Which Life Insurance Settlement Option is Best?
Did you know that how you receive a financial payout after the death of a loved one, may be one of the most important financial decisions that you make.
How to compare the most common settlement option vs the best settlement choice.
Should you try and invest the money yourself, hire a trusted financial adviser, or allow the insurance company to hold it either for a given long period of time or temporarily (say one year) until you are able to get your act back together?
All About Life Insurance Settlement Options:
There is no complete list of settlement choices because each insurer will have their own spefic list. Therefore this list of options are just a general list with some insurers providing some of these and some providing others. Generally speaking the pure payout life settlement option is available with every life insurance carrier.
Settlement Option 1
The pure payout settlement option, often called a Lump Sum, is the simplest option. Up until the 1980s the option was the most used. The full amount of death benefit is received via a lump sum, essentially in one single check. That means if it was a $250,000 term life policy a $250,000 check is received by the beneficiary. Some insurance companies will on occasion immediately dispense with a small initial payout amount and therefore the final amount would deduct for that amount.
The Lump Sum or Pure Payout method is the settlement choice that most consumers already understand. Most of the of rest of the options may be new to them and in many scenarios overly confusing to them. As such I generally consider the LUMP Sum / Pure Payment method to be the default standard. However as far as insurance companies are concerned this is not necessarily the case.
Settlement Option 2
Retained Asset Account
A retained asset account is a temporary vehicle to store your money with the insurance company. The money is usually held in the insurance companies general account. Retained Asset Accounts are somewhat new life insurance settlement option that was created in 1984. Technically speaking they could, in theory, be considered a derivative of the Interest Income option below.
This settlement option, the retained account allows beneficiaries to keep the money in the account and draw the money out, at will, via something akin to a check. The work 'check' is typically not used, for legal and statuary reasons to avoid confusion with the account being considered a bank account, but these "drafts" as they are sometimes known are very similar to checks. If this option does exist, with no fees, and pays out interest, it is a powerful choice allowing clients to leave the money in the account, while they decide what to do, all the while earning money in an interest bearing income.
However there are several caveats to this.
First off, Insurance Company Accounts are typically not FDIC insured.
Second, the interest rate can sometimes be better than the best banks are able to offer you. As an example an Ally Bank Account may offer you 1% while a Metlife Retained Asset Account could theoretically give you say 2%.
Third, it can be a bit confusing to have the payer of the insurance essentially be the receiver of the insurance monies.
Insurance Retained Asset Accounts are NOT bank accounts and should never be considered as such.
The insurance information Institute offer a good one page brief on Retained Asset Accounts for life insurance.
Settlement Option 3
The interest income option is when the insurance carrier keeps the death benefit and pays a defined interest amount on the principal accruing daily, monthly, depending on their rules, paid out monthly or typically quarterly. You would generally receive a check at each agreed upon period. With this settlement option, the interest income is somewhat similar to having a bank hold the money and pay you interest.
Generally if something were to happen to you before the entire principal was received the beneficiaries beneficiary would receive the rest of the proceeds. However it is important that clients ask this very question to the underlying insurer,
Settlement Option 4
The remainder of this life settlement options are more complex, so be prepared to study them thoroughly before choosing any of them.
A life income option is similar to setting up an annuity that will pay out for the lifetime of the recipient. The exact amounts will greatly depend on the age of the person, so it is difficult to exactly characterize this.
Since you could in theory be setting up an annuity though, you should do your homework on this one before accepting it. Is the amount paid out competitive with the open annuity market? You could of course always just accept the lump sum payout and move it to an annuity from a different insurance company. I find this option a tough one to recommend to anyone because it requires to much darn work to decide if it is a good value or not. And who amongst us has the fortitude to comb through this just after loosing a loved one?
There are possibly other slightly different versions of a Life Income Settlement involving a period of time, I have seen these referenced as Periodic Certain.
Settlement Option 5
Joint/Survivor Life Income
The Joint - Survivor life income option is very similar to the pure life income option, but it involves two people. Typically this could be a husband and a wife. Considering that this is as well basically an Annunciation of the life insurance proceeds, clients should take great care when considering this option.
What are the best rates offered for this type of product on the market? The potential selling point, I suspect, is that a properly created joint survivor settlement option might be able to provide income to to the remaining spouse if one should die. These are complicated beasts, so there is much homework that consumers should do if you are seriously considering it.
Settlement Option 6
Some insurance companies may allow you to choose a specific dollar amount to receive each year or month within the basic financial framework of total payout. An an example you might get a $3,000 per year payout on a total of a $100,000 death benefit. Based on the interest rates that would accrue this may last perhaps for 40 years. Often these options would them pay out the remaining lump sum upon the death of the beneficiary to another beneficiary.
This settlement option can seem quite open, but it is important to understand that it is (obvsoulsy) extremely limited by the underlying principal and its' potential growth.
Settlement Option 7
Both Fixed Period and Fixed Amount are relatively similar. In some ways they are the opposite. Some insurers will allow you to set a Fixed period of time for which you will receive the principal and interest. The fixed period life settlement choice should be able to forecast for how long you will be able to do this.
Both the Period and Amount options may be of good value for people that are potentially prone to mishandling money, people that may live on a fixed income and need just a little bit more per year. Certainly various lawyers may also be able to come up with some reasons for this option as a good option.
Settlement Option 8
A fixed amount option, very similar to the Fixed period, may allow you to set a specific dollar amount that you receive at given intervals. When the full principal plus any interest are depleted your payout will end.
The difference between Fixed Amount and Fixed Period seem to be one of semantics, so I occasionally group them together and I have noticed do as well.
Notes on Settlement Options & Taxation:
There is an old saying in life insurance in that life insurance is paid out income tax free. This is generally the case, but sadly this is not the case with the interest that you receive from an insurance company while they hold your money. In other words, the initial death benefit should be tax free, but the income that it receives after the time of death is not. That can even be the case from the Time of Death to the Time of payment made out even in a Lump Sum payment.
To Review this Important Concept:
Proceeds from Life Insurance = Almost always Tax Free
Interest from the proceeds of a payout, after the Death = Usually Fully Taxed, and Often at an Income Rate
Therefore, it is extremely important that clients of life insurance understand that the one time tax free status of their benefits was just a one time thing. Instantly life insurance "accounts" so to speak can become a confusing and costly headache of various taxes.
To add another layer of confusion to this is when the payout is annuitized. Annuities carry all sorts of odd tax rules and it is well beyond the scope of this article to attempt to explain. However, I do advise clients that if they are considering annuitizing a life insurance payout that they do their homeowner and ask lots of questions about their foreseeable tax future.
Notes on Settlement Options, Insurers:
As stated each insurance company has their own list of options that are available to you the client. Likely they will not offer you all of the above options, rather a few of them. Although it may be difficult to understand, it is advised that clients consider the interest rate being offered vs the best interest rate available at the best bank or other investment options.. A good place to check national interest rates is an independent company such as bankrate.com. We are big fans of reminding consumers to "do their own homework."
Best Life Settlement Options:
Pure Payout/ Lump Sum Vs Retained Asset Account
As discussed Retained Asset Accounts can appear to be very similar to a savings account, however they are not FDIC insured and are not true bank accounts. But the look and feel is similar. According to OPM.gov - Metlife's Total Control Account or TCA for short: offers an account that "MetLife guarantees the full amount in the MetLife TCA, including all interest earned." The plan "offers a minimum guaranteed annual effective interest rate, meaning that MetLife commits to pay the beneficiary at least that specified rate of interest on the money in the account." If an account such as this is offered to you and the rate easily beats the best internet banks, than you can decide if it is worth the risk to have your account in a non FDIC insured account. Another important consideration with this account is if "The beneficiary can withdraw the full amount from the MetLife TCA at any time"?
With the lump sum vs retained asset account -I find these types of accounts to be a solid plausible short term option for consumers who need some time to make financial decisions. What exactly is the other solution, deposit the a $250,000 check into your Bank of America account where it may pay .1%? As is 1/10 of one percent?
If you are offered such an Interest bearing account with the ability to remove it at any time, I believe it can make sense, especially for short term endeavors. If your insurance company is offering you a low interest rate and laden with fees and obstructions, I would probably consider opting out and pulling your money out via the Pure Payout method.
The final decision of what to do, is yours and should best be done with the assistance of a financial planner.
Pure Payout Vs Life Income:
This consideration pits two completely different goals against each other, do you take out the entire amount or set up an annuity, filled with the many decisions that that entails?
With the pure payout vs life income settlement option - One may provide you peace of mind but with possibly a lower rate of return for the rest of your life. The other is a simple check that you will then have to decide what to do with it. Given the complexities of annuities though, its best to meet a fee for service financial planner, in my opinion, before considering this option.
Pure Payout/ Lump Sum Vs All the other Settlement Options:
It is my belief that the Lump Sum payout method is the general choice that all other options should be compared against. The pure payout method may come with its own headaches and numerous decisions to make, but it probably could be the least bad decision that you can make. When dealing with the lump sum payout, depositing the money into an FDIC internet bank account that pays a top interest rate, will allow it to grow safely while is it is simultaneously insured. The concept of insured growth is very difficult to come by in these modern times.
When considering all of the various life insurance settlement options, to me the Lump Sum - Pure Payout is the one to beat. Is the competing method as simple? Is it as guaranteed? Do you understand it? Are you getting ripped off by the competing settlement option?
Best Practices when Considering Life Insurance Settlement Options:
So what is the Best Settlement Option for you and your family after the loss of a loved one? The best settlement choice more than likely will be the option that provides you with both the safest place to put your money combined with a low rate of return, until you are able to consider the best long term solution.
However, this is an overly simplistic answer to the question about the best settlement option. A financial adviser or banker may be a great place to direct this question.
Statistics on Life Insurance Settlement Options:
According to Bob DeFillippo of Prudential, "retained asset account(s are) the most popular way survivors get insurance proceeds industry wide."
According to IRMI, the four most popular alternative life insurance settlement options are (in no particular order): the Interest Option, the Fixed Period option, the Fixed Amount option, and the Life Income option." It is unclear to me as a writer if these statistics include the newer Retained Asset Account option.
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