What is a Death Benefit?
A death benefit is a payment that is made to someone when a person dies. Usually, the person who dies has a contract with an insurance company or a pension plan that promises to pay a certain amount of money to a person or a group of people who are chosen by the person who dies. These people are called beneficiaries.
For example, suppose your father has a life insurance policy that says if he dies, the insurance company will pay $100,000 to your mother. Your mother is the beneficiary of the policy. The $100,000 is the death benefit. If your father dies, the insurance company will pay the death benefit to your mother.
A death benefit can also be paid by an annuity or a pension plan. An annuity is a contract that pays a regular income to a person for a certain period or for life. A pension plan is a program that pays a regular income to a person after they retire from work. Sometimes, these contracts have a clause that says if the person dies before the payments end, the remaining payments will be paid to a beneficiary as a death benefit.
For example, suppose your grandmother has an annuity that pays her $1,000 every month for 20 years. She also has a pension plan that pays her $2,000 every month for life. She names you as the beneficiary of both contracts. If she dies after 10 years, the annuity will pay you $1,000 every month for the next 10 years as a death benefit. The pension plan will also pay you $2,000 every month for the rest of your life as a death benefit.
Why Do People Buy Contracts with Death Benefits?
People buy contracts with death benefits for various reasons, such as:
- To provide financial security and support to their loved ones after their death
- To cover the expenses of their funeral, estate taxes, debts, or other liabilities
- To leave a legacy or a donation to a charity, a school, or a cause
- To reduce their taxable income or estate value
A death benefit can help people achieve their financial goals and protect their families from financial hardship or uncertainty after their death.
How Do Beneficiaries Claim Death Benefits?
Beneficiaries must submit proof of death and proof of their relationship to the person who died to the insurance company or the pension plan that pays the death benefit. They must also fill out some forms and provide some information, such as their name, address, bank account, and tax identification number. They may also have to pay some fees or taxes, depending on the type and amount of the death benefit.
Beneficiaries may have the option of receiving the death benefit in different ways, such as:
- A lump sum, which is a one-time payment of the full amount of the death benefit
- An annuity, which is a series of payments of a fixed or variable amount over a certain period of time or for life
- A life income, which is a series of payments of a fixed or variable amount for the life of the beneficiary
- A life income with period certain, which is a series of payments of a fixed or variable amount for the life of the beneficiary or for a minimum number of years, whichever is longer
- A joint and survivor annuity, which is a series of payments of a fixed or variable amount for the life of the beneficiary and another person, such as a spouse or a child
Beneficiaries should choose the option that best suits their needs and preferences, considering factors such as their age, health, income, expenses, tax situation, and risk tolerance.
How Are Death Benefits Taxed?
Death benefits are taxed differently, depending on the source, the amount, and the recipient of the payment. Generally, the following rules apply:
- Death benefits from life insurance policies are not subject to income tax, unless the policy was transferred for value, meaning the person who died sold or gave away the policy to someone else before their death. However, death benefits from life insurance policies may be subject to estate tax, if the person who died owned the policy or had any control over it at the time of their death.
- Death benefits from annuities or pension plans are subject to income tax, to the extent that they exceed the contributions or the cost basis of the contract. The contributions or the cost basis are the amount of money that the person who died paid or invested in the contract. However, death benefits from annuities or pension plans may be eligible for some tax exemptions or deductions, such as the exclusion ratio, the marital deduction, or the charitable deduction.
- Death benefits from employer-provided plans, such as group life insurance, accidental death and dismemberment, or workers’ compensation, are generally not subject to income tax, unless they exceed a certain limit or they are paid in installments. However, death benefits from employer-provided plans may be subject to payroll tax, such as Social Security and Medicare tax, if they are considered wages or compensation.
Beneficiaries should consult a tax professional or a financial planner to determine the tax implications of receiving a death benefit.
Summary of Death Benefit
Here is a list of bullet points that summarize the main points of the term death benefit:
- A death benefit is a payment that is made to a beneficiary when a person dies, as part of a contract with an insurance company or a pension plan
- A death benefit can provide financial security and support to the loved ones of the person who died, or fulfill their financial goals and wishes
- A death benefit can be paid in different ways, such as a lump sum, an annuity, a life income, or a joint and survivor annuity
- A death benefit can be taxed differently, depending on the source, the amount, and the recipient of the payment, and may be subject to income tax, estate tax, or payroll tax
