United States
Hong KongSettlement options: how a death benefit is actually paid
Five options: lump sum, interest only, fixed period, fixed amount, and life income. The death benefit itself is not taxable income; interest paid under any option that holds the money is. Fixed period sets the length and lets the payment fall out; fixed amount does the reverse.
A settlement option decides how the beneficiary receives the money, not how much money there is. That sounds obvious and it is the source of half the errors here, because two of the five options have names that describe what is fixed and candidates fix the wrong thing.
The five
| Option | What the beneficiary gets | What is fixed |
|---|---|---|
| Lump sum | The whole benefit at once | Nothing to fix |
| Interest only | Interest payments; the principal stays with the insurer | The principal |
| Fixed period | Payments across a stated number of years | The length of time |
| Fixed amount | Payments of a stated size until the money runs out | The size of each payment |
| Life income | Payments for life, in the shapes an annuity uses | The duration is a lifetime |
Fixed period against fixed amount is the pair. Fix the period and the payment size is whatever the fund supports. Fix the amount and the period is however long the fund lasts. Each answers a different question, and a stem that says she wants a set monthly income until the money is exhausted is fixed amount, while one that says she needs the money spread across her daughter's college years is fixed period.
Life income, and the shapes it borrows
The life income option comes in the same varieties as an annuity payout: straight life, life with period certain, refund options and joint and survivor. That is not a coincidence. The insurer is doing exactly what it does with an annuity, using a death benefit as the fund rather than a fund the owner built.
So the ranking you learned there carries over unchanged. More lives and more guaranteed years mean a smaller payment. If you have already worked through annuity payout options, you have already done most of this.
The tax line
A life insurance death benefit paid to a named beneficiary is not taxable income. Any interest the insurer pays on money it is holding under a settlement option is. So a lump sum is generally received free of income tax, and an interest only option produces a taxable stream from day one, and a fixed period option contains a bit of both in each payment.
That distinction is examinable in section II and again in section IV, where the outline lists the tax treatment of premiums, proceeds and dividends. Two sections, one fact, and it is the most reliable tax fact on the whole paper.
Who chooses
The owner may select a settlement option during their lifetime and may restrict the beneficiary's ability to change it. If the owner has selected nothing, the beneficiary chooses at claim time. That order matters, and a stem naming an owner who arranged payments in advance is telling you the beneficiary cannot simply take the cash.
Owners do this for a reason. A beneficiary who would spend a large sum quickly, or a minor who cannot receive one at all, are both handled by choosing the option in advance rather than leaving it open.
A widow wants a monthly payment of a size she names from her husband's death benefit, and does not mind when the fund runs out. Which settlement option matches?
- Fixed period
- Fixed amount
- Interest only
- Life income with period certain
Texas requires prompt settlement
The Texas Insurance Code requires a life policy to provide that settlement after the insured's death be made not later than two months after the insurer receives proof of death and of the claimant's right to the proceeds, at TIC 1101.011. The Texas outline lists time for settlement of a claim as its own sub-item. So how quickly is a state question, and how it is paid is a general question.
The opinion, and the concession
Settlement options are easier than they look and they are worth doing immediately after annuity payouts rather than in section order. The overlap is close to total for the life income shapes, and the two topics reinforce each other. Studying section II in the outline's order means meeting the same ideas twice, a week apart, and gaining nothing from the repetition.
The concession: the amount actually payable under a fixed period or life income option comes from the insurer's settlement option tables, which depend on interest assumptions and, for life income, on age. We hold none of those tables and publish no example figures. What the exam asks is which option fits which stated need.
Common questions
Is a life insurance death benefit taxable?
The death benefit paid to a named beneficiary is not taxable income. Interest paid on proceeds the insurer is holding under a settlement option is taxable, so an interest only arrangement produces a taxable stream while a straightforward lump sum generally does not.
What is the difference between fixed period and fixed amount?
Fixed period sets how long payments run and lets the payment size be calculated from the fund. Fixed amount sets the size of each payment and lets the fund last as long as it lasts. Read the stem for which of the two the beneficiary has specified.
Can the policy owner choose the settlement option in advance?
Yes, and the owner can restrict the beneficiary's power to change it. Where the owner has selected nothing, the beneficiary chooses at claim time. Owners typically select in advance where the beneficiary is a minor or would struggle to manage a large sum.
How quickly must a Texas insurer pay a death claim?
The Insurance Code requires a life policy to provide for settlement not later than two months after the insurer receives proof of death and of the claimant's right to the proceeds, at TIC 1101.011. The Texas portion of the outline lists time for settlement of a claim as a topic of its own.