Annuities are often touted as a reliable source of income during retirement. By exchanging a lump sum for a guaranteed stream of payments, you can mitigate the risk of outliving your savings. However, what many people overlook is what happens to their annuity after they pass away.
A common misconception is that the remaining value of an annuity automatically passes on to heirs. In reality, the outcome can vary significantly. While some annuities offer death benefits, others may revert back to the insurance company.
This article dives into the different annuity death benefit options to help you make informed decisions for your financial future and the wellbeing of your loved ones.
What happens to an annuity after you die?
The fate of your annuity after you die largely depends on the specific type of annuity you own and the choices you made when setting up the contract. Some annuity payments end upon the owner’s death, while others offer various death benefit options that can provide financial security for your beneficiaries.
Different annuity payout options
When you purchase an annuity, you get to choose your desired payout option. This can impact the death benefit, if any, your beneficiaries receive after you’re gone.
Once you begin receiving payments, you can’t change your payout option, so it’s important to understand what’s available.
Here are the most common options.
Life only
With a life-only annuity, payments continue for the rest of your life. Upon your death, payments stop entirely. This option usually offers the highest monthly payment since there’s no payout to your beneficiaries after you die.
The amount of your annuity payments is primarily determined by your life expectancy. Generally, the longer you are expected to live, the smaller your monthly payment will be. While there’s no guarantee you’ll recoup your entire investment, you can be assured of a steady income for the rest of your life.
Life with period certain
Payments continue for your entire life. If you die before the specified “period certain” (usually 10 or 20 years), payments continue to your beneficiary for the remainder of the period.
For example, if you select a 15-year period certain option and pass away after receiving payments for 10 years, your beneficiary will continue to receive payments for the remaining five years.
This option provides a safety net for beneficiaries but results in lower monthly payments compared to the life only-option due to the added guarantee.
Joint life with survivor
Payments continue as long as either you or your designated beneficiary (usually a spouse) is alive. This option offers income protection for both you and your spouse, but typically results in lower monthly payments since payouts must last for two lives instead of one.
The payment amount for the surviving annuitant can be either the same as or different from the amount received by the deceased annuitant.
What are annuity death benefits?
A common concern with annuities is the possibility of dying shortly after income payments begin, resulting in the rest of the money going back to the insurance company.
A death benefit, particularly a period-certain option, safeguards against this. By guaranteeing payments to a named beneficiary for a specified period, even if the annuity owner dies prematurely, the annuity’s value is better preserved for heirs.
Typically, the death benefit is equal to either the total amount you invested (premiums paid) or the current value of the annuity, whichever is higher.
Some annuities, particularly deferred annuities, offer a death benefit if you pass away before income payments begin. This means your beneficiaries could receive a payout even though you didn’t start receiving income from the annuity.
The size of an annuity death benefit varies depending on the annuity type and the options selected when the contract was established.
There are several common types of death benefit options available:
- Standard death benefit: This is the most basic option. Your beneficiary receives the current account value of the annuity at the time of your death.
- Return of premium death benefit: This option guarantees that your beneficiary will receive at least the total amount of premiums paid into the annuity, regardless of the account value.
- Guaranteed death benefit: This option provides a minimum death benefit, ensuring your beneficiaries receive a specific amount, even if the annuity’s value declines. It offers greater certainty but may come with higher costs.
Factors impacting death benefits
Several factors influence the value and structure of your annuity’s death benefit.
- Annuity type: Different annuity types (fixed, variable, indexed, etc.) offer varying death benefit options.
- Contract terms: The specific provisions outlined in the annuity contract, including the chosen death benefit option and any riders or add-ons, will also impact the outcome.
- Annuitization date: If the annuity owner has begun receiving regular payments (annuitization), the death benefit may be reduced or eliminated, depending on the contract terms.
- Economic conditions: With variable annuities, the performance of the annuity’s underlying investments can impact the account value and, consequently, the death benefit.
For fixed annuities, the beneficiary typically receives the present value of future payments. In the case of immediate annuities without a period certain, the insurance company may keep the remaining funds upon the owner’s death. However, some immediate annuities offer a provision to continue payments to the beneficiary for a minimum period.
Deferred annuities generally pay beneficiaries the total account value if the owner dies during the accumulation phase. If death occurs during the payout phase, the beneficiary receives the remaining value minus any previous payments to the original owner.
Naming a beneficiary for your annuity
Designating a beneficiary for your annuity is crucial to ensure your assets are distributed according to your wishes.
Most annuities allow you to name one or more beneficiaries. However, the specific options available can vary depending on the annuity contract.
The tax implications of inheriting an annuity can be complex, depending on factors such as the beneficiary’s relationship to the deceased and the state of residence. Consulting a tax professional is recommended.
Annuity death benefits can be paid out to a beneficiary as a single lump sum or in the form of ongoing income payments, depending on the specific terms of the contract.
Bottom line
Understanding how annuities work after your death is essential for protecting your loved ones’ financial future. By carefully considering your options and consulting with a financial advisor, you can choose the annuity and death benefit that best align with your goals. Remember to review your beneficiary designations periodically to ensure they still reflect your wishes.
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