If You Choose an Annuity and Die, What Happens?

Annuities are financial contracts designed to provide a steady stream of income, often during retirement. A common concern for annuity holders and their families is what happens to these assets upon the annuitant’s death. Understanding the disposition of an annuity after death is important for both the purchaser and potential inheritors.

Annuity Payout Options and Death Benefits

The initial choices made when purchasing an annuity significantly determine whether a death benefit exists and how it is structured. For immediate annuities, options like a “life-only” payout cease payments entirely upon the annuitant’s death, leaving no benefit for heirs. Conversely, a “period certain” option guarantees payments for a specific number of years, such as 10 or 20, with a named beneficiary receiving remaining payments if the annuitant dies before the period concludes.

Joint and survivor annuities continue payments to a surviving co-annuitant, typically a spouse. This arrangement ensures income for the survivor but might not provide a lump sum death benefit to other beneficiaries. Some annuities include a “cash refund” or “installment refund” feature, which guarantees that if the annuitant dies before receiving payments equal to their initial premium, the remaining balance is paid to beneficiaries either as a lump sum or continued installments. For deferred annuities, death benefits typically pay out the greater of the premiums paid or the accumulated account value if death occurs before annuitization.

Designating Beneficiaries

Properly designating beneficiaries for an annuity is an important step in ensuring the asset passes according to one’s wishes. Without a named beneficiary, the annuity generally becomes part of the deceased’s probate estate. This process can delay distribution and incur additional legal and administrative fees. Naming a beneficiary typically allows the annuity to bypass probate, leading to a quicker and more streamlined transfer of assets.

Beneficiary designations can be made as “per stirpes” or “per capita,” which dictates how assets are distributed if a named beneficiary predeceases the annuitant. A “per stirpes” designation means the share of a deceased beneficiary would pass to their heirs, while “per capita” means the share would be divided among the remaining living beneficiaries. It is important to review and update beneficiary designations regularly, particularly after significant life events such as marriage, divorce, the birth of a child, or the death of a named beneficiary. Keeping these designations current ensures the annuity proceeds go to the intended individuals.

Beneficiary Payout Choices

Upon the death of an annuitant, beneficiaries typically have several options for receiving the inherited annuity death benefit. One common choice is to take a lump sum distribution, which provides immediate access to the funds. While this offers liquidity, the entire taxable portion of the death benefit becomes subject to ordinary income tax. Another option involves annuitizing the inherited annuity, allowing the beneficiary to receive payments over a specified period or for their lifetime.

For qualified annuities, such as those held within an IRA, beneficiaries may also utilize a “stretch” option, though this has been altered by recent legislation. Under the SECURE Act, most non-eligible designated beneficiaries are now generally required to distribute the inherited funds within 10 years following the annuitant’s death. Eligible designated beneficiaries, such as a surviving spouse, minor child, or chronically ill individual, may still be able to stretch payments over their life expectancy. The choice of payout method should align with the beneficiary’s financial needs, income tax situation, and long-term financial goals.

Tax Considerations for Beneficiaries

The tax treatment of annuity death benefits for beneficiaries depends on whether the annuity is qualified or non-qualified. For a non-qualified annuity, only the earnings portion is subject to ordinary income tax for the beneficiary. The original investment, representing the return of principal, is generally received tax-free. For instance, if a $100,000 annuity grew to $150,000, the beneficiary would pay ordinary income tax on the $50,000 gain.

Conversely, qualified annuities, such as those held within an Individual Retirement Account (IRA) or 401(k), are typically fully taxable as ordinary income when distributed to a beneficiary. These distributions are considered “income in respect of a decedent” (IRD), meaning they would have been taxable income to the original owner had they lived. As a result of the SECURE Act, most non-spouse beneficiaries of qualified annuities are now subject to the 10-year rule, requiring full distribution of the account within a decade of the original owner’s death. While death distributions from qualified plans are generally exempt from the 10% early withdrawal penalty, the entire amount distributed is typically added to the beneficiary’s gross income.

Claiming Annuity Death Benefits

Claiming an annuity death benefit involves a process beneficiaries typically follow with the annuity issuer. The first step involves notifying the annuity company of the annuitant’s death as soon as reasonably possible. This initial contact will prompt the company to provide the necessary claim forms and instructions.

Beneficiaries will then need to submit documentation to support their claim. This usually includes a certified copy of the annuitant’s death certificate, a completed beneficiary claim form provided by the insurer, and proof of the beneficiary’s identity, such as a driver’s license or Social Security number. After receiving all required documents, the annuity company will review the claim, verify the information, and process the death benefit distribution according to the terms of the contract and the beneficiary’s chosen payout option. The typical processing timeline can vary, often ranging from a few weeks to several months, depending on the claim’s complexity and the responsiveness of all parties involved.