If people rely on you financially, consider buying life insurance to replace your income first
The primary purpose of life insurance is to protect those who depend on you financially, not to build or pass along wealth. Knowing loved ones will be financially secure after you're gone can be a great comfort, and it’s a top priority for many.
That said, life insurance can also be an effective way to pass money to your heirs. The life insurance death benefit goes directly to the policy’s beneficiaries and is typically tax-free. And it's a popular strategy. Among Americans who have life insurance, 39% purchased a policy to leave an inheritance or transfer wealth, according to the 2026 Insurance Barometer Study by LIMRA, a life insurance trade group.
Who can be a life insurance beneficiary?
A life insurance beneficiary is the person or entity that receives the payout from a policy if the insured person dies. You can choose almost anyone to receive your death benefit, including people, organizations and trusts.
Here are some common choices for life insurance beneficiaries:
👤 A person, like your spouse
A common approach is to name your spouse or partner as a beneficiary. Keep in mind some states that have community property laws may require you to assign a spouse as your life insurance beneficiary.
👤👤👤 Multiple people, like your children
When you specify multiple people should receive your life insurance payout, you’ll be asked what percentage goes to each person. You don’t need to divide the payout evenly.
📑 A trust
Naming a trust as your life insurance beneficiary is helpful if you’d like your payout to go to a child who is still a minor.
🏛️ Your estate
If you choose to name your estate as the beneficiary, just know the life insurance proceeds may be held up in probate.
🤝 A charitable organization
You can choose a charity to receive a part or all of your life insurance death benefit.
💼 A legal entity, like your business
Providing a payout for a business could help a partner retain ownership upon your death.
How does a life insurance payout work?
When you buy a life insurance policy, you choose the amount of coverage you want. In most cases, the face value of your life insurance is the sum of money your beneficiaries receive if you die. This payout is known as the “death benefit.” Your life insurance beneficiaries can often choose to receive the payout as a lump sum or in installments.
You can have more than one life insurance policy, but insurers generally place limits on how much coverage you can buy. This limit is typically 20 to 30 times your annual income.
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What type of life insurance should you use as an inheritance?
The two main types of life insurance are term life and permanent life. Term life insurance lasts for a set number of years, such as 10, 20 or 30 years, while permanent life insurance can last your entire life.
If you want a long-term policy that may last your entire life, consider permanent coverage such as whole life insurance.
» MORE: Best life insurance companies
In general, term life insurance is affordable and the best fit for most people.
Affordability with an expiration date
Term life is considerably cheaper than permanent life, but if you outlive the policy, your beneficiaries won’t receive a payout.
If you’re simply looking for cheap life insurance, a term policy is likely to be a better fit.
Lifelong coverage at a cost
Permanent policies typically last your entire life, but larger amounts can be pricey.
However, a type of permanent life insurance called whole life may be a good idea for parents of special needs dependents who may rely on them financially long term.
» MORE: Term vs. whole life insurance
Benefits of using life insurance as an inheritance
The payout goes directly to your beneficiaries
In general, the person or entity you list as the policy’s beneficiary receives the death benefit, not your estate. This means the funds don’t have to go through probate or pay off any outstanding debts before reaching your beneficiaries. In short, your beneficiaries receive the payout regardless of how your estate is handled.
Even if the payout goes directly to a beneficiary, the funds are still considered part of your estate for tax purposes if you own the policy. The federal estate tax limit is $15 million for 2026.
⚠️ Note that if no beneficiaries are named or if all of the beneficiaries are deceased, your policy’s payout could become part of your estate. To avoid this, make sure to check and update your policy’s beneficiaries often.
It’s also worth naming a contingent beneficiary. This person or entity receives the payout if the primary beneficiary is no longer alive when the policyholder dies.
The death benefit is tax-free
In general, life insurance is not taxable, which means your beneficiaries do not have to pay income tax on the proceeds.
Beneficiaries may have to pay tax on any interest earned on the principal amount. This typically occurs when the beneficiary receives the payout in installments. The principal amount can generate interest while it’s being held by the insurer. Beneficiaries must pay tax on this interest, but not the principal amount.
If you live in a state with an inheritance tax, heirs may be required to pay tax on any money they inherit. Currently these states include Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. However, a life insurance policy is typically considered separate from your estate and not subject to this tax.
Your beneficiaries can use the payout for any purpose
Life insurance is a way to leave cash without strings attached. Your beneficiaries can use the money for any purpose. This is not the case with some types of coverage, such as credit life insurance, which typically goes to a lender to pay off debt.
Is life insurance the best way to leave an inheritance?
Although the payout from a life insurance policy is usually tax-free for heirs, life insurance is an expensive way to leave an inheritance. Life insurance rates are based on your health and age. If you’re older or have a pre-existing condition, the cost of coverage may not be in your budget.
For example, the average annual premium for a $500,000 whole life policy for a 60-year-old man is $8,335, according to LifeStein.com, an online life insurance brokerage.
If you cannot afford the premiums, or are denied coverage, you may want to consider other ways to build wealth either through investing or other savings vehicles. Talk to a fee-only financial advisor about your options.
What happens when you inherit a life insurance policy?
Will I be notified if I am a beneficiary of life insurance?
Do children automatically inherit a parent's life insurance?
Article sources
- 1.LIMRA: MarketFacts. 92 Million Reasons to Talk About Life Insurance. Accessed Sep 22, 2026.
- 2.IRS. Estate Tax, Filing Threshold for Year of Death. Accessed Sep 22, 2026.
