What Happens to an Annuity When You Die?

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An annuity is an investment product typically purchased from an insurance company to provide additional financial security in retirement. Annuities generally consist of two phases: the accumulation phase and the payout phase. 

Read More: 5 Genius Things All Wealthy People Do With Their Money

During the accumulation phase, the policy owner (typically the “annuitant”) pays into the policy. The payout phase, or “annuitization” is when the “annuity investment is converted into regular payments” and the policy owner starts to receive money. Annuitization occurs over a predetermined period or for the rest of the annuitant’s life. 

But what happens to an annuity when the policy owner dies before or during annuitization? 

The death of an annuitant triggers a death benefit. What specifically happens depends on what payout option the annuitant originally set up in the policy.

What Are Annuity Death Benefits?

If a policy owner dies before or during annuitization, a death benefit ensures that a predetermined beneficiary receives at least what’s been invested so far. Annuity payout terms are set at the time of purchase, so be sure you fully understand all the terms of your contract. 

How Much Does a Death Benefit Cost?

The death benefit is typically covered under the Mortality and Expense, or M&E, Risk Charge. This charge, usually around 1.25% of your contract value per year, helps the insurance company cover risks — like an annuitant’s death.

There are additional features you can add to your annuity contract for an upcharge called “riders.” Depending on the insurance company you purchase your annuity from, you can get a rider that enhances the death benefits in your contract.

For example, Nationwide offers a “Combination Enhanced Death Benefit Rider” that ensures your beneficiary gets the highest payout possible. 

How Do Annuity Death Benefits Work?

When setting up an annuity, you select a payout plan that determines how the investment is distributed after annuitization which is then written into the contract. Different payout plans affect how a death benefit gets distributed.

Do Annuities Have a Guaranteed Death Benefit?

In short, no. “An annuitized policy will only have a death benefit if the contract stipulated that payments should be made for a certain [dollar] amount or length of time and that obligation was not satisfied.” Stephen Kates, CFP®, Principal Financial Analyst at Annuity.org shared. “For instance, if the owner of an annuity contract agrees to receive payments for 20 years but dies after 10, the beneficiary will receive 10 more years of payments.”

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If you’re not sure whether your annuity has a death benefit, review your contract with a financial advisor.

How Death Benefits Work With Each Payout Option

There are several different payout options you can choose from when you initially purchase an annuity. It’s important to understand how each option will affect you in the present and future before making a decision.

Standard Death Benefit

The standard death benefit pays out the contract’s value to the beneficiary of your choice.

Life Only

The “life only” annuity payout option pays as long as you’re alive, but payments stop when the annuitant dies. In this case, a beneficiary would not receive any inheritance.

Life with Period Certain

The “life with period certain” payout option provides income for as long as you’re alive, but unlike the “life only” payout option, your beneficiary could receive an inheritance. Beneficiaries only receive an inheritance if the period certain — typically 10 or 20 years — has not expired.

Joint and Survivor

The “joint and survivor” payout option provides income for you and your spouse as long as either person is alive. After one spouse dies, the surviving partner can reduce the monthly payout amount if they wish. After both spouses die, payments will cease.

Best Ways To Maximize Death Benefits To a Beneficiary

According to Kates, there are a variety of strategies to enhance the amount of money left as a legacy by using annuities. Five main strategies he recommends include:

More Retirement Income

“Utilize annuities to enhance the amount of guaranteed retirement income, and place any remaining surplus assets into a portfolio earmarked only for inheritance such as an irrevocable trust.”

Use a Short Payout Schedule

“For those in excellent health, an annuity payout scheduled for a limited amount of time, such as 10 years, could be used to fully fund a life insurance policy that pays out more than the originally invested amount.”

Use Your Annuity as a Tax-Saving Strategy

“Deferred annuities can be used as supplemental tax-deferred savings vehicles with no limit on contributions. Placing excess savings into an account would allow the money to grow without the added drag of taxes on investment income, therefore allowing it to grow faster.”

Use Riders to Your Advantage

“Any riders added may reduce the amount of income received by the owner or increase the fees on the contract but will further define the benefit the beneficiary can receive. For instance, a Guaranteed Minimum Death Benefit (GMDB) rider will set a floor on the amount the beneficiary will receive regardless of the performance of the annuity.”

Before You Purchase an Annuity, Consider The Following

Annuities can be great investment products if the contract is the right fit for the annuitant. To ensure your contract will work for you, consider the following: 

• Personal financial goals: There are many ways an annuity can help you achieve your financial goals, whether that means you receive monthly income or that you use a lump sum to purchase an even more valuable life insurance policy. Being able to communicate your financial goals to a financial advisor can help them present the right options to you for consideration.
• On-hand capital: Annuities are an investment, and how much capital you have on hand is an important factor. Some contract terms allow you to pay a monthly premium, while others require a lump sum upfront.
• Withdrawals: Depending on the amount of money and the timing, you could incur a surrender charge–also referred to as a withdrawal fee–for making withdrawals from your annuity. 
• Risk tolerance: All annuities carry some level of risk, but some types are more risky than others. According to the Financial Industry Regulatory Authority (FINRA), variable annuities carry the most risk, followed by indexed annuities and fixed annuities. 

Takeaways

• An annuity is a type of investment product typically purchased from an insurance company to provide additional financial security in retirement.
• Death benefits ensure that a beneficiary chosen by the annuitant receives, at least, what they’ve invested so far.
• Death benefits are typically covered under the M&E Risk Charge.
• The payout plan chosen during the annuity purchase affects how a death benefit gets distributed.

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