Estate Planning: Annuities After Death

By on January 8, 2017
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A year after my father passes, my mother turned ninety and the details of finances became harder for her to manage, so it became my responsibility. While I am adept at taxes and personal finances, when it came to my mother’s (and my father’s) annuity contracts we both were full of questions for her financial advisor.

What happens to her annuity when she dies? What about the annuity my father passed to her? Does she get to pass along the (remaining) value with her estate or do we need to designate a beneficiary now? In most cases the answer to both is yes, but with a major caveat. What happens to an annuity after the death of the owner largely depends on the type of annuity plan.

The owner (annuitant) elects the annuity type and any beneficiaries at inception, though beneficiaries may be changed by the annuitant prior to death. There are several types of annuities – with some, payment ends with the death of the annuitant, but others provide for payment to a spouse or other beneficiary for years afterward.

Before you sit down with your trusted team of tax professionals and financial advisors to review your annuity or that of a loved one, here are the basics for annuitants and their beneficiaries.

What Annuity Investors Should Know

The majority of annuity contracts are either immediate or deferred. These investments are either in deferral (usually until retirement) or are used for regular interest and/or occasional principal withdraws.

Immediate Annuities

For fixed-period annuities, the annuitant is guaranteed payments for a set length of time – 10, 15 or 20 years – distributed monthly until death or benefits are exhausted. If the owner outlives the fixed period or exhausts the account before death, no further payments are guaranteed.

However, if the annuitant dies before the defined benefit is paid, some plans provide for the remaining benefits to be paid to a beneficiary. This feature may be activated if either the full term has not yet elapsed or a balance remains on the account at the time of death. Depending on the plan, disbursements will be paid to a spouse or beneficiary until the term is complete or the balance reaches zero.

For lifetime income annuities, the owner is guaranteed a payment for as long as they live – payments are determined by age, life expectancy and account balance of the contract owner. The longer you are expected to live, the smaller your monthly payment; and if you live beyond the expected term, you are still guaranteed payments, so it is possible to collect more than your initial balance.

These annuities do not generally provide a death benefit unless specifically stated, in which case, any payments not distributed below the minimum may go to your beneficiary. Annuitants may also have the option for a joint life annuity which guarantees payment for both you and a spouse who will then receive payments until his/her death.

Deferred Annuities

When it comes to deferred annuities, such as fixed index annuities and variable annuities, there are a wide range of options for death benefits; however, it will be very important to review these options with a tax professional to ensure you account for future tax liabilities as well as your legal advisor who will help your choices stay within the law.

Here are some of the common death benefits available with these types of annuities:

  • Standard Death Benefit: the current value of the annuity (starting the date the insurance company is informed of the annuitants passing or until the beneficiary makes a claim).
  • Return of Premium Death Benefit: the greater of the initial premium paid or the current value of the annuity (less any withdrawals or fees).
  • Stepped-up Death Benefit: the highest anniversary value (less any fees withdrawals or fee).

Paying Benefits to Your Loved Ones

A beneficiary may have different options for accepting a death benefit. These options include payment of a lump sum, regular disbursement payments, deferral of receiving the death benefit, or taking over ownership of the annuity contract (for example, as a spouse).

If your annuity is still in the accumulation phase, many plans provide a death benefit to your beneficiary; usually comprised of a lump-sum payment, though some plans provide additional options. If an owner dies before the annuity commencement date, the general rule is that the entire interest in the contract must be distributed within five years after the date of the owner’s death.

Taxation Upon Death

It is important to take into account the effect of taxes on your annuity upon death. Your annuities may be taxed as either a part of your estate or as a payment to your beneficiary. If a spouse takes over “ownership”, the after-death distribution rules and tax liabilities take effect upon the surviving spouse’s death, rather than upon the original owner’s death.

Here are the two (2) most common ways your annuity might be taxed upon your death:

  1. Estate Tax: The value of your annuities (without a designated beneficiary) will be assessed as part of your total estate, and subject to estate tax. Annuities passing to a surviving spouse or charity may exempt the annuity from estate tax.
  2. Income Tax: Annuity payments collected by your beneficiary will be subject to income tax. You may want to estimate if a lump-sum payment or multiple disbursements will be better given their income tax bracket. (note: some penalties may apply to beneficiary withdrawals before the age of 59 1/2)

What Annuity Beneficiaries Should Know

It seems that most beneficiaries are unaware of the numerous financial products set to pass to them upon the death of a parent or loved one. And it is hard to know how to prepare for inheritance if you do not know what might be coming your way. So the first thing to do is sit down with your parent (or loved one) and review the existing policies which pertain to you.

The Process of Claiming an Annuity

When you inherit an annuity, you need to notify the insurance company of the owner’s death and file a claim for the annuity’s benefits. You must provide a copy of the death certificate as proof. Once the claim is processed you will need to decide how to receive the proceeds (unless it is determined by the type of contract).

While much of your inheritance will pass through probate, annuities are typically passed directly to the beneficiaries when the original policyholder dies. This additional income may be subject to personal income taxes.

Deciding How to Receive Inherited Distributions

Because annuities are subject to ordinary income tax, any income received is added to your gross income. It may result in a higher marginal tax rate which means you will pay more in income taxes.

The first step in determining your taxes is understanding exactly what you are inheriting. If your parent died before she began receiving annuity payments, you will inherit the cash value of the annuity. You may also receive a death benefit in excess of the cash value.

If your parent was receiving annuity payments, the policy generally no longer has a cash value. You may receive payments if your parent did not fully collect a guaranteed number or amount of payments. If your parent’s annuity included survivor benefits, you may receive payments for a set period or for the rest of your life

Discuss all of your death benefit options with your parent’s financial planners, insurance agent(s) and a trusted tax professional. And do not forget to make plans for what you will do with any income received from an annuity – purchasing an annuity contract of your own, rolling funds into a personal IRA, and spacing out payments may help limit your immediate tax liability.

Getting Help for Annuitants and Beneficiaries

How you set up your annuity contract can make all the difference in providing you with an income, limiting your tax liability and providing for your loved ones. Any annuity owner or person named as a beneficiary should take the time to understand their wide range of death benefit options before making a final decision.

For all estate planning, it is vitally important to run your strategies by a lawyer and tax professional to make sure that you are addressing your personal needs, financial situation and any relevant state or federal guidelines.

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About Harold Goldman

I am the founder of FinancialSafetyNet.org, and a Retirement Planning and Long-Term Care specialist. I am also the President of Emes Insurance Services, Inc., a Murrieta based insurance agency designed to help people with Retirement Planning and funding for College. I believe in educating my clients to become financially competent in an effort to develop plans for guaranteed income, protection against loss and tax-advantaged growth. To contact me Call (844)-376-2265

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