When conducting life insurance planning with a client, it is important to plan how the death proceeds will be handled. When the proceeds of a life insurance policy are payable in a lump sum, the company’s liability under the policy is fully discharged when it pays out that sum. However, if the company retains the proceeds under one of the optional methods of settlement, its liability continues beyond the maturity of the policy and must be laid out in a legal document, called the settlement agreement.
If the beneficiary has problems managing money, it would be appropriate not to grant him this right and to include the spendthrift clause.
Basically, upon the insured’s death, the insurance company’s obligation under the original contract terminates, and it assumes a new obligation, defined by the terms of the settlement agreement. A typical settlement agreement is between the insurance company and the policyowner (typically the insured) and controls the distribution of the policy proceeds to third-party beneficiaries after the insured’s death. The policyowner may or may not give the primary beneficiary the right to set aside the prior agreement after the insured dies. (See the spendthrift clause below.)
Depending on company practice, the agreement can be a basic part of the insurance policy or separate from it. It can also be drawn up at the time the policy goes into effect or at any time prior to the insured’s death.
If the policyowner did not elect a deferred settlement, or elected one but gave the primary beneficiary the right to set it aside, the beneficiary usually can elect a settlement option and enter into an agreement with the company to govern the distribution of the proceeds. The beneficiary is usually given six months after the insured’s death to elect a settlement option, provided he has not cashed the check the insurer offered in full settlement of the death claim. Insurers pay interest on the portion of proceeds it holds after the insured dies. The interest starts accruing from the date of death—even if the election of the specific option is made long after the insured dies—and continues until the proceeds are distributed to the beneficiary.
A spendthrift clause states that the life insurance proceeds will be free from attachment or seizure by the beneficiary’s creditors. This clause may be included in a life insurance policy or settlement agreement acquired by one person for the benefit of another. It cannot, however, be incorporated into an agreement at the request of the party for whose benefit the agreement is being drawn up. That means when a beneficiary elects the settlement option, or when the policyowner elects a deferred settlement for his own benefit, a spendthrift clause cannot be included in the settlement agreement. This supports the argument for having the policyowner elect the settlement option on behalf of the beneficiary, especially if the beneficiary has (or may have) credit problems.
When a lump-sum payout does not meet the needs of the client, he must decide between utilizing a trust or a settlement agreement. A trust is more flexible and can be customized to better meet the beneficiaries’ needs. However, the costs may be prohibitive. If the client decides to utilize a settlement agreement, it is important to determine whether his needs and circumstances would dictate giving the beneficiary the ability to set aside the prior agreement after the insured dies. For example, if the beneficiary has problems managing money, it would be appropriate not to grant him this right and to include the spendthrift clause.
For more information about life insurance settlement agreements, be sure to check out “The Essentials of Life Insurance Products,” which is part of the curriculum for NAIFA and The American College’s Financial Services Specialist designation.
Kirk Okumura is an LUTC author and editor at The American College. Contact him at kirk.okumura@TheAmericanCollege.edu.