An annuity can provide a stream of guaranteed income for life, taking some stress out of retirement planning. But what happens to an annuity when you die? That’s a question you might be pondering if you currently own an annuity or you’re thinking of purchasing one for retirement income.
What Happens to an Annuity When You Die?
The short answer is that it depends on the type of annuity you own. However, it also depends on the payout options’ structure and the death benefit terms.
When you purchase an annuity, you’re purchasing an insurance contract. During the initial accumulation phase, you make premium payments toward the annuity. During the distribution phase, the annuity makes payments back to you. Payouts can begin almost right away, as with an immediate annuity, or begin at a later date, as with a deferred annuity.
Regardless of whether you have an immediate or deferred annuity, the goal may be the same: to provide an income stream. Your annuity contract can include death benefit terms spelling out what happens to your annuity after your death. Specifically, you can name a beneficiary that you’d like to receive any remaining annuity payments. In that sense, an annuity is similar to life insurance, in that you can provide a death benefit for a named beneficiary.Types of Annuity Payouts
Whether your annuity offers that option depends on the type of annuity you have. Here’s a quick look at how different annuities compare when it comes to death benefits:
If you have a single life or life only annuity, there would be no death benefit for someone else to receive. However, you do have the choice of purchasing an annuity that includes the provisions for a beneficiary.
It’s also worth noting that choosing the period certain option or purchasing a joint and survivor annuity directly affects your payment amount from an annuity. With a joint and survivor annuity, for example, annuity payments are divided between two people. If you pass away first, your spouse would continue receiving payments but you would have received a lower payment amount during your lifetime.Who Can Be an Annuity Beneficiary?
If your annuity contract allows you to name a beneficiary, there are a few things to keep in mind when deciding who to include. First, you can choose one beneficiary only or name more than one individual you’d like to receive a percentage of any remaining annuity payments. That’s an option you might choose if you have multiple children that you’d like to benefit from the annuity.
Second, you can typically name anyone to be a beneficiary, although you should check with your annuity issuer for any exclusions. That means you can name your spouse, adult children or other family members as beneficiaries. Minors aren’t eligible to access death benefits from an annuity until they become legal adults. You could also assign a beneficiary status to charitable organizations or a trust you’ve established as part of your estate plan.Death Benefit Payout
Once you’ve chosen one or more beneficiaries for your annuity, they can decide how to receive annuity payments when you pass away. Generally, an inherited annuity pays out in three ways:
With a period certain annuity, the beneficiary would receive the same payment you were receiving during your lifetime. If you have a joint and survivor annuity, your spouse would continue receiving regular payments for life.Annuity Beneficiaries
Beneficiaries must pay taxes on any death benefits they receive from the annuity. How the taxes add up depends on the beneficiary and the annuity’s structure. For example, a spouse may opt to continue receiving annuity payments. In this case, they would still enjoy tax-deferred status. The IRS taxes distributions from the annuity only as they’re received.
On the other hand, say you’ve named your adult child as beneficiary. They may take out all of the remaining money in the annuity in one lump sum. However, they’d owe taxes on the full amount right away. In other words, there’s a trade-off you and your beneficiaries are making. The longer payments are spread out, the longer the beneficiary can spread out taxation. Taking a lump sum gives them access to all of the money at once but it involves a more immediate tax bite.The Bottom Line
What happens to an annuity when you die depends on your contract terms. If you want to create financial security for your loved ones it is important that you choose an annuity that let’s you do that.Tips for Investing
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