accelerated death benefit: If you were diagnosed with a terminal illness and utilized the option to accelerate a portion of the death benefit amount (typically 25%–75% of the face amount), and later passed away, your beneficiaries will collect the face amount minus the amount you took while you were still alive. Some companies also charge a fee to exercise this option, so you will be paying that fee, too.
2. Loans or withdrawals: If you have a permanent policy that has accumulated cash value and you took a loan, it would be treated as a lien on your death benefit. In other words, if you didn’t repay the loan, your beneficiaries will collect the death benefit minus the loan and accrued interest.
3. Universal life policy: If you have universal life coverage, you have a unique opportunity to choose between two death benefit options:
   • Option A: Also called a level death benefit, your beneficiaries will collect the purchased face amount when you first got the policy.
   • Option B: Also called increasing death benefit because your beneficiaries will collect the face amount plus the cash value that was accumulated throughout the years.
4. Graded benefit policy: When buying guaranteed issue life insurance or a graded benefit plan, your face amount on the application pays a different death amount if you die within two years after purchasing the policy. For instance, if you bought $10,000 in face amount and died six months later, your beneficiaries will collect the amount of paid premiums plus 10% in interest and not the asserted face amount of $10,000 on the application.

Is the death benefit taxable?

Death benefit proceeds paid to your beneficiaries in a lump sum, whether a person or an institution, is not subject to a taxable income. If you died owning a policy with a $200,000 in death benefit, your designated recipient will not pay income tax on the amount.

This is true whether you paid all the premiums yourself or your employer-subsidized part or all of the premiums under a group life insurance. The exception to the rule is if the life insurance beneficiary chooses to receive the funds throughout the years instead of a lump sum, the interest on the original amount is taxable while the principal portion is tax-free.

How do you choose the death benefit amount?

This headline is another matter and is a good idea for a complete post. Without going too much off-topic here, the death benefit you chose when you first signed up for the policy must reflect your financial goals, liabilities, and income. If your purpose for buying life insurance is income replacement, a simple but effective rule to follow is that it is typically 10-15 times your income that you’ll need for the long term. You may just want to provide your child with an income through college or provide your spouse with sufficient income to live on. There are many factors you should consider when calculating the percentage.

If you do the math on your insurance policies, you should reflect on your policy death benefit and the schedule of benefits and feel confident that it should give your beneficiary sufficient time to get back to life while having the same lifestyle they were used to before your death. If your ideal coverage is needed to cover burial expenses and nothing else, a $10,000–$15,000 death benefit will do just fine. We concentrate too much on the amount rather than the objective of the policy for which was bought in the first place. Insurance companies can help you nail down a dollar amount if you go over your life insurance policy together; you don’t need to be a finance expert to provide your loved ones with security later on.

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What is the difference between death benefits and cash value in a life insurance policy?

Cash value refers to the savings portion of permanent coverage such as whole life or universal life insurance offers. When paying for coverage, a part of the premium payment goes for the cost of insurance (COI), and the remainder accumulates dividends and interest (depending on the policy type and carrier) in a cash account. The policy owner can do a few things with the cash in the policy:

• Make withdrawals. If you don’t pay it back, it would be reduced from the death benefit amount. Most insurers allow you to do this with their policies. Policies are not just a security blanket, they’re also financial products.
• Take a loan. The loan is subject to interest and if not paid back, the total dollar amount you borrowed would be deducted from the death benefit.
• Surrender the policy and collect all the cash value in the account. If you cancel your policy, you are entitled to the cash, however, this would terminate your coverage. Before you sell your policy in return for cash, though, make sure that the cash surrender value is worth more than the terms or features of your policy.
• If you have a universal life policy, you can use the cash account to pay premiums, provided there is enough cash. Insurers allow you to use the cash value of your policy to make your payments for your monthly premiums. As long as there is enough free cash, you can let it pay your entire premium. Just remember, not making your payments may be considered a risk to insurance companies.

How can a death benefit help the policyholder?

Arguably, no amount of money in the world can ease the continuous emotional distress your loved ones may have to go through upon your death. A life insurance death benefit can only reduce the financial burden and give the beneficiaries an opportunity to get back to living.

This is why it’s imperative you buy the right life insurance coverage for your circumstances and weigh it carefully before obtaining your policy. Here are a few examples of how a death benefit can be used:

• A partial income replacement. Your beneficiaries can supplement the lifestyle they have become accustomed to, pay an outstanding mortgage loan, or pay school tuition.
• The final expense and burial costs. Usually, small whole life policies to cover costs that are related to your passing away such as cremation, burial, and final medical bills.
• Leaving a legacy. Your death benefit can support causes that are dear to your heart such as universities, hospitals, or any charity you like.

What is the bottom line?

Life insurance death benefit is the primary reason for buying life insurance. You’ve worked hard all your life to build a life for yourself and your loved ones.

Understanding life insurance death benefit and how your beneficiaries can use it once you are no longer here is a reminder of why you bought the policy in the first place: peace of mind. Life insurance is a serious business, much of which remains baffling to the masses. Make sure you plan ahead because you will not be able to do it when it’s too late.

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