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: 6 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 you die? Read on to learn more.

How Annuities Work After Death

If a policy owner dies before or during annuitization, a death benefit is triggered. The death benefit ensures that a predetermined beneficiary receives at least what’s been invested so far, and potentially much more. 

When setting up an annuity, you generally get to choose from several death benefit payout options offered by the insurance company. The one you select will determine how the investment is distributed after annuitization. As these choices can have significant financial ramifications on how your money is distributed, it’s essential to fully understand all the terms of your contract and properly designate your beneficiaries. 

The process for calculating a death benefit can vary considerably depending on whether you own a fixed or a variable annuity. The details of this process are covered below.

Death Benefits in Annuities

Although it’s common for an annuity to have a death benefit, it’s not mandatory. According to Stephen Kates, CFP®, Principal Financial Analyst at Annuity.org, “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,” 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.”

One of the main benefits of an annuity is that it can often be customized, especially when it comes to a death benefit. However, there are three very common guaranteed payment options that many annuities offer:

• Return of premium: A return of premium death benefit pays all of the money invested in the annuity to the beneficiary 
• Account value: In this case, the death benefit simply equals the value of the account at the time of death
• Stepped-up value: Some contracts take the peak value of an annuity contract over the course of its life and use that as a “stepped-up value” or “high water mark” death benefit

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

Common Annuity Payout Options and Their Impact After Death

Life-Only Annuities

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.

Joint and Survivor Annuities

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.

Period Certain Annuities

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.

What Happens to Fixed Annuities After Death?

Fixed annuities are relatively straightforward insurance contracts that pay a set interest rate for a specified period of time – sometimes, as long as an annuitant’s life, or even beyond.The death benefit will vary from product to product, so it’s important to check the fine print and understand the terms of your specific investment.

According to The Guardian Life Insurance Company of America, there are generally three different ways that insurance companies calculate the death benefit of a fixed annuity:

• A fixed amount equal to the original investment amount
• An amount that varies based on the annuity’s present value, which is the current value of all future payments from the annuity
• A special calculation based on riders or options chosen by the annuitant at the time of purchase

As these options can vary considerably in value, it pays to take the time to fully understand your options before purchasing.

What Happens to Variable Annuities After Death?

Variable annuities tend to have additional riders or death benefit variations when compared with fixed annuities. This is due in part to the variable nature of the account balance. A good death benefit protects account holders and their heirs from suffering from poor market performance, which could result in an account value below the original premium paid. For this reason, many variable annuities offer one of two broad death benefits:

• Guaranteed minimum: This death benefit guarantees an amount payable to an agreed-upon minimum; this can be the amount of premiums paid into the account or a specified fixed amount, such as a previous “high water mark” value of the account.
• Account value: One of the most common death benefits is the account value option, which simply pays the account value at the time of death.

Beneficiaries can generally choose payouts in one of two forms: structured payments, which can stretch as long as a lifetime, or lump sum, in which the entire benefit is paid at once.

Beneficiary Designations

At the time of purchase, an annuitant will have to select beneficiaries. This is an essential step in setting up an annuity contract.

Importance of Naming Beneficiaries

There are two primary reasons why naming beneficiaries on an annuity contract is critical. First, it ensures that your money will find its way to the people you want it to after you die. Second, it will do this in a way that avoids probate. This keeps your financial affairs private and makes the transfer process smoother.

Primary vs. Contingent Beneficiaries

In addition to any primary beneficiaries you want to distribute your money to after your death, you should also choose a number of contingent beneficiaries. Choosing a single beneficiary isn’t sufficient, particularly for a long-term contract like an annuity, as there is a chance that your primary beneficiary will die before you do. If your primary beneficiary predeceases you and you neglect to update your designation, the recipient of your annuity payout could end up being decided by the courts instead.

Ensuring Your Annuity Benefits Are Protected

Whether the bulk of your portfolio is invested in annuities or you simply own one for diversification purposes, it’s essential to select the right annuity type and payout option for your needs. Take the time to understand the pros and cons of various types of death benefits, especially those that come in the form of special riders or add-ons, before you make your purchase, and communicate with your annuity provider about how you want to distribute your assets after you die. Also, be sure to update your beneficiary designations regularly to ensure that you are securing a financial future for your loved ones. 

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