Key Takeaways
- In most cases, beneficiaries can use coverage from their life insurance policy for whatever they choose.
- Insurance companies do not start the claims process automatically — that is up to the beneficiaries.
- Deaths that occur during the first two years of a life insurance policy usually receive extra investigative attention before the death benefit is paid out.
- With some permanent life insurance policies, you can borrow against your policy to get money while you are alive.
In many cases, insurance products are used for financial security. But while houses and cars almost always require insurance by lenders or by state law, life insurance does not. Life insurance is never mandatory, and it requires a caregiver’s mindset. Essentially, you are purchasing a financial instrument that, in some cases, won’t benefit you while you’re alive.
Life insurance policies provide financial support for your loved ones after you’re gone, allowing them to live comfortably for the following weeks, months or years. As soon as your beneficiaries can send your insurance company an original death certificate, they can start the claims process to collect the death benefit.
It is vital to remember that you are entering into a contract with an insurance company and therefore all your submitted information must be truthful. Withholding relevant information from the insurance company can jeopardize your policy. Always read and understand the inclusions and exclusions of any potential policy before purchase.
Stephen Kates, CFP®Founder of Clocktower Financial ConsultingStephen Kates is a Certified Financial Planner™ and personal finance expert specializing in financial planning and education. Stephen has expertise in wealth management, personal finance, investing and retirement planning.
What Causes of Death Does Life Insurance Cover?
Life insurance typically covers natural causes of death, accidents, illnesses and forces of nature. If the death results from a crime, even homicide, the insurer must still pay the beneficiary unless the beneficiary is guilty of the criminal activity.
Life insurance policies are thorough and filled with specifics about what they will — and won’t — cover when someone dies. However, most causes of death are covered in full.
| Cause of Death | Is It Covered by Life Insurance? |
|---|---|
| Car or motorcycle accident | Yes |
| Illness | Yes |
| Suicide | No, unless the policy is over two years old in most cases |
| Overdose | Yes |
| Murder | Yes |
| Risky behavior | Yes, but depends on the policy |
Life insurance covers almost any cause of death unless the policy’s terms explicitly state otherwise. One common exclusion noted within policy terms is suicide. Typically, a suicide exception has a time limit.
The insurer may not pay the policy benefit if the insured party dies by suicide within the first two years of the policy’s existence. This provision avoids scenarios in which a person arranges for insurance and then commits suicide to obtain the payment for their survivors.
What Expenses Can Life Insurance Cover?
Typically, the beneficiaries of a life insurance policy can use the proceeds for whatever they choose. The policyholder should account for all the expenses they would need to cover in the case of their absence. This may include everyday living expenses, bills and even your children’s future education costs.
When you buy life insurance, you should estimate how much coverage you will need to cover all your expenses. For example, if you’re the beneficiary of your spouse’s policy, then you’ve most likely discussed how much insurance you would need to replace your spouse’s income should something were to happen.
Bills and Debt
Payment of ongoing expenses is a common use of life insurance proceeds because the policy amount is often intended to replace the lost income of the person who died. For example, a beneficiary can pay off a credit card balance to reduce monthly obligations or put the money in an account to use for regular living expenses such as rent, utilities, internet service, phone contracts and more.
Child Care
When someone with young children passes away, the burden on their surviving partner may grow. Not only have they lost their significant other, but they also must now raise the kids with less (or different) financial, physical and emotional support.
In this case, they may need money to pay for childcare services and after-school programs. The death benefit can help provide for such expenses. However, most policies don’t permit death benefits to transfer directly to minor children. The money must first go to a parent, guardian or a trust.
Education
Another typical use of death benefits is establishing or supplementing a college fund or some other educational account for young children. If one parent dies prematurely, the surviving parent may need help paying current or future education costs.
If the deceased partner was the primary income provider, the surviving partner might need to use funds from the policy to pay for more of their own education in the pursuit of a higher-paying or more fulfilling job or career.
End-of-Life Expenses and Estate Planning
Sometimes, the beneficiary needs the payout to cover the expenses associated with the funeral and burial of the policyholder. Depending on where you live, even a simple funeral may cost $6,000 or $7,000. While cremation is cheaper, it can still be a significant expense for the beneficiaries.
Also, some insured individuals view the funds from a life insurance policy as a helpful tax-free legacy to leave to their heirs. Many investment advisers suggest that there are better ways to accumulate wealth than by adding to your life insurance policy, but the payment is almost always untaxed.
Medical Needs
A 2021 U.S. Census Bureau survey found that 19% of households in American could not afford to pay their medical debt up front or when care was given. So, a beneficiary may need the death benefit to help pay for the medical bills that the policyholder accumulated before passing away. Doctors, hospitals and labs often bill patients separately, and it can take months for the final bills to roll in.
Viatical Settlements
Sometimes, the policyholder may need access to the funds before death. For example, some life insurance policies have provisions that allow for partial payouts in certain circumstances such as terminal illness, but this stipulation is not universal.
Instead, some people turn to third parties for a sale, called a viatical settlement, in which the policyholder sells their policy for a portion of the proceeds, which is paid out before their death. In these cases, the beneficiaries won’t receive the death benefit when the policyholder dies. Instead, the third-party buyer becomes the new beneficiary.
What Does Life Insurance Not Cover?
Life insurance does not offer coverage if the provider finds fraudulent information on the application. For example, if a policyholder died of a smoking-related illness after stating they are a nonsmoker on their application, then the provider would not cover their death.
The insurance provider will often request a medical examination before authorizing the issuance of a policy and sometimes will investigate a death if they think there might be some misstatements. This investigation is common if the policyholder dies during the first two years of coverage, also known as the contestability period.
Additionally, providers will not cover any policies in which the policyholder failed to make all the premium payments. In this case, the policy would lapse, and the death benefit would not be paid.
Fraud and Misrepresentation
Any misrepresentation on the application must be deemed material for the insurance company to deny the claim. Sometimes, the misrepresentation is considered fraudulent, which may have additional consequences.
No matter what, pay attention to any exclusions on your policy, and be sure your beneficiary knows how to start the claims process. While the process is typically simple, the insurance provider may require multiple documents beyond the death certificate.
