How Annuities Work as a Beneficiary

An annuity beneficiary is the individual designated to receive payments or a lump sum after the annuity holder passes away. Annuities offer varied payout options for beneficiaries, which can depend on the specific annuity terms chosen, like lifetime income or a guaranteed minimum payout. When an annuity owner names a beneficiary, they secure that person’s right to receive the remaining annuity benefits, which can often bypass probate. These arrangements help ensure beneficiaries have financial support while potentially offering tax advantages, depending on the annuity type and structure.

Questions surrounding annuities and beneficiaries are complex, so it may be a good idea to work with a financial advisor.

What Is an Annuity?

An annuity can be described as an insurance contract negotiated between an insurance company and an individual. The individual pays money upfront or makes a series of payments in exchange for a steady stream of payments. An immediate annuities can starts paying out immediately, while payments from a deferred annuity, typically begin at a later date. Annuities can also last for a set amount of time or a lifetime.

In addition to deferred and immediate annuities, annuity buyers will need to decide between fixed, indexed or variable annuities. A fixed annuity earns a set amount of returns that don’t fluctuate much over time. Indexed annuities are attached to the performance of a specific index, though they often feature downside protections and upside limits. Variable annuities come with a higher variance of risk and reward, since your payout fully depends on how well the money behind your annuity is invested.

Annuities are a popular financial tool for lottery winners and others who receive lump sums of cash, as they give the annuitant a guaranteed and regular income stream. They’re also popular for retired people for similar reasons. As a result, it’s fairly common for annuities to pass from an individual to one of their beneficiaries in the event of the owner’s death.

Annuity Death Benefits: How They Work

Annuity death benefits are designed to provide a guaranteed payout to beneficiaries if the annuity owner passes away before the contract ends. These benefits help ensure that the funds invested in the annuity don’t go to waste and can provide financial support to heirs. In most cases, annuity owners specify a beneficiary who will receive the remaining balance or guaranteed payout. Death benefits vary depending on the type of annuity and any additional riders (optional contract add-ons) that the owner may have selected.

For instance, in deferred variable annuities, a basic death benefit often guarantees that beneficiaries receive at least the original investment amount or the current account value, whichever is higher. This guarantee can be appealing when market fluctuations impact the annuity’s value.

Some annuity contracts also allow for enhanced death benefits – a rider that increases the payout amount. Enhanced benefits may provide an additional percentage of growth on the original investment or lock in gains at certain intervals, although they typically come with extra fees.

Inheritance Options for Annuity Beneficiaries

When a beneficiary inherits an annuity, they usually have several options for receiving the payout. These choices provide flexibility in how the funds are accessed and how taxes are managed. Below are the most common options:

Continuation of payments: If the annuity owner was already receiving income through annuitization, the beneficiary may opt to continue these scheduled payments. This is often the case with joint-and-survivor annuities, which are structured to continue payments for a spouse or another beneficiary after the owner’s death.
Lump-sum payment: The beneficiary may choose to take the entire value of the annuity in a single payment. While this option offers immediate access to the full amount, any growth beyond the original investment is taxed as ordinary income, which could result in a significant tax liability if the gains are substantial.
Five-year distribution: Some annuities allow beneficiaries to withdraw the annuity funds over a five-year period. This option can help spread out the tax impact, as only the gains in each withdrawal are taxed. By spreading distributions over time, beneficiaries might manage their taxable income more effectively, especially if they are in a higher tax bracket.
Annuitized payments: Beneficiaries may also choose to receive regular payments over a longer period, such as 10 years or even their lifetime, depending on the annuity contract. With annuitized payments, taxes are calculated on a portion of each payment that represents gains. This choice offers predictable income while potentially lowering the annual tax burden.

Beneficiaries of Period-Certain Life Annuities

Some annuities are period-certain annuities, which combine the benefits of a fixed annuity and life annuity by guaranteeing both payments for life and at least for a set amount of time. If the owner of a period-certain life annuity dies during the fixed period of the annuity, the beneficiary is eligible to continue to receive payments for the remainder of the fixed-period, though not for the rest of their life.

Bottom Line

Being the beneficiary of an annuity can be complicated, and often times the implications depend heavily upon the specifics of the annuity in question. However, there are certain questions you should ask that can help streamline the process.

Know that you’re entitled to a lump-sum if you inherit an annuity in the accumulation phase, and that you may not get anything if an heir has a life annuity that has already been paying out for some time. Above all, make sure you understand all the details of the annuity you’re inheriting, as your expectations may not quite match up to the benefits you receive.

Tips for Retirement Planning

Timing Social Security benefits strategically can increase lifetime benefits. Delaying benefits up to age 70, for example, increases the monthly payment by up to 32%, which can be especially valuable for individuals expecting longer retirements.
Annuities are one option when it comes to generating incomes streams during retirement. A financial advisor can help you sort through other alternatives. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.