3 Surprising Facts About Life Insurance

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  • Life insurance rules can be complicated.
  • Many people do not know the tax rules surrounding death benefits.
  • Some policyholders also don't understand all of their rights.

Don't get caught off guard by life insurance rules.

Many people buy life insurance in order to prepare for the possibility of an untimely death. Since people often have loved ones depending on their income or services, having a policy in place could help stave off financial disaster in the event of their passing. 

Although life insurance policies are common, not everyone understands the details about how they work. In fact, there are three life insurance facts that may come as a surprise to many. Here's what they are. 

1. Death benefits are tax free

As a general rule, the beneficiary of a life insurance death benefit is not going to be charged any taxes on the money they receive. There are limited exceptions. For example, if a policy isn't paid out right away and interest accrues, beneficiaries might be taxed on the interest. But, for the most part, any benefits aren't considered income and those who receive them will not need to worry about giving the IRS or their state's Department of Revenue a cut of the money that is intended to help support them after a loved one's untimely death. 

The fact that death benefits are tax free makes them more valuable to those who receive the money. It's one reason why people should typically include a life insurance policy as part of their plan to provide for the people they care about if something goes wrong. 

2. A named beneficiary will trump a will

There's another key rule to know about life insurance. When a policyholder names a beneficiary, that is typically the person who will get the death benefit -- regardless of what the deceased person's will says.

For example, if someone says their spouse should get all of the money they leave behind, but they named their cousin as the beneficiary of a life insurance policy they purchased before getting married, the cousin would generally get the death benefit despite what the will says. 

There are some limited exceptions to this. For example, some states have revocation-upon-divorce statutes which apply if a policyholder forgets to change his or her beneficiary after a marriage ends. But, for the most part, the named beneficiary will get the money and this is why it is so important to update life insurance policies as circumstances change over time. 

3. Death benefits can sometimes be paid out while the policyholder is alive

Most people associate life insurance policies with paying out after death. And that's what happens in the majority of cases. Sometimes, however, a policy could provide much-needed funds while alive.

This can occur, for example, if a policyholder has purchased an accelerated benefit rider. This is an add-on to coverage that allows money to be paid out in the event that the covered person becomes terminally ill. This type of rider can help ensure money is available to pay for expensive medical care or to provide support when a serious illness makes working impossible. 

Ultimately, it is important to understand these three key facts so insured individuals and their beneficiaries know what to expect when it comes to a death benefit. Knowing these rules helps ensure informed choices are made when getting covered and when a life insurance claim is made. 

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