Death Benefit: How It’s Taxed and Who Can Claim It

A death benefit is a payout to the beneficiary of a life insurance policy, annuity, or pension when the insured person or annuitant dies. With life insurance policies, death benefits are not usually subject to income tax and named beneficiaries typically receive the death benefit as a lump-sum payment.

What Is a Death Benefit?

A death benefit is a payment made to a beneficiary of a contract such as a life insurance policy after the insured person dies. It may also be paid as a result of an annuity or pension.

With life insurance, the amount of the death benefit is set in the terms of the contract and is chosen by the policyholder, who makes regular premium payments. The amount of the premium payments will increase as the amount of the death benefit increases. Generally, the younger and healthier you are, the lower your premiums. 

Types of Death Benefits

Types of death benefits with insurance policies include all-cause death benefits, accidental death benefits (ADB), and accidental death and dismemberment benefits (ADDB). Let’s look at each type of death benefit in more detail.

• All-cause death benefit: A death benefit from a standard life insurance policy is paid for all causes of death except for those specifically excluded in the policy.  
• Accidental death benefits (ADB): An accidental death benefit is payment typically made as a result of a death included in a rider added to an insurance policy.
• Accidental death and dismemberment benefits (ADDB): Accidental death and dismemberment policies are usually added to life insurance as a rider. Death benefits are payments made for deaths from covered accidents. These policies also include accidental dismemberments, or the loss of body parts or functions. Many different insurance companies can help you add these benefits to a policy.

How Death Benefits Work

Under the contract with the insurance company or other company, a death is guaranteed to be paid to the listed beneficiary or beneficiaries, as long as premiums are paid while the insured or annuitant is alive.

Death benefits of life insurance policies are commonly issued as a lump-sum payment in the full amount of the benefit. Another option that beneficiaries may have is to accept the death benefit in installments, such as quarterly or monthly, in a fixed amount until the proceeds are depleted or for a set period of time. 

Beneficiaries may also have the option of receiving an annuity that makes payments in installments for life in an amount determined by the insurer. Or they may opt to take only interest payments and then eventually pass on the proceeds to another beneficiary. 

For an insurer to issue a death benefit, it will likely require a completed claim form along with copies of the contract and a death certificate.

Proceeds paid through life insurance or annuity death benefits avoid probate, which can provide the benefit faster. Probate is a legal process in which a will is reviewed to determine if it’s valid. However, for most policies and accounts, if the policyholder does not name a beneficiary, the insurer pays the proceeds to the estate of the insured, which may be probated.

Taxation

Death benefits from life insurance policies are generally not subject to ordinary income tax, while annuity beneficiaries may pay income tax on death benefits. Death benefits from pensions are treated differently from benefits from life insurance policies, and they may be subject to taxation.

Requirements for Payout of Death Benefits

The process of receiving a death benefit from a life insurance policy, pension, or annuity is straightforward.

First, beneficiaries need to know which life insurance company holds the deceased’s policy or annuity. The policyholder has a responsibility to share policy or annuity information with beneficiaries when they name them as beneficiaries.

Once the insurance company is identified, beneficiaries must complete a death claim form, providing the insured’s policy number, name, Social Security number, date of death, and payment preferences for the death benefit proceeds.

Beneficiaries must submit death claim forms to each insurance company with which the insured or annuitant carried a policy, along with a copy of the death certificate. Most insurers require a certified death certificate listing the cause of death. If multiple beneficiaries or survivors are listed on a policy or annuity, each one must complete a death claim form.

The Bottom Line

Death benefits are designed to provide funds to beneficiaries so they can receive financial support following the death of the insured. A death benefit can help offset the expenses of funeral services or provide money for necessary life expenses, among other purposes.

If you are naming beneficiaries in a contract or inheriting a death benefit, consider consulting a financial professional to guide you through your options for your specific situation.