How can a Lump Sum of Life Insurance Payout be Used?

There are a lot of?different kinds of life insurance: A policy can be temporary, or last a lifetime. It can have a cash value component – or not. But the one defining feature shared by all life insurance policies is a?death benefit. It’s the primary reason to get life insurance, and how policies are almost always described: when someone says they have a K2,000,000 policy, it really means they have K2,000,000 worth of death benefit insurance

As the primary beneficiary, receiving such a substantial amount of money all at once can feel overwhelming. You may often wonder what to do with a lump sum life insurance payout.

A life insurance payout can be a real lifeline for any surviving partner or family that is trying to cope financially after the loss of a loved one.

Life insurance companies typically offer a variety of payout options for life insurance death benefit proceeds: a lump sum, an annuity, installment agreements, and other similar structured payout plans, although this can vary by company and insurance policy (so make sure you understand such terms before signing any life insurance policy). The default payout option of most policies is a lump sum of the death benefit.

As the name suggests, a lump sum payout allows the life insurance beneficiary to receive the entire death benefit at once. Generally, it is not counted as taxable income (only in rare cases would an estate tax come into play).

Pros: A lump sum payout is the most common life insurance payout by far because it gives people the most flexibility, says Daniel Kopp, a fee-only fiduciary financial planner. You have full control over the money and can use it how you want.

Cons: Receiving such a large amount of money at once can be overwhelming. “It’s on you, the individual, the beneficiary, to make this money last,” Kopp says.

Receiving such a substantial amount of money all at once can feel overwhelming. That’s why it’s so important to take time to understand the best ways to manage a lump-sum life insurance payout. The following tips from financial professionals can help.

1. Don’t rush to make big financial decisions

The best thing to do when you receive a lump-sum life insurance payout is to hold onto that money for several months before making any significant financial decisions.

“If you have received a life insurance payout, this is the one time where it may make sense to let the cash just sit in your account,” says R.J. Weiss. “Your goal is to make a rational, educated decision, not an emotional one.” Keeping part of the lump-sum payout in cash will allow you to cover bills and other pressing financial needs in the months after losing a loved one.

2. Consider stable & credible investment vehicles

Instead, you may want to consider putting some of the payout in a credible and stable compounded interest-generating investment vehicle to earn interest on the principle. What you do not want is being careless with such a huge amount and invest in every single investment or business idea you come across. Make sure to verify any such information.

After making sure you’ve covered all of the immediate expenses, your first priority is using some of a life insurance payout to build an emergency fund, Kopp says. This will give you a cash reserve so you won’t be derailed by the unexpected, he notes.

Financial professionals typically recommend having enough in an emergency fund to cover three to six months’ worth of expenses. If the life insurance proceeds are kept in a compounded interest-generating account, it can earn interest and be easily accessed if and when emergencies arise.

If the loved one you lost was the breadwinner, you may want to set aside more in an emergency fund to keep you afloat financially as you ensure that you don't fall into any kind of financial crisis.

3. Pay off high-interest debt

If you have high-interest debt, you could use a lump-sum life insurance payout to eliminate that debt, Kopp says. By paying off what you owe, you’ll free up more cash in your budget each month to cover other bills and to have more of a financial cushion.

Wondering whether to pay off a mortgage with a life insurance payout? It depends on your situation, Kopp says. You might be considering using the life insurance proceeds to pay off your mortgage if the thought of that big monthly payment is keeping you up at night. You may also want to consider the trade-offs of other approaches as well, such as savings accounts or investment vehicles. Working with a financial professional can help.

4. Find a trusted financial advisor

Figuring out how to invest a lump-sum life insurance payout can be difficult on your own. That’s why it can be smart to talk to a financial planner. “Having that third party to walk through options will help,” Kopp says. When he lost his wife in 2017, Kopp says he talked to a financial planner “to be that rational third party to help me see the errors in my thinking.” It can also equip you with the information and perspective needed to make sound financial decisions.

You may want to work with a financial planner who is a fiduciary — a professional who is legally and ethically bound to act in the best interests of a client. Take the time to interview several advisors to find the best fit for your circumstances.

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About Luyako Nsamba

Luyako Nsamba has been a full-time wealth consultant since March 2022, with a focus on life insurance, education financing, investments & retirement planning. You can also follow him on socials, Facebook, Twitter, Instagram, YouTube and TikTok.

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