Receiving a Life Insurance Payout? How to Handle Money Properly
Losing a loved one is an incredibly difficult experience.
You’ll be experiencing emotional turmoil and having to adapt to your new life without them.
If your loved one was the breadwinner for your home, or contributed a significant amount of your income, you’ll also have to handle financial hardships alongside the emotional difficulties.
Life insurance is a good way to provide for your loved ones if you pass away, but if you’re the one who survives your loved one, how should you handle the life insurance payment you receive?
Are Life Insurance Payouts Taxable?
According to the IRS:
Life insurance payouts are generally not counted as income, meaning they are not taxable.
The amount that you receive is yours to keep and use as you see fit.
If a portion of the payout is taxable, the insurance company should notify you as to the taxable amount.
You must declare any taxable portion of the payout and pay taxes on it.
Should You Use the Money for Funeral/Burial Costs?
Funerals are an important part of grieving your loss and celebrating your loved one, but funerals can also be expensive.
According to the AARP, the median funeral costs $7,500, which is more than many people have on hand for an unexpected cost.
The loss of income from your loved one’s job also makes paying this cost difficult. Some life insurance policies include additional clauses that specifically cover the costs of the funeral and burial.
Check with the insurer to see if the policy included additional burial insurance.
If the policy does not include burial insurance, you can use some of the money you receive to pay for the funeral and burial costs.
What to Do with a Life Insurance Payout
Losing a loved one is hard, so you might not be thinking as clearly as you usually do, which can make managing a large life insurance payout difficult.
Keep these do's and don’ts in mind so you can make the most of your life insurance payout.
Create a plan
The first thing that you need to do is come up with a plan for how you’ll use the money. Sit down and go over your budget and your typical expenses.
If your loved one contributed to your household income, then make sure to account for the reduction in income each month.
Then, look at your expenses.
You can reduce your budget in some areas. If your income is now far below your normal spending, you might have to make difficult cuts to your budget.
Finally, think about how you can allocate the money from your life insurance payout.
If you need to spend some of the money from the payout to make ends meet, do your best to keep your spending low and find ways to increase your income for when the insurance payment runs out.
Handle final expenses
As part of your plan, you should also decide on funeral and burial arrangements.
Funerals are an important part of the grieving process. But, make sure not to spend extravagantly on one, especially if money is tight.
You can use some of the payout to cover these expenses if you don’t have the savings available to do so.
Depending on the size of the payout that you receive, you may not need to spend most of it in the short-term.
Setting up a conservative investment portfolio can help you grow the money and preserve its spending power.
A portfolio of bonds and stocks is a good way to do this. Index funds are inexpensive and provide easy diversification.
You can adjust the balance as desired based on how long you have before you’ll need to access the money.
The longer you have, the more volatility you can handle, which means you can increase the stock portion of the portfolio.
Use the money as needed
Money is a resource and you should treat it as such. Use it when you need to, but don’t overspend and exhaust your financial resources too quickly.
Stick to your budget and supplement your income with the insurance payout where you need to.
It’s okay to spend a bit on entertainment and fun but prioritize a reasonable budget and cover your necessities.
What Not to Do
If you aren’t used to having large sums of money at your disposal, it can be tempting to overspend or use the insurance payout poorly.
The emotional strain of dealing with loss can make this temptation even stronger.
Try to avoid doing the following to make sure you make the insurance payout last.
Go on a spending spree
Retail therapy is popular for a reason. Buying things can be fun and feels good but spending large amounts on things that you don’t really need isn’t a sound financial decision.
While it’s okay to splurge once in a while, try to avoid huge shopping trips with the insurance money that you’ve received.
Avoiding overspending is especially important while you’re recreating your budget to account for your reduction in income.
Buy risky investments
Investing in risky things like cryptocurrency, penny stocks, or options can be tempting as a get rich quick scheme, especially if you have a lot of money to devote to the task.
If you put all of your insurance money into a risky investment that doesn’t pan out, you’ll have no money left to cover your expenses.
Taking the risk for a huge win isn’t worth the financial ruin that can come if your investment fails.
Deviate from your budget
Do your best to stick to your budget, or a modified version of your budget that reduces spending.
You can use your insurance payout to cover essential living expenses but try not to let the money burn a hole in your pocket, leading to overspending.
If you increase your budget, your insurance payout won’t last as long as you expect it to last and you could find yourself in difficult financial straits down the line.
Losing a loved one isn’t easy.
Life insurance can help ease the financial burden of losing someone who helps provide for your family, but managing that payout well is important.
Proper management of the insurance payout can make it last for years while you grieve your loss and adjust your budget.
Managing the insurance payout poorly can lead to a difficult financial situation down the road.