Annuities are an important financial product for individuals who want to create a steady stream of retirement income. Some annuities include an annuity death benefit as a clause in their contract. This provides your beneficiaries with a sum of money when you pass away. However, the amount and terms vary from one annuity type to another.
An annuity death benefit is a financial payout given to a beneficiary upon the death of the annuity owner or the annuitant. It is designed to provide financial security and peace of mind to those who have been left behind.
What Happens to an Annuity When You Die?
When you die, your annuity can be paid to beneficiaries, depending on the type of annuity and contract you have.
If you die before you start receiving annuitized payments, then beneficiaries can usually receive your annuity’s value in a lump sum or as payments over time. If you die after annuitization and have a death benefit in place, your beneficiaries will receive the remaining funds in your annuity.
Variable Annuity Death Benefits vs. Fixed Annuity Death Benefits
A variable annuity death benefit can vary greatly between different contracts. A return of premium death benefit will ensure your beneficiaries receive the original amount that was contributed to the annuity. This is less than ideal because you will want your family to enjoy the benefits of your full account value. On the other hand, the beneficiaries of a fixed annuity death benefit will usually receive the current accumulated value of the retirement account.
Immediate Annuity vs. Deferred Annuity
Immediate annuities don’t usually have a lump sum death benefit. For this type of annuity, any remaining money after the annuitant dies will not be given to beneficiaries without a previously agreed upon rider or option.
Deferred annuities allow investments to grow over a long-term period. When the annuitant dies, the beneficiary will receive whatever remains in the account or a guaranteed minimum amount.
How Are Annuity Death Benefits Paid Out?
Some insurance companies may force you to have payouts over time, but there are other options for how an annuity death benefit is paid to beneficiaries. Make sure you have access to options. Annuity death benefits can be dispersed in these ways:
1. Lump-sum Distributions
Lump-sum distributions mean that the annuity is paid in one lump sum, which means income taxes may be due on the entire amount. While a lump sum can be enticing, always keep in mind that it may come with a heavy tax burden.
2. Non-qualified Stretch
This refers to the payout for a non-qualified annuity death benefit being stretched throughout the beneficiary’s life expectancy.
3. Assumption of the Existing Contract
This option will allow a spouse to assume ownership of an annuity contract. Assuming ownership of the annuity contract is often the easiest choice following the death of a loved one, as there is no need to transfer funds.
4. Qualified Stretch IRA
This option is for non-spouse beneficiaries of qualified or IRA funds and must generally be taken out within 10 years of the owners death.
5. Five-year Rule
Here, the full amount is paid out within five years. Annuity death benefit taxes are due when payouts are received by your beneficiaries. This will give your beneficiaries the option to withdraw amounts during five years or withdraw the entire payout in the fifth year.
Who Gets an Annuity After Death?
If you have named beneficiaries for your annuity, then they will receive the remaining payments. The rules of annuity death benefit beneficiaries depend on the type and terms of the annuity contract.
- The primary beneficiary of an annuity contract is the individual or organization designated to receive the death benefit when the annuity owner passes away.
- The contingent beneficiary is the secondary beneficiary of an annuity contract in case the primary beneficiary can't receive it. If that happens, the contingent beneficiary will be given the death benefit instead.
- It is possible to appoint a successor annuitant when you purchase an annuity. If the initial annuitant dies before the expiry of the contract, this person will be eligible to receive any remaining payments.
- If no primary or contingent beneficiaries are named in the annuity owner's policy, or if all eligible beneficiaries have passed away before them, the death benefit will be paid to their estate.
However, if you don’t have beneficiaries, the account defaults to the financial institution. This would mean the account goes to probate. This can mean less money for your family, since expenses like legal fees will be taken from your estate.
Are Annuity Death Benefits Taxable?
Annuity death benefits are subject to different tax rules. This is based on the type of annuity and other factors.
Qualified Annuities
Qualified annuities are held in tax-deferred accounts, which means the contributions are made with pre-tax dollars. Examples include an annuity holding a retirement account, like a 401k plan or IRA. The annuity beneficiary will need to pay income tax on the death benefit. However, the taxes can be deferred and rolled over into another account, like another IRA.
Non-Qualified Annuities
Non-qualified annuities have after-tax dollar contributions. The deferred interest in these accounts is taxable as ordinary income. A non-qualified account will allow a pro-rata distribution, which is an annuitized payout of the interest and principal. You have five years to take the distribution, or 10 years if you have an IRA.
Who Should Get an Annuity with an Annuity Death Benefit?
If you are considering an annuity death benefit clause, consult with a financial advisor to make sure it is the right course of action for you. Some contracts force annuitization, which is something you don’t want.
Annuity death benefits offer financial security to your family or any beneficiary you designate. It's reassuring to know that your beneficiaries will be taken care of after your passing. They'll have access to a steady stream of income when they need it most.
An annuity death benefit gives you flexibility in how to structure payments for your beneficiaries. A lump sum can be rolled over into another account without penalties. On the other hand, a longer, structured payout can give you more control. It helps to eliminate family in-fighting over assets by clearly assigning those funds.
Find Sage Financial Advice
It is essential to review annuity contracts before making a final decision. Having trusted financial advisors by your side can help you find the best annuity options. Annuities and annuity death benefits should be structured to support your needs, even after death.
Call the Pros at Asset Preservation Wealth & Tax
Any comments regarding safe and secure investments and guaranteed income streams refer only to fixed insurance products. They do not refer in any way to securities or investment advisory products. Fixed insurance and annuity product guarantees are subject to the claims paying ability of the issuing company; not guaranteed by any bank or the FDIC.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
The commentary on this blog reflects the personal opinions, viewpoints and analyses of the author, Stewart Willis, providing such comments, and should not be regarded as a description of advisory services provided by Foundations Investment Advisors, LLC (“Foundations”), an SEC registered investment adviser or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment, legal or tax advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Personal investment advice can only be rendered after the engagement of Foundations for services, execution of required documentation, including receipt of required disclosures. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Any statistical data or information obtained from or prepared by third party sources that Foundations deems reliable but in no way does Foundations guarantee the accuracy or completeness. Investments in securities involve the risk of loss. Any past performance is no guarantee of future results. Advisory services are only offered to clients or prospective clients where Foundations and its advisors are properly licensed or exempted. For more information, please go to https://adviserinfo.sec.gov and search by our firm name or by our CRD # 175083.
