8 Ways to Use Your Life Insurance Benefit Wisely

Life insurance proceeds can ease the financial burden after losing a loved one, giving the bereaved time to focus on emotional recovery. However, receiving a large sum can also lead to tough decisions. It's crucial to assess the beneficiary’s financial situation and goals before deciding whether to save, spend, or invest the funds. A careful financial analysis helps determine the best course of action and the optimal method for receiving the death benefit—whether as a lump sum, annuity, or installments. Typically, life insurance benefits are income tax-free and can be used freely.

Experts recommend delaying any immediate financial decisions after receiving a payout. Emotional distress may cloud judgment, and rushing to spend on luxuries can lead to regret. Beneficiaries should take time to research options and consult trusted advisors to ensure they use the funds wisely for long-term financial needs.

Option 1: Pay Off Debt

For those with significant debt, it may make sense to use the lump-sum payout to pay off high-interest credit card balances or student loans. This will free up disposable income that can be redirected toward long-term goals such as retirement or saving for a down payment on a house.

Experts suggest that paying off high-interest loans or credit card debt should be the first priority for life insurance proceeds. Doing so will not only eliminate debt but also reduce monthly expenses. When it comes to return on investment, the interest paid on revolving credit card balances often outweighs any potential earnings from other investments, making it unwise to invest while carrying high-interest debt.

Option 2: Create an Emergency Fund

A life insurance payout is also an excellent opportunity to start or strengthen an emergency fund. A portion of the proceeds can be placed into a liquid, interest-bearing account, such as a savings or money market account, to cover future unexpected expenses. This can help protect against financial shocks, such as medical bills, home repairs, or job loss.

Financial advisors recommend having an emergency fund with at least $10,000 to $20,000 to cover unforeseen expenses, such as car breakdowns or a new furnace. Having such savings ensures that unexpected events won’t derail long-term financial plans.

Option 3: Purchase an Annuity

For those who need a steady income to cover monthly living expenses, it may be wise to purchase an annuity with the life insurance proceeds. This can be especially helpful for young families replacing a breadwinner’s paycheck or retirees who lose a second source of household income when a spouse passes.

There are various types of annuities available, some providing a guaranteed income stream either immediately or in the future, while others are designed to help accumulate savings for long-term goals, such as retirement. However, annuities are complex, and it is important to carefully review the details and consult a financial advisor to understand the best options.

Option 4: Collect Installments

Another option is to collect the death benefit in installments, which can provide a steady income stream. The beneficiary might receive a fixed percentage of the total death benefit each year over a set period, for example, 10 years. The portion of the benefit not yet paid out continues to earn interest for the beneficiary.

It is important to note that while the death benefit itself is generally not subject to income tax, any interest earned from the installment payments may be taxable.

Option 5: Invest for Growth

Beneficiaries who do not need immediate access to the funds may choose to invest the lump sum in stocks, bonds, or other investment vehicles for long-term growth. Financial advisors can help determine an appropriate investment strategy based on the beneficiary’s age, goals, and risk tolerance.

For example, life insurance proceeds could be used to supplement retirement savings if the beneficiary has not been fully funding their 401(k) or IRA. Investing in a diversified stock portfolio can also generate compounded growth over time, helping to achieve long-term financial goals, such as buying a vacation home or retiring early.

Option 6: Fund Children’s Education

Another option for beneficiaries is to use a portion of the payout to fund a college savings plan, such as a 529 plan. A $50,000 investment in such a plan could grow to $101,000 over 12 years with a 6 percent annual return, helping to support a child’s education.

Contributions to 529 plans are made on an after-tax basis, but the earnings and distributions are tax-free when used for qualified education expenses.

Option 7: A Combination Approach

For beneficiaries with a large death benefit, a combination of strategies may be the best option. For example, they could use part of the funds to create a guaranteed income stream through an annuity or installment plan, while investing the remainder in stocks for potential growth.

This strategy allows for short-term income security while giving the invested portion time to grow. If the investment generates a reasonable return over the years, it can provide long-term income.

Option 8: Establish a Legacy

For those who have secured their own financial future, they may choose to use the life insurance proceeds to support a charity or cause. This can be done through direct donations or by purchasing a permanent life insurance policy, such as a whole life policy, and naming a charity as the beneficiary.

Such donations may provide tax benefits, and the donor can continue to access the policy’s cash value during their lifetime.

Conclusion

Life insurance proceeds can help beneficiaries meet a variety of financial needs, providing the resources needed to secure financial stability after the loss of a loved one. To determine how best to use these funds, it is important to seek advice from a trusted financial advisor and consider both short- and long-term financial goals.