Many people aren’t aware that when they purchase and structure an annuity, they can name a beneficiary or beneficiaries, just as they can with a life insurance policy. Annuities are similar in other ways to life insurance policies and have even been called “life insurance policies in reverse.”
Jump ahead to these sections:
- Who’s the Default Annuity Beneficiary After a Death?
- Who Else Can Be an Annuity Beneficiary?
- How Do You Change an Annuity Beneficiary?
- What Are the Annuity Beneficiary Payout Options After a Death?
With an annuity, you give money to an insurance company, they invest it, and then they credit you with a guaranteed interest rate so the annuity’s value grows over time. The insurance company then pays you back the accumulated money over a period of years or until you die.
In this article, we’re going to delve into the different people and parties who can be your annuity beneficiaries and the various ways they can take payments upon the death of the annuitant.
Who’s the Default Annuity Beneficiary After a Death?
Technically, there’s no default annuity beneficiary after the annuitant dies. Like a life insurance policy, the annuity owner selects one or more people to receive a payout after they die. Most annuities pay money to a beneficiary when the owner dies, but some types of annuities stop paying anyone when the owner dies. Those annuities are known as “single life annuities.”
However, most annuity owners want to leave money to family members when they die, and not necessarily from a life insurance policy. They want their loved ones, if they’re responsible for funeral costs, to have money for final expenses and often want to provide additional money to help survivors with their living expenses.
If you’re an annuity owner, it's important to know that if you neglected to name a beneficiary when you bought your annuity, the remaining money in the annuity could become the property of the life insurance company when you die.
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Who Else Can Be an Annuity Beneficiary?
The owner of an annuity has a lot of flexibility when it comes to naming a beneficiary. The beneficiary of an annuity can be a person, an organization, a charity, or a trust.
Anyone with an insurable interest
If the beneficiary is a person, the insurance company issuing the annuity will make sure that there is an “insurable interest” between the annuity owner and the beneficiary. This is done to protect the annuity owner against someone who would do them harm to get an annuity payout as a beneficiary.
Insurable interest, in short, means that the beneficiary would suffer financial hardship if you were to die. Thus, in the vast majority of cases, family members are named as the beneficiaries of an annuity. This could be a child, a parent, a spouse, or a variety of other people who depend on your income.
Naming a spouse as your beneficiary comes with an additional benefit: spousal continuation. Many annuity contracts allow the spouse named as the beneficiary of the contract to decide what to do with the annuity after the annuitant passes away.
Legally, a spouse can change the contract into their name. When they do this, they assume all of the rights and rules of the initial contract, and they delay any tax consequences.
The spouse can collect all remaining payments and any death benefits and choose their beneficiaries. The spouse then becomes the new annuitant. The surviving spouse maintains a tax-deferred status (meaning any investment account growth isn’t taken out immediately and isn’t taxed until funds are paid out to the beneficiary).
Rather than naming a spouse as your beneficiary, you can also purchase a joint or joint survivor annuity, which provides the same benefit of continuation when one spouse dies.
An organization or charity
However, an institution or charity can be named as a beneficiary, too. For example, college alumni often leave an endowment to their alma mater by naming them as a beneficiary of their annuity, as well as organizations and causes they want to support financially, such as the American Cancer Society.
How Do You Change an Annuity Beneficiary?
As the annuity owner, if you’ve named someone or an organization as your beneficiary, you have the option to change that beneficiary at your discretion, as long as it’s not an “irrevocable beneficiary,” which often comes into play when a trust is involved.
Most beneficiaries are “revocable,” meaning they can be removed or replaced as a beneficiary. Irrevocable beneficiaries cannot, by contract, be changed.
Estate planners and tax attorneys often utilize “irrevocable trusts” where the payout would be made to a trust at the annuitant's death with the benefit of not having to go through a lengthy and costly probate process.
What Are the Annuity Beneficiary Payout Options After a Death?
The type of payout that the beneficiary receives will depend upon what was specified and directed by the annuity owner when they signed the contract to purchase the annuity.
There are three annuity beneficiary payout options after a death that we’ll discuss: standard death benefit, return of premium, and a stepped-up death benefit rider. We’ll also look at your options for spouse and non-spouse beneficiaries.
Standard death benefit
With this benefit, the contract value is determined the day the insurance company is notified of the annuitant's death. You could say that the dollar value of the annuity is frozen, and a picture is taken of it. Then, the payout is figured by the insurance company and paid to the beneficiary based on that frozen value. This benefit provides the most negligible value to the beneficiary, but the annuity owner doesn’t pay anything extra for it.
Return of premium
This benefit has a higher value than the standard death benefit, and the annuity owner may pay an extra surcharge for this feature. Under this contract, the insurance company pays the beneficiary the greater of two amounts:
- The market value of the contract
- The sum of all contributions minus fees and withdrawals
Stepped-up death benefit rider
Since this is a “rider,” the contract owner will pay extra for this feature. With the rider, the insurance company calculates the value of the contract at each anniversary date of the policy’s purchase. Then, when the annuitant dies, the insurance company pays the beneficiary the highest amount recorded minus any fees or withdrawals, instead of just the annuity’s value when the insurer learned of the annuitant’s death.
There are additional riders for “variable annuities,” which are tied to underlying investments that determine the value of the annuity. For example, with a variable annuity rider, the insurance company takes the highest value of the account for the month of the annuitant's death and then pays the beneficiary the amount based on that value.
Want to Avoid Market Risk?
No conversation about annuities would be complete without talking about market risk.
The bottom line is that you will avoid market risk with annuities unless you put your funds into a variable annuity, which will have your money invested in stock or bond mutual funds. With a variable annuity, you can lose money if the market takes a downturn.
If you want to guarantee that your beneficiaries receive income from your annuity, avoid variable annuities and purchase a “fixed annuity.” Yes, guarantees come with a cost; but at least you’ll be receiving the payment amounts you were promised.