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How an Annuity Death Benefit Works


Annuities can generate income for retirement. However, most annuities also feature a standard death benefit. That lets you pass on assets from the annuity to an heir after your death. If you have an annuity of you’re thinking of purchasing one, here’s what you need to know about an annuity death benefit and how it works. SmartAsset’s free tool can also match you with financial advisors who can help you manage your annuity.

What Is an Annuity Death Benefit?

An annuity is a contract between yourself and an insurance company. You pay the insurer a set amount of money to purchase the contract. In turn, the insurer agrees to pay you according to a set schedule. These payments can begin right away if you have an immediate annuity or be deferred until a later date.

As part of your annuity contract, a standard death benefit may be included. This ensures that a beneficiary receives a financial payout when you die. In that sense, it’s similar to a life insurance policy, although there are some key differences. Death benefits pay out differently in an annuity, and face different tax liabilities.

That annuity death benefit can help create a financial legacy. For example, you may want to leave money to your spouse to help fund their retirement. Also, you name one of your children as beneficiary and fund or increase their inheritance. Heirs can take an annuity death benefit as a lump sum payment or as regular payouts.

Determining the Size of an Annuity’s Death Benefit

Annuity Death Benefit

Generally, there are two ways to determine a standard annuity death benefit. First, you can pay out any remaining assets to your beneficiary. Say you purchased a $500,000 annuity and it paid out $300,000 during your lifetime. The remaining $200,000 could pass on to someone else as part of the death benefit.

Secondly, you could choose a preset minimum amount for the death benefit. For example, the annuity can pay out exactly what you paid in for premiums, minus any amount you received. In that scenario, the amount paid to the beneficiary would depend on how much you paid for premiums. Also, it would  factor in the difference between the annuity’s market value and the payments you’ve already received.

In either case, payouts could be unpredictable. But generally, the higher the value of the annuity and the more value that’s left in it when you pass away, the bigger the death benefit is likely to be.

Increasing an Annuity Death Benefit

Your insurance company may offer opportunities to increase your annuity death benefit. This typically involves adding riders to the annuity for a fee.

In terms of the different options that might be available, here a few ways you could potentially increase the annuity death benefit:

Market-Linked Increases

Some annuity issuers will offer your beneficiary a higher death benefit depending on what’s happening with the stock market. For example, if you pass away during a market upswing, the annuity’s death benefit may automatically increase.

Annual Increases

Another option may be a death benefit that increases year over year as you get older. The premise of this type of step-up is that if you’re living longer, then you’ll receive more money from the annuity. In exchange, the insurance company increases the death benefit payout your beneficiaries are eligible to receive, since there may be less money left in the annuity by the time you pass away.

The advantage of these types of death benefit increases can be twofold. In the case of market-linked increases, you may be able to lock in market gains for your beneficiaries if the underlying assets in the annuity are performing well at the time of your death. At the very least, this type of benefit upgrade would guarantee the return of your premiums paid, less any investment gains.

With this type of increase or an annual step-up increase, you could leave behind a larger financial payout for your loved ones. Meanwhile, that could help when it’s time to pay taxes on your estate or cover burial and funeral expenses. However, those types of riders come at a cost. If you also have other assets to leave behind, such as life insurance, real estate, cash assets and investments, then paying more money to increase your annuity’s death benefit may not be necessary.

Annuity Death Benefit Riders

Aside from death benefit upgrades, there are other riders that can increase an annuity’s value. For example, you may be able to add a rider to cover long-term care in case you need nursing home care in retirement. Having this rider could reduce the amount of the death benefit. But it could provide funds to pay for long-term care if you don’t have a separate long-term care insurance policy. Remember, Medicare doesn’t cover long-term care.

When considering how to structure your annuity and its death benefit, look at the other financial tools you already have. A permanent life insurance policy, for example, could provide both a death benefit and cash value during your lifetime. It’s important to look at how the different parts of your financial plan work together. Make sure that you’re covering all the bases, but not paying more for those parts than you need to.

Bottom Line

Annuity Death Benefit

When adding an annuity to your financial plan, the death benefit is an important consideration. The annuity company you’re working with should be able to walk you through different death benefit scenarios to help you decide which one is the best fit for your needs. However, if you’re still unsure whether or not an annuity is a necessary portion of your retirement plan, you may want to consult an advisor.

Financial Planning Tips

  • Consider talking to a financial advisor about the underlying investments included in an annuity if you’re unclear on how they work or how they’re likely to perform in different market conditions. That information could help if you’re upgrading an annuity death benefit for a specific market return. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • An annuity can be a valuable tool in your retirement income plan but it’s not the only way to create financial security for your loved ones. Drafting a will, checking your life insurance coverage and considering whether you need to establish trust are all things to keep in mind as you plan for the long-term.

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