1. What are Annuities?
Annuities are very popular investments by the elderly, so they are common assets for survivors to deal with after the death of a loved one. A traditional annuity provides a regular income stream to the beneficiary for a term of years or for lifetime. Other “deferred” annuities permit accumulation of investment gains until a later date when payments to the beneficiary begin. The payment amount is calculated using the age and life expectancy of a person, who is referred to as the annuitant. The owner can be almost anyone, including a living trust, but is usually the annuitant. From an investment perspective, annuities can be very complicated. Although some annuities are very simple and easy to understand, the myriad of options and investment choices can make the topic very complex to even the most financially astute.
Some annuities are owned inside Individual Retirement Accounts (“IRAs”). The IRA “wrapper” makes the situation even more complex because annuity payments might be collected inside the IRA before coming out as IRA distributions to the owner.
2. Who inherits an Annuity after the annuitant dies?
The good news is that annuities are not as complicated after the owner’s death as they during lifetime. Every annuity has a beneficiary designation with a death beneficiary, which should be fairly simple to interpret. In most cases the death beneficiary is identified on the initial application, although the owner may change the beneficiary designation prior to death. The beneficiary of record must be confirmed by the annuity company.
3. How is the amount of the Annuity death benefit determined?
In order to determine what the beneficiary receives, one must know whether the annuity was in the accumulation phase or payout phase at the annuitant’s death.
The accumulation phase is the period before the beneficiary begins to receive regular payments from the contract. The payout phase is the period during which the beneficiary receives regular payments, usually monthly. This should be somewhat obvious by looking at a recent statement from the annuity administrator. If the statement shows regular distributions out to an account owned by the deceased person, then you know the annuity is in payout phase. If the answer is not clear, then contact the annuity company to find out.
The distinction between accumulation and payout phase is very important. For the annuity in accumulation phase, the beneficiary is usually entitled to the current balance of the account (or premiums paid, if more) plus any additional death benefit outlined in the contract. For example, an annuity in accumulation phase may have $73,000 in investments and a $100,000 death benefit. In this case, the death beneficiary would receive $173,000. However, many annuities do not offer an additional death benefit if the annuity was still in accumulation phase.
For the annuity in payout phase, as it often is for elderly persons, there will not be a death benefit but rather a payout option identified in the contract itself. The basic options available to the annuity owner at the start of the payout phase are:
- Life Only. Payments end when annuitant dies.
- Life with Period Certain. Payments might continue to beneficiary after annuitant’s death if guaranteed number of payments has not been reached, usually 10 or 20 years.
- Joint and Survivor. Payments continue to the surviving person designated in the contract; the payments ends when that person dies.
4. What are the pay-out options for Annuity beneficiaries?
A non-spouse beneficiary usually has three options for how to receive the annuity payout.
- Lump sum distribution (aka "Blow-out").
- Annuitize the distribution over the beneficiary's life expectancy of a period of years (aka "Stretch-out")
- Entire amount must be distributed by the 5th anniversary date of the owner's date of death (aka "Five Year Rule").
The Stretch-out option is only available to individual beneficiaries, not trusts (contrary to similar IRA regulations). However, some companies permit the annuity owner to establish a “control payout” option, which restricts the beneficiary’s access to funds while still distributing enough to satisfy requirements.
A spouse beneficiary has the same three options plus an additional option to continue the contract. The surviving spouse would become the new owner and annuitant.
About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.