Introduction
A life insurance payout can provide significant financial relief, though it often arrives during a challenging emotional period for the beneficiary. Managing a substantial lump sum effectively while grieving requires careful thought, as initial decisions can have long-lasting impacts on financial security.
This guide offers practical advice on the crucial steps and common pitfalls to avoid after receiving a life insurance benefit payment. It aims to help you navigate this complex situation, make informed choices about the funds, potentially with guidance from a financial adviser, and use the payout to support your future financial stability.
Immediate Steps After Receiving a Life Insurance Benefit
Take Time Before Making Big Decisions
Receiving a life insurance payout often occurs during a period of grief, which studies suggest can impair decision-making abilities for several months. Resisting the urge to make immediate, significant financial choices with the lump sum benefit payment is crucial.
Unless there is an urgent financial need, allow yourself time to process the situation before committing to:
- Large purchases
- Investments
- Irreversible financial moves
This pause is not about inaction but deliberate non-commitment while you formulate a plan. Consider parking the funds temporarily in a safe place, such as a high-interest savings account.
This approach allows emotions to settle and provides space for clearer, more rational financial thinking, reducing the risk of impulsive decisions you might later regret.
Secure the Payout Funds Safely
Upon receiving the life insurance benefit, your immediate priority should be to secure the funds. Deposit the cheque or electronic transfer straight away into a secure bank account. Keeping these funds separate from your everyday transaction accounts is advisable.
Consider using one of the following options for initial placement:
- A high-interest savings account: This keeps the funds safe and earns some interest while remaining accessible.
- A mortgage offset account: If you have a home loan with a 100% offset facility, placing the payout here can immediately reduce the interest paid on your mortgage while keeping the funds liquid.
Ensure the bank is an Authorised Deposit-taking Institution (ADI) covered by the Australian Government’s Financial Claims Scheme. This scheme protects deposits up to a certain limit per account holder per institution, providing peace of mind while you plan the next steps for the insurance payout.
Notify Relevant Organisations like Centrelink
You have a mandatory obligation if you receive any income support payments or benefits from Services Australia (Centrelink) or the Department of Veterans’ Affairs (DVA). You must notify Services Australia within 14 days of receiving the life insurance payout. This notification period generally starts when the funds arrive in your bank account.
Reporting this change in your financial circumstances is essential because the lump sum will affect the income and assets tests used to determine your eligibility and payment rate. An asset increase or deemed income from the payout will likely reduce or potentially stop your benefits.
Failing to report the payout within the 14-day timeframe can lead to overpayments, resulting in a debt you will need to repay.
Developing Your Financial Strategy for the Insurance Payout
Assess Your Complete Financial Picture and Goals
Before allocating the life insurance payout, it’s vital to understand your overall financial situation. This involves taking stock of everything you own and owe. Create a clear list that includes:
- Assets: Detail items like your home’s value, savings balances, superannuation funds, investments, vehicles, and other significant possessions.
- Liabilities: Note all outstanding debts, such as mortgages, credit card balances, personal loans, car finance, and any other money owed.
- Income: Document all sources of regular income, whether from employment, investments, or government benefits. Consider how the loss of the deceased’s income impacts this.
- Expenses: Track your living costs, covering housing, utilities, food, transport, insurance, healthcare, and discretionary spending.
Alongside this financial inventory, define what you need the money to achieve. Setting clear goals provides direction for the payout. Consider these across different timelines:
- Short-term goals (next 1-3 years): This might include paying off high-interest debts, establishing an emergency fund, or covering immediate essential costs.
- Medium-term goals (3-7 years): Examples could be funding education, saving for a significant purchase, or planning a major trip.
- Long-term goals (7+ years): Focus on ensuring a comfortable retirement, funding potential aged care needs, or leaving an inheritance.
Prioritise Covering Essential Expenses and Debts
A primary use for the life insurance benefit is often to maintain financial stability by covering immediate needs. If the deceased was a main income provider, the payout can help bridge the gap.
Ensure funds are available for essential living expenses, such as:
- Mortgage or rent payments
- Utility bills (electricity, gas, water)
- Groceries and household supplies
- Ongoing costs like school fees or childcare
- Transport and medical expenses
Once immediate living expenses are secured, focus on strategically managing debts. A lump sum offers a significant opportunity to reduce financial burdens.
It is generally advisable to prioritise paying off high-interest debts first. These typically include:
- Credit card balances
- Personal loans
- Store cards or other high-cost borrowing
Clearing these debts provides a guaranteed financial return by saving on high-interest charges and can significantly improve your cash flow.
Decisions regarding larger debts like a mortgage require careful consideration, weighing factors like interest rates against potential investment returns and personal peace of mind.
Build or Boost Your Emergency Fund
Establishing a financial safety net is a fundamental step in managing the payout. An emergency fund provides readily accessible cash to handle unexpected events without derailing your long-term plans or forcing you into debt. Use a portion of the life insurance payout to create or increase your emergency savings.
Financial advisors typically recommend holding enough funds to cover three to six months’ essential living expenses. Calculate your non-negotiable monthly costs (rent/mortgage, food, utilities, transport, insurance) and multiply by three to six to determine your target amount.
This fund should be kept separate from your everyday spending and long-term investments.
The ideal place for an emergency fund is a secure and easily accessible account. A high-interest savings account is a common choice, ensuring the money is safe (covered by the government guarantee up to the applicable limit) and available when needed. Some may also use a mortgage offset account, which saves on home loan interest while keeping the funds accessible.
Speak To An Adelaide Financial Planner Today
Our financial planners are based right here in Adelaide, South Australia.
Long Term Financial Management Using Your Life Insurance Benefit
Invest Wisely Based on Professional Advice
Once immediate financial needs and high-interest debts are addressed, investing a portion of the life insurance payout can help grow the funds over the long term. However, it is crucial to approach investment decisions carefully and avoid rushing into complex or high-risk ventures without thorough understanding.
Developing a sound investment strategy requires careful consideration of:
- Your personal financial goals
- The timeframe you have for investing
- Your tolerance for risk
Seeking guidance from a licensed financial adviser is highly recommended before committing funds. An adviser can help you:
- Assess your complete financial picture and clarify your long-term objectives
- Develop a diversified investment portfolio aligned with your goals and risk profile
- Understand the potential risks and returns associated with various investment options available in Australia
- Navigate the tax implications of investment earnings
Diversification involves spreading investments across asset classes like shares, property, fixed interest, and cash to help manage risk. Investment options in Australia include direct shares, managed funds, Exchange Traded Funds (ETFs), or investment properties.
It’s important to note that income like interest, dividends, rent, and capital gains generated from the payout money is generally taxable.
Steer clear of unsolicited investment offers or schemes promising unusually high or guaranteed returns, as these are often scams targeting individuals who have received a lump sum benefit payment. A professional financial adviser will help you make informed choices based on regulated products and realistic expectations.
Consider Boosting Your Superannuation
Contributing part of the life insurance benefit payout to your superannuation fund can be a tax-effective strategy, particularly for enhancing retirement savings. Superannuation offers a concessionally taxed environment where investment earnings are taxed at a maximum of 15% during the accumulation phase, potentially boosting long-term growth.
For retirees over 60 accessing their super through an income stream, earnings, and withdrawals are often tax-free.
Key ways to add the payout (which is generally after-tax money) to your super include:
- Non-Concessional Contributions (NCCs): Personal contributions from your bank account. There are annual limits (caps) on how much you can contribute this way.
- Bring-Forward Rule: If you are under 75, you might be eligible to make larger contributions by bringing forward future years’ NCC caps, allowing up to three times the annual limit in one go, subject to your Total Super Balance (TSB).
Eligibility to make NCCs and use the bring-forward rule depends on your age and your TSB on the 30th of June of the previous financial year. Contribution caps and rules can change, so verifying your eligibility and understanding the limits is essential before contributing.
A financial adviser or accountant can guide you in boosting your superannuation to align with your financial plan and retirement goals.
Understanding Key Considerations for Your Payout
Understand the Tax Implications of the Payout and Earnings
Understanding the tax implications of a life insurance payout is essential. The tax treatment often depends on how the policy was held and the beneficiary’s relationship to the deceased.
Generally, for life insurance policies held personally (outside superannuation), lump sum payouts for death, terminal illness, or Total and Permanent Disability (TPD) are received tax-free by the beneficiary. However, income protection payments are usually treated as taxable income.
The situation is more complex for policies held within a superannuation fund:
- Payout to a ‘Tax Dependant’: If the lump sum death benefit is paid to a beneficiary defined as a ‘tax dependant’ under the Income Tax Assessment Act 1997 (Cth) (such as a spouse, child under 18, or someone financially dependent or in an interdependency relationship), the payout is typically tax-free.
- Payout to a ‘Non-Tax Dependant’: If the benefit payment goes to someone not considered a tax dependant (like an adult, financially independent child), the ‘taxable component’ of the lump sum is subject to tax, potentially up to 17% (15% plus Medicare levy). The ‘tax-free component’ remains tax-free.
It is crucial to remember that even if the initial lump sum payout is tax-free, any income or investment returns generated from investing that money afterwards are generally taxable. This includes:
- Interest
- Dividends
- Capital gains
Seeking advice from a tax professional is highly recommended to understand your situation.
Review and Update Your Estate Plan and Insurance
Receiving a significant life insurance benefit payment represents a major change in your financial circumstances. This makes it crucial to review and update your personal estate planning documents.
Ensure your Will accurately reflects your current wishes to distribute your larger asset pool. An outdated Will might not cover the increased assets properly or could lead to disputes.
Review your Enduring Power of Attorney (EPoA) to confirm the appointed person is still appropriate, and the powers granted are sufficient to manage your potentially more complex financial affairs if needed.
When checking your superannuation beneficiary nominations:
- Confirm if you have made a Binding Death Benefit Nomination (BDBN) and if it is still valid (some lapse every three years)
- Ensure the nominated beneficiaries align with your current intentions
- Consider the tax implications for non-tax dependent beneficiaries receiving superannuation death benefits directly
Finally, review your insurance policies to ensure they align with your changed financial situation and future needs. This includes:
- Life cover
- Income protection
- TPD insurance
What Not To Do After a Life Insurance Payout
Avoid Rash Spending and Impulse Decisions
Receiving a significant life insurance payout can create a temptation to make immediate, large purchases. It is important to resist the urge to spend impulsively before establishing a clear financial plan.
During this vulnerable time, be cautious about spending on:
- Luxury cars
- Expensive holidays
- Major home renovations
Grief and other strong emotions following a loss can impair judgment, potentially leading to decisions you might regret later. Sticking to a carefully considered budget is essential during this period.
Additionally, avoid unplanned lifestyle inflation, where increased available funds lead to gradually higher spending habits without conscious decision-making. Such spending can quickly erode the lump sum benefit payment intended for long-term security.
Steer Clear of High Risk Investments and Scams
Exercise extreme caution regarding investment opportunities after receiving a life insurance benefit payment. Be wary of “get rich quick” schemes, unsolicited investment offers, or complex financial products you do not fully understand. High-pressure sales tactics or promises of unusually high or guaranteed returns often indicate potential scams targeting individuals with a recent lump sum.
Scammers frequently target beneficiaries, employing various tactics:
- Investment Scams: Offering opportunities in areas like cryptocurrency, forestry, or fake bonds, often promising unrealistic returns
- Impersonation Scams: Posing as banks, government agencies (like the Australian Taxation Office (ATO) or Centrelink), or other legitimate organisations to trick you into transferring money or revealing personal information
- Phishing: Using fake emails, texts, or websites to steal banking details or passwords
Always independently verify any investment proposal or unexpected contact through official channels. Do not invest in anything without thorough research and understanding, ideally with guidance from a licensed financial adviser. Remember the Australian Competition and Consumer Commission (ACCC)’s Scamwatch advice: Stop, Think, Protect.
Navigate Family Expectations and Gifting Rules Carefully
After receiving the payout, you might face requests or pressure to provide financial assistance to family members or friends. While the desire to help is natural, prioritise your long-term financial security and needs according to your established plan before committing funds to others. It is acceptable to set boundaries or decline requests if necessary.
If you receive Centrelink benefits, understanding the gifting rules is crucial:
- Gifting more than $10,000 in a single financial year, or $30,000 over a rolling five-year period, can negatively impact your payments
- Amounts gifted above these limits are treated as ‘deprived assets’ by Centrelink for five years
- These ‘deprived assets’ still count towards your income and assets tests
Ensure any financial help provided is a planned decision within these rules and doesn’t compromise your financial stability. Consider formalising significant loans or gifts with legal documentation.
Conclusion
Managing a life insurance payout effectively involves pausing before making major decisions, securing the funds, planning strategically for debts and future needs, and seeking professional guidance. Avoiding common pitfalls like impulsive spending, high-risk investments, and neglecting tax or Centrelink obligations is equally crucial for long-term financial security.
Consider leveraging expert advice to navigate these complexities and ensure the benefit payment secures your financial future. Contact Money Path in Adelaide today for trusted expertise and tailored financial planning to help you make informed choices with your life insurance payout.
