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Understanding the Death Benefit of a Variable Annuity


Variable annuities are insurance contracts designed not only to provide regular income during retirement but also a death benefit to the policyholder’s beneficiaries. The latter ensures that a certain amount of money is distributed to your heirs when you pass away. As the average life expectancy increases and one’s retirement savings must last longer, understanding how the death benefit of a variable annuity can benefit your loved ones’ financial security is more crucial now than ever. A financial advisor can also help you assess whether a variable annuity aligns with your financial needs. 

What Is a Variable Annuity?

A variable annuity is a financial product that combines elements of insurance and investment. It’s essentially a contract between an individual and an insurance company, where the individual invests a sum of money, often for retirement purposes, and in return, the insurance company promises to make periodic payments to the individual in the future. These payments can be a source of income during retirement.

One of the key features of a variable annuity is the ability to invest the money in a variety of investment options, typically referred to as “sub-accounts.” These sub-accounts are similar to mutual funds and can include a mix of stocks, bonds and other securities. The performance of these investments directly impacts the value of the annuity.

However, variable annuities come with an element of risk. Unlike fixed annuities that offer guaranteed returns, the returns on a variable annuity can fluctuate based on the performance of the chosen investments. If the investments perform well, the annuity’s value can increase, potentially providing a higher income stream in the future. If the investments perform poorly, though, the annuity’s value may decrease, lowering the eventual income payments.

How the Death Benefit Works

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The death benefit in a variable annuity provides a safety net in case the annuitant dies before their payments begin. The specific workings of the death benefit can vary among different annuity contracts, so it’s important to read the terms carefully. 

For example, some death benefits guarantee that your beneficiaries will receive either a set minimum or the total amount you’ve paid in premiums, minus any withdrawals – whichever is greater. 

However, you may opt for what’s called a “stepped-up” death benefit, which locks in the highest account value reached by the annuity. This “step-up” in the death benefit ensures that your beneficiaries receive a payout reflective of the investment’s peak performance, even if the market experiences subsequent declines. 

For instance, if an individual initially invested $100,000 and the annuity’s account value grew to $150,000 before their passing, the beneficiary would receive a death benefit of at least $150,000, regardless of the current account value.

Costs of a Death Benefit

It’s important to note that death benefits might come with additional costs, which can impact the overall return on your investment. Be sure to understand the trade-offs between these benefits and the fees associated with them.

Mortality and Expense (M&E) Fee

The M&E fee is a recurring charge that covers the insurance component of the variable annuity, including the death benefit. This fee can range from 0.5% to 2% of the account value annually, although the Securities and Exchange Commission (SEC) says it’s typically around 1.25%. Take note that this fee can erode the potential returns on your investments over time.

Administrative Fees

Variable annuities often come with administrative fees, which are typically around 0.15% of the account value per year, according to the SEC. These fees cover the administrative costs of managing the annuity, including processing transactions and maintaining account records.

Surrender Charges

If you decide to withdraw a significant portion of your annuity’s value or surrender the contract during the surrender period, you may incur surrender charges. These fees can vary widely but often decrease gradually over several years. Surrendering the annuity to access the death benefit may result in substantial costs.

Investment Fees

Variable annuities allow you to invest in sub-accounts, which are similar to mutual funds. These sub-accounts come with their own set of fees, including management fees and operating expenses. These fees can eat into your investment returns, affecting the overall value available for the death benefit.

Other Variable Annuity Benefits to Consider

A husband and wife consider purchasing a variable annuity with a death benefit

While the death benefit is an important aspect of variable annuities, it’s essential to recognize the additional advantages they bring to the table.

One significant advantage of variable annuities is their tax-deferred growth. Unlike taxable investment accounts, the money you invest in a variable annuity can grow without being subject to annual taxes. This can result in substantial savings over time, allowing your investments to compound more effectively.

Variable annuities also provide a steady stream of income during retirement, making them an attractive option for those seeking guaranteed income. This can help alleviate concerns about outliving your savings and provide financial security in your golden years.

Another benefit is the flexibility they offer in terms of investment options. Variable annuities allow you to choose from a variety of sub-accounts. This flexibility empowers you to tailor your investments to match your risk tolerance and financial goals.

Furthermore, some variable annuities come with optional riders that can enhance their value. For instance, a guaranteed minimum withdrawal benefit rider can ensure you receive a minimum level of income during retirement, regardless of market performance.

Bottom Line

The death benefit of a variable annuity can provide valuable protection for your loved ones but comes with costs that can affect your overall returns. Before investing in a variable annuity, carefully evaluate your financial goals, risk tolerance and the specific terms of the annuity contract to determine if it aligns with your long-term financial plan.

Retirement Planning Tips

  • Calculating how much you may receive in Social Security is a critical component of the retirement planning process. SmartAsset’s Social Security calculator can help you estimate how much your benefits could be based on when you plan to claim them.
  • A financial advisor can help you build streams of income to meet your needs in retirement. 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.

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