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Life insurance is a foundation of financial planning for anyone with dependents. Sufficient life insurance means the death of a breadwinner won’t be a financial catastrophe.

If your spouse or another provider dies and you need to replace the income he or she brought in—usually wages or self-employment income—what are the best options for using the death benefit of a life insurance policy to create sufficient lasting income?

Each family’s situation is different. A parent with young children is in a different situation than someone whose kids are in their twenties and living independently, but some general advice applies.

The first step is to determine how much cash you need to cover immediate expenses and future liquidity and how much ongoing income you need. Today, with interest rates up, the options are better than a couple of years ago.

You’ll normally want to get the policy payout under your control as soon as possible. The best course usually is to place the funds in a money-market fund that will pay a good interest rate until you decide on what to do.

Bonds and bond funds have pros and cons
Corporate, government bonds and tax-free municipal bonds provide a set level of interest income payments, which is why they’re called fixed-income investments. They have advantages but drawbacks too.

If you buy an individual bond, you’ll get your money back if you hold it until the bond reaches maturity and pays back the principal. Bonds can be traded in the secondary market, so you can sell them before maturity, but you may have a gain or loss if you do.

If you own a corporate or municipal bond, you also need to choose carefully to reduce the odds that the issuing entity will have repayment difficulties or go bankrupt before it can pay off bondholders. This isn’t a concern with US Treasury notes and bonds.

Investing in bond funds (mutual funds and exchange-traded funds or ETFs) reduces the credit risk of individual bonds. Today, bond funds come in many varieties.

All bond funds have varying share prices. When you sell fund shares, you may have a profit or a loss. And over time, the interest rate will vary. If you buy a bond fund today and interest rates decline in the future, your share price will typically go up but interest payments will ultimately go down. If rates go up, the opposite will occur.

CDs and fixed-rate annuities guarantee interest
Offered by banks and credit unions, certificates of deposits are safe because they are insured by the federal government (FDIC) up to $250,000 per bank, per person. Terms from a few months to five years are readily available, and a few banks offer up to 10 years.

While CD rates are much higher than they’ve been in the last few years, a disadvantage is lack of liquidity. Many banks require you to wait until the term is up to make any penalty-free withdrawals. Others may let you take out interest. If you’re considering a CD for current income, make sure you understand the restrictions on withdrawals.

A deferred fixed-rate annuity is the insurance industry’s version of the CD. It too guarantees a set rate of interest for a term but is not backed up by FDIC.

If you’re 59½ or older, this kind of annuity, also known as a multi-year guaranteed annuity (MYGA), can be a great place to deploy life insurance proceeds. Rates are up, typically higher than CD rates. You now can get up to 6.00%. Most MYGAs provide some liquidity, often allowing the owner to withdraw up to 10% of the policy value annually without penalty. Any interest you earn is not taxed until it’s withdrawn.

If you’re younger and need current income, a MYGA has a big drawback. If you withdraw money before age 59½ you’ll pay a 10% IRS penalty on any interest you receive in addition to federal and state income taxes on it, unless you’re permanently disabled.

Lifetime annuity provides 
most income

With an income annuity, you convert a lump sum into a stream of income that starts almost immediately. A single premium immediate annuity, or SPIA, is bought with a lump sum. A lifetime annuity is the most popular variant, but you can buy one with a set term, such as 20 years. Income from a lifetime annuity is not subject to the pre-59½ tax penalty.

Here’s why it produces the most income. Each income payment includes both taxable interest and non-taxable return of principal. Typically, the tax-free portion is larger. The two usually combine to give you more monthly income than you could get any other way, and certainly more than you can get from any other guaranteed-rate vehicle.

You can choose to receive monthly, quarterly or semi-annual payments. While much of the income is your own money coming back to you, it’s convenient and guaranteed, and your remaining principal is earning a good rate over the years. Think of an income annuity as your own private pension.

A lifetime annuity normally has no cash surrender value. If you have other significant savings or investments, putting the entire death benefit toward one might make sense. But if you don’t, it wouldn’t.

What’s unique about a lifetime annuity is that the same income will keep coming to you no matter how long you live. If you live past your life expectancy, the annuity will have paid back your entire principal, but you’ll still get the same guaranteed payments. This is why it’s often called “longevity” insurance.

One word of caution: some insurers let you convert the death benefit into a lifetime annuity directly. It’s not a good idea to accept that option immediately because the odds aren’t high that the company that provided the life insurance will also offer the best deal on an annuity. Do comparison shopping to make sure that you’ll get the most guaranteed income available. Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed, and lifetime income annuities. He’s a nationally recognized annuity expert and prolific writer on retirement income. A free rate comparison service with interest rates from dozens of insurers is available at -or by calling (800) 239-0356.

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