Answers · Annuities

What happens to an annuity when you die?

It depends on which kind you own and what you chose when you bought it. A life only income annuity stops paying, and heirs get nothing. Most other contracts pass a value straight to your named beneficiary. The part people miss is tax: annuity growth reaches heirs as ordinary income, with no step up in basis.

Everything depends on whether you already turned it into a paycheck.

One word covers two very different contracts, and the answer at death is different for each. Work out which one you hold first.

A deferred contract is still in its accumulation phase. Money went in, it has an account value, and you have not yet asked the insurer to turn it into payments. Most owners are here. An annuitized contract is the other kind. You handed over a sum and the insurer pays you a set amount, usually for life. That switch generally cannot be unflipped, and what your family receives was decided the day you signed.

To be clear about who is talking. opfinances.com is a licensed insurance agency, not a financial advisor and not a fiduciary. This is general education, and your own contract and your own tax professional outrank it.

A life only payout pays nothing to anyone after you.

When you annuitize you pick a payout option, and that choice decides what your family gets. It is permanent.

Life only pays you the largest monthly amount for as long as you live. When you die the payments stop. If you died fourteen months in, the balance does not go to your children. It stays with the insurer. That is not a trick. The large payment is what you were paid for accepting it.

The other options buy your heirs back in, and every one of them lowers your check. Period certain keeps paying a beneficiary until a fixed term has run, commonly ten or twenty years. Cash refund pays the difference if you die before the payments add up to what you handed over. Joint and survivor keeps paying a second person, often at a reduced rate, for as long as they live.

So read any quote by asking what was given up to reach the number. A life only figure always looks best on paper. It looks best because it protects nobody but you.

If you never annuitized, the money moves fast and stays private.

A deferred annuity has a named beneficiary, and that is the whole mechanism. The value goes to that person directly, outside the will and outside probate. It is one of the genuine advantages of the contract, and one of the few that costs nothing.

What they receive is usually the account value at death. Some contracts promise a floor instead, such as total premiums less withdrawals, and some carry an enhanced death benefit rider you paid an annual charge for. Any promise of that kind rests on the claims paying ability of the issuing insurance company.

Surrender charges are commonly waived at death, so the family is usually not penalised for a lock up you were still inside. Commonly is not always. It is a contract term, so read it.

A surviving spouse gets an option nobody else does. Spousal continuation lets a husband or wife step into the contract as the new owner and keep it running, which leaves the money where it is and delays the tax. A child cannot do that.

The tax treatment is the part almost nobody explains before the sale.

Start with a taxable brokerage account, because that is what most people are quietly comparing it to. You bought shares for 50,000, they are worth 150,000 when you die, and your children inherit them. The 100,000 of growth is generally wiped clean for tax purposes by a step up in basis. They could sell the next morning and owe nothing on it.

An annuity gets no step up. The growth inside it is taxable to whoever inherits it, as ordinary income at their rate, not at lower long term capital gains rates. A 50,000 deposit that grew to 150,000 hands your beneficiary a 100,000 taxable event, stacked on top of what they already earn that year. If that is a working adult in their peak earning years, the timing could hardly be worse.

There is a clock as well. With money you already paid tax on, a non spouse beneficiary generally has five years to empty the contract, or can elect a payment stream over their own life expectancy if they choose soon enough after the death. Inside an IRA, the ten year rule that covers most non spouse beneficiaries applies instead. Both say the same thing. The deferral you enjoyed does not pass down intact.

If the goal is leaving money to people, an annuity is not the efficient tool for that, because a life insurance death benefit is generally income tax free to the beneficiary and annuity growth is not. Those are two different jobs. An annuity is built to pay you while you are alive.

The beneficiary form outranks your will, and it is probably out of date.

Whoever is named on the annuity gets the money. Your will does not override it. If the form still names an ex spouse, the ex spouse is paid, and the family learns this during the worst month of their lives. It is entirely preventable.

Leaving the line blank, or naming your estate, is the expensive default. The money then goes through probate, it becomes public, it is exposed to claims against the estate, and the payout flexibility a named person would have had is generally gone.

Name a contingent beneficiary too, in case the first one dies before you or alongside you. Then review the form after every marriage, divorce, birth and death in the family.

If you already own a contract, one phone call to the insurer will get you written confirmation of who is currently named.

Related

What happens if I die before the annuity starts paying?

Nothing is forfeited to the insurer, which is the common fear. A deferred contract that has not been annuitized pays a death benefit to your named beneficiary, usually the account value at the date of death. Some contracts promise a floor instead, such as total premiums less withdrawals, and any promise of that kind depends on the claims paying ability of the issuing insurance company.

Do beneficiaries pay taxes on an inherited annuity?

Generally yes, on the growth. There is no step up in basis, so the gain is taxable to the beneficiary as ordinary income at their own rate rather than at capital gains rates. On a contract bought with money you already paid tax on, that original deposit comes back tax free and only the growth is taxed. An annuity held inside an IRA is generally taxable in full. Ask your own tax professional about your situation.

Does an annuity go through probate?

Not if a living person is named as the beneficiary. The contract pays that person directly, which keeps it out of probate and out of the public record. It does end up in probate if the beneficiary line is blank or if you named your estate, which is why that default is worth ten minutes of your time to fix.

Can my spouse keep my annuity after I die?

Usually, through what is called spousal continuation. A surviving husband or wife can generally step into the contract as the new owner and keep it running rather than cashing it out, which delays the tax. This option belongs to spouses only. Children, siblings and other beneficiaries cannot do it, and they face a distribution deadline instead.

What is the five year rule on an inherited annuity?

For an annuity bought with after tax money, a non spouse beneficiary generally has to take the whole thing out within five years of the death. There is an alternative, sometimes called the annuitization option, where the beneficiary elects payments over their own life expectancy if they do so within about a year of the death. Contracts vary, so the exact options are in the paperwork.

Where this fits.

This question sits inside a bigger one. Annuities walks through the whole decision rather than this one piece of it.

On Point Finances is a licensed insurance agency, not a tax, legal, or investment adviser. This page is general education, not a recommendation, and reading it does not create a client relationship.

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