People who are the beneficiaries of a life insurance policy often find themselves in a complicated position. They’ve usually lost a loved one, but at the same time, they might also receive a substantial payout from the life insurance company. When this happens, there are some ways that life insurance benefits can be used effectively.
1. Pay off debt
One of the most common uses for a large windfall, such as a life insurance payout, is to pay off outstanding debt like a credit card or student loan balance. This is particularly critical if the debt carries a higher-than-average APR and the interest charges are significant.
Paying off a mortgage can be another smart use of the death benefit. Many people see paying off their homes as the ultimate step in becoming debt free because it can potentially free up thousands of dollars from their annual budget. Additionally, a person who no longer has a mortgage payment can have the luxury of reducing their retirement nest egg target since their largest monthly expense has now been eliminated.
2. Max out retirement plans
Every year, the IRS allows the majority of workers to save a significant portion of their income into tax-advantaged retirement plans. These might be employer-sponsored accounts such as a 401(k) or 403(b), but they can also be individual plans like an IRA.
People who don’t already max out their plans can use the windfall from their life insurance benefits to save more money in these accounts, all the way up to the annual IRS limit. In fact, if they’re age 50 and older, then they’ll also get to utilize what’s called a “catch-up contribution,” allowing them to save even more.
Couples who both work can essentially double these limits. Even if the life insurance benefit was paid to one spouse, they can still use the proceeds to max out the other’s retirement plan for the year.
3. Acquire income-producing assets
Depending on the size of the life insurance death benefit, some individuals may want to consider purchasing assets that will have the ability to produce future earnings. These may include:
- Rental properties
- Dividend-paying stocks
- Business interests
Much like a retirement account, a smart strategy would be to first check with a financial advisor and pick options that also have some tax advantages associated with them. For instance, owners of rental properties can often write off repairs and appreciation, which will lower their tax bills.
4. Buy a life insurance policy
People who don’t already have adequate life insurance could use the benefits they received to purchase their own policy. However, they may be able to take this one step further and use it for investment gains as well.
Some life insurance policies such as whole life, universal life, and variable universal life also contain a feature in addition to a death benefit called cash value. Depending on the type of policy, this cash value can grow significantly and even be used for future financial goals.
Because this growth is also tax-deferred, it can be a very creative way for an individual to take their tax-free death benefits and continue to shelter them.