Settlement Options
Settlement options (also called payout options or modes of settlement) determine how the death benefit is paid to beneficiaries. Instead of receiving a lump sum, beneficiaries can choose to receive payments over time.
Overview of Settlement Options
When the insured dies, the beneficiary can choose how to receive the death benefit:
| Option | Description |
|---|
| Lump sum | Entire benefit paid at once |
| Interest only | Insurer holds funds; pays interest |
| Fixed period | Equal payments for a set number of years |
| Fixed amount | Specific payment amount until funds exhausted |
| Life income | Payments for beneficiary's lifetime |
Who Can Select?
| Party | When They Can Select |
|---|
| Policy owner | Before death (may restrict beneficiary options) |
| Beneficiary | After insured's death (from available options) |
Lump Sum (Cash) Option
The lump sum option pays the entire death benefit in a single payment.
Features
| Feature | Description |
|---|
| Payment | Full death benefit paid immediately |
| Control | Beneficiary has full control of funds |
| Investment | Beneficiary responsible for investing/managing |
| Tax | Death benefit is income tax-free |
Advantages
- Immediate access to full amount
- Maximum flexibility
- Can invest or use as needed
Disadvantages
- No guaranteed income stream
- Funds may be quickly spent
- Beneficiary must manage investment
Exam Tip: Most beneficiaries choose the lump sum option, but other options may provide better financial security for those who need structured payments.
Interest Only Option
The interest only option leaves the death benefit with the insurer, who pays interest on the funds to the beneficiary.
How It Works
| Feature | Description |
|---|
| Principal | Remains with insurer |
| Payments | Interest only, paid periodically |
| Access | May withdraw principal later |
| Duration | Until beneficiary chooses another option |
Features
| Feature | Details |
|---|
| Interest rate | Guaranteed minimum; may pay higher |
| Payment frequency | Monthly, quarterly, or annually |
| Principal at death | May pass to contingent beneficiary |
Advantages
- Guaranteed principal preservation
- Regular income stream
- Time to decide on other options
- Principal available if needed
Disadvantages
- Lower income than other options
- Interest payments are taxable
- Inflation erodes purchasing power
Tax Treatment
| Component | Tax Treatment |
|---|
| Death benefit | Not taxable |
| Interest payments | Taxable as ordinary income |
Fixed Period Option
The fixed period option (also called installments for a specified period) pays the death benefit in equal installments over a specified number of years.
How It Works
| Feature | Description |
|---|
| Period | Beneficiary selects number of years |
| Payments | Equal installments (principal + interest) |
| Guarantee | Payments continue for full period |
| If beneficiary dies | Remaining payments go to estate or contingent |
Example
| Item | Amount |
|---|
| Death benefit | $500,000 |
| Period selected | 20 years |
| Monthly payment | Approximately $2,500 (principal + interest) |
Advantages
- Guaranteed income for specified period
- Larger payments than interest only
- Systematic income management
- Payments continue if beneficiary dies
Disadvantages
- Fixed period—may outlive payments
- Less flexibility than lump sum
- Payments end after period
Fixed Amount Option
The fixed amount option (also called installments of a specified amount) pays a specified dollar amount each period until the funds are exhausted.
How It Works
| Feature | Description |
|---|
| Amount | Beneficiary selects payment amount |
| Duration | Until principal + interest depleted |
| Payments | Specified amount each period |
| Flexibility | Duration depends on amount chosen |
Example
| Item | Amount |
|---|
| Death benefit | $500,000 |
| Monthly amount selected | $3,000 |
| Duration | Approximately 16-17 years (with interest) |
Fixed Amount vs. Fixed Period
| Feature | Fixed Amount | Fixed Period |
|---|
| What's fixed | Payment amount | Number of years |
| What varies | Duration | Payment amount |
| Control | Over income level | Over duration |
Life Income Options
Life income options provide payments for the beneficiary's entire lifetime, regardless of how long they live.
Types of Life Income Options
Straight Life Income
| Feature | Description |
|---|
| Payments | Continue for beneficiary's lifetime |
| Guarantee | None—payments stop at death |
| Amount | Highest per-payment amount |
| Risk | Payments lost if death is early |
Life Income with Period Certain
| Feature | Description |
|---|
| Payments | For life OR guaranteed period, whichever is longer |
| Common periods | 10, 15, or 20 years |
| If death during period | Remaining payments to estate/contingent |
| Amount | Lower than straight life |
Life Income with Refund
| Feature | Description |
|---|
| Payments | For life, with refund guarantee |
| If death occurs early | Refund of remaining principal |
| Refund type | Cash refund or installment refund |
| Amount | Lower than straight life |
Joint and Survivor Life Income
| Feature | Description |
|---|
| Payments | Continue until both annuitants die |
| Coverage | Covers two lives (often spouses) |
| Survivor options | 100%, 75%, 50% to survivor |
| Amount | Lower than single life options |
Comparison of Life Income Options
| Option | Payment Amount | Guarantee | Risk |
|---|
| Straight life | Highest | None | Payments stop at death |
| Period certain | Medium | For specified period | Lower but some |
| Life with refund | Lower | Principal refunded | Protected |
| Joint and survivor | Lowest | Both lives | Most protection |
Comparison of All Settlement Options
| Option | Duration | Payments | Principal |
|---|
| Lump sum | Immediate | One payment | All at once |
| Interest only | Indefinite | Interest only | Preserved |
| Fixed period | Specified years | Principal + interest | Depleted |
| Fixed amount | Until depleted | Specified amount | Depleted |
| Life income | Lifetime | Guaranteed | Not returned |
Key Takeaways
- Lump sum pays everything at once—most common choice
- Interest only preserves principal; pays interest income
- Fixed period pays equal amounts over a specified number of years
- Fixed amount pays a specified amount until funds are exhausted
- Life income pays for the beneficiary's entire lifetime
- Straight life provides highest payments but no guarantee if death is early
- Period certain and refund options provide protection if beneficiary dies early
- Joint and survivor protects a surviving spouse