Most people are aware of how life insurance works. If we pass away, we can name a beneficiary, or a person who is related by blood or by a business relationship can receive the face amount of the policy. This money can come in very handy to pay bills, obligations and enable the relative or business associate to carry on from a financial standpoint.
The taxation of life insurance
Life insurance works on the principle of the law of large numbers. This means that out of a very large pool of individuals, not everyone is going to die right away. The many who survive that year will be paying their premiums into the investment pool. This provides enough money to fund the death claims that will occur that year.
Life insurance proceeds are not taxed to the beneficiary as far as income taxes are concerned. This is a great benefit of life insurance. The purpose of life insurance is to provide cash for people or entities at the very time that it is needed. When a breadwinner or a key employee or business partner dies, a financial gap occurs that the deceased person would have filled, had he or she lived.
The problem and solution
One factor that is not widely known is that once the death proceeds are paid to the named beneficiary, it ceases to be life insurance as it turns into cash and is vulnerable to the whims of creditors who can then go after the cash as an owed debt obligation. The attachment of the proceeds could be a great hardship to a widow who would need all of the money for living expenses.
There is a way to keep this from happening in most cases. Simply have the insurance company set up the terms of the death proceeds to be paid to the beneficiary as a settlement option. Settlement options are legal methods of paying the proceeds of life insurance to a beneficiary.
The money can be paid out to a named beneficiary over a period of time in the form of an income. There are different means of establishing how much is paid out at a time, and these terms can be very flexible. For example, a payout could be arranged where the beneficiary could receive a monthly payout over a 15-year period.
One very popular and flexible settlement option is to use the deposit option with interest accumulating and with full right of withdrawal. This allows the beneficiary the right to withdraw money as it is needed, and the remaining money will draw interest on the amount that remains.
There is no point in exposing the life insurance proceeds to any creditors and when the proceeds are arranged in this manner, it stops creditors from a wholesale attachment of the life insurance money.
Of course, the beneficiary of the life insurance policy may wish to pay off the creditors anyway, but the beneficiary will have the chance to make that decision in his or her own timing.