Annuities are a popular way to turn part of a person's retirement savings into a stream of steady income to live on in retirement. Unlike other kinds of investments – like stocks or bonds – an income annuity is actually a contract with an insurance company: you provide them with a sum of money, and they turn it into a stream of guaranteed1 payments that lasts a set number of years, or even the rest of your life. And since it's impossible to predict how long a given individual will live, some people can end up getting more from their guaranteed payments than the amount they paid in. However, depending on the options chosen, annuity payments could stop when the annuity owner dies, and the contracts place other limits on how funds can be accessed. That's why some annuities include a death benefit provision. This article will tell you about:
How annuity death benefits work
Common death benefit variations and options
Tax implications and other considerations
What is a death benefit in an annuity?
Simply put, an annuity death benefit guarantees1 a certain payment to beneficiaries when the annuitant – the individual whose life expectancy is used to calculate payments – passes away. The death benefit payment is typically either a specific pre-determined amount, or the remaining value of the annuity contract. Annuity death benefits serve as a form of financial protection for loved ones, ensuring that at least a portion of the annuity's value can be passed on to heirs.
NOTE: The annuitant and the owner of the annuity contract can be two different individuals. The owner is the person who purchases the annuity and holds the contractual rights, while the annuitant is the individual whose life expectancy is used to calculate annuity payments and death benefits – and that is how the term is used in this article. The owner can designate a different individual as the annuitant, and in such cases the death of the annuitant is what triggers the death benefit. It's important to understand the terms and conditions laid out in the specific annuity contract, as this will determine how the death benefit is triggered and paid out.
How annuity death benefits work
Determining the death benefit amount
The annuity contract should state exactly how the death benefit amount is calculated. In some cases, the death benefit may be a fixed amount – for example, equal to the original investment amount. In other cases, the death benefit amount may vary, for example, because it is based on the annuity's "present value" (the current value of future payments from the annuity) at the time of the annuitant's death. The annuity's specific features and added additional riders or options can also affect the death benefit payout. As you purchase an annuity, it's important to ask your financial professional to spell out exactly how the death benefit will be calculated in different scenarios and points in time.
The type of annuity can affect how the death benefit is calculated
There are two basic types of income annuities: immediate and deferred. An immediate income annuity starts paying income right after you buy it, so the death benefit may vary accordingly. Some immediate annuities offer an option to guarantee1 that the beneficiary will continue to receive payments for a certain period.
A deferred income annuity doesn’t start paying right away, which lets you build funds for a number of years before annuitization (the conversion of the annuity to a stream of income). There are typically different formulas for determining the death benefit if the annuitant dies before annuitization, or after income payments start. After all, if the annuitant has been taking income for several years, the annuity has less value.
There are also different ways for assets to grow in a deferred annuity. A fixed annuity pays a fixed interest rate, so you can predict its value at any point in the future. A variable annuity lets you invest and take advantage of the highs (and lows) of the financial market. An indexed annuity provides the potential for growth tied to a specific index, such as the S&P 500. Since the future value of a variable or indexed annuity can’t be predicted, you also can’t know the exact value of a death benefit based on that value. But depending on the specific annuity, certain options and features may be available to give you a better sense of what the minimum death benefit would be at a given point in the future.
Riders2 and other features can affect the death benefit
Annuity contracts often offer riders (optional features) that can enhance the death benefit. For example, the "Guaranteed Minimum Death Benefit," or GMDB, is a common option that can ensure beneficiaries receive a minimum amount regardless of the annuity's performance. Other death benefit options may include:
1. Standard Death Benefit
Generally speaking, this is either a fixed sum or the current contract value, paid directly to the designated beneficiaries after the annuitant's death. Beneficiaries can usually choose to receive the funds as a lump sum or opt for periodic payments.
2. Return of Premium
With this option, if the annuitant dies before receiving annuity payments equal to the total premiums paid, the beneficiary will receive the difference as the death benefit. This ensures that the principal investment is protected even if the annuitant passes away just after annuitization.
3. Stepped-up Benefit
This type of rider can increase the death benefit over time. The annuity contract specifies a predetermined growth rate that is applied to the original investment, potentially resulting in a larger death benefit for the beneficiary.
4. Guaranteed Increase
This works similarly to the stepped-up benefit but guarantees a certain growth rate over a specific period, regardless of the annuity's performance. This can provide additional security to the beneficiary.
Tax implications and other considerations3
The death benefit in a life insurance policy, such as term or whole life insurance, is almost always paid out as a income tax-free lump sum. Annuities are different, and the tax treatment of their death benefits depends on the type of annuity, the age of the annuitant at the time of death, and other factors. But generally speaking, with "non-qualified annuities" (those purchased with after-tax dollars), beneficiaries only pay taxes on annuity earnings. With "qualified annuities" (those purchased with pre-tax dollars, like in a retirement account), the death benefit is typically taxed, either as ordinary income or via inheritance taxes. In any case, you should always speak with a tax consultant to ensure the death benefit and other annuity provisions are consistent with your needs and expectations.
Naming a beneficiary
As an annuity owner, you can name one or more beneficiaries to receive the death benefit. Beneficiaries can be people, such as family members or close friends, but they don't have to be. Charitable organizations and trusts are also commonly named as beneficiaries. Whoever you choose to designate, it's important to ensure that the beneficiary information is kept up to date with the insurance company that issues the annuity contract.
If you want to change or update your beneficiary designations, you should be able to easily do so by contacting the insurance company or financial professional who sold you the annuity. Regularly reviewing and updating beneficiary information will ensure that the annuity death benefit will be paid out according to your wishes.
What if you don’t want or need an annuity death benefit?
It's important to note that while optional death benefit provisions are commonly added to annuities, they don't have to be. If you don't have heirs you want to leave assets to, or their financial needs are being taken care of in other ways, you’re not required to elect an added death benefit – and in return, you'll typically benefit from lower fees or somewhat higher income payments.
Is an annuity appropriate for you?
An annuity can be an important part of your retirement planning strategy, and an added way to save money on a tax-deferred basis along with 401(k) plans, whole life insurance cash value, and other assets. But unlike those vehicles, it can guarantee1 that no matter how long you live you won’t outlive all your retirement income. We suggest talking to a financial professional to see if a deferred annuity could be suitable for your needs.
Yes, annuities can pay a death benefit. A death benefit in an annuity may ensure that the designated beneficiaries receive a lump sum, or a continuation of recurring payments, upon the annuity holder's death. The death benefit can be structured in various ways, and some annuities may also offer a return of premium option, where the annuity beneficiary receives the total premiums paid if the annuitant dies before receiving annuity payments. The details of the death benefit and how it is calculated are always clearly specified in the annuity contract. Some annuity contracts will not pay a death benefit.
When the annuity holder passes away, the ownership and any annuity death benefits are typically transferred to the designated beneficiaries based on the contract language. The process is facilitated by the annuity company and generally involves submitting a death claim and required documentation. Beneficiaries depending on contract language can often choose how they want to receive the death benefit, either as a lump sum payment or periodic payments, depending on the terms of the annuity.
The tax treatment of an annuity death benefit depends on several factors, such as the type of annuity and the age of the annuitant. These are some general strategies to minimize income tax on an annuity death benefit, but you should always consult with a tax professional to get guidance for your specific situation:
Choose the appropriate type of annuity: Consider a non-qualified annuity (purchased with after-tax funds) to potentially reduce the tax burden compared to qualified annuities (purchased with pre-tax funds, like in a retirement account).
Name beneficiaries wisely: As you designate annuity beneficiaries, consider their potential tax situations. For example, spouses may have more favorable options for rolling over the death benefit, while non-spouse beneficiaries may have different distribution options that affect taxes.
Take advantage of a stepped-up basis: In some cases, a stepped-up basis at the time of the annuitant’s death may reduce the death benefit tax liability for beneficiaries.
Consider a stretch payout: Some annuity contracts let the beneficiary stretch distribution of the death benefit over an extended period, which may help minimize the tax impact in any given tax year.
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1 All guarantees including the death benefit payments are dependent upon the claims paying ability of the issuing company and do not apply to the investment performance of the underlying funds in the variable annuity. Assets in the underlying funds are subject to market risks and may fluctuate in value. Variable annuities and their underlying variable investment options are sold by prospectus only. Investors should consider the investment objectives, risks, charges and expenses carefully before investing. This and other information are contained in the prospectus or summary prospectus, if available, which may be obtained from your investment professional. Please read it before you invest or send money.
2 Riders may incur an additional cost Riders may not be available in all states.
3 Current tax law is subject to interpretation and legislative change. Tax results and the appropriateness of any product for any specific taxpayer may vary depending on the particular set of facts and circumstances. Entities or persons distributing this information are not authorized to give tax or legal advice. Individuals are encouraged to seek specific advice from their personal tax or legal counsel.
This material is intended for general public use. By providing this content, The Guardian Life Insurance Company of America, The Guardian Insurance & Annuity Company, Inc. and their affiliates and subsidiaries are not undertaking to provide advice or recommendations for any specific individual or situation, or to otherwise act in a fiduciary capacity. Please contact a financial representative for guidance and information that is specific to your individual situation.
There are no additional tax benefits if you purchase an annuity to fund an IRA or qualified retirement plan. Therefore, an annuity should only be purchased in an IRA or qualified plan if you value some of the other features of the annuity and are willing to incur any additional costs associated with the annuity to receive such benefits.
Variable annuities are long term investment vehicles designed to help investors save for retirement and involve certain contract limitations, fees, expenses and risks, including possible loss of the principal amount invested. The investment return and principal value may fluctuate so that the investment, when redeemed, may be worth more or less than original cost. As with many investments, there are fees, expenses and risks associated with these contracts.
Withdrawals of taxable amounts from a variable or fixed deferred annuity will be subject to ordinary income tax and possible mandatory federal income tax withholding. If withdrawals are taken prior to age 59½, a 10% IRS penalty may also apply. Withdrawals may also be subject to a contingent deferred sales charge.
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