An annuity offers you guaranteed income, either for a specific term or for the rest of your life. This can help ease any concerns you have about your retirement income since you can count on annuity payments after you retire.
You may wonder what will happen to your annuity after you pass away. Will the payments simply vanish, or will the annuity continue to pay them? And does it matter how long you have held the annuity before you die?
Here's what you need to know.
How Do Annuities Work?
When you purchase an annuity, you enter into a contract with an insurance company. In exchange for your payment — which you can make all at once in a lump sum or through a series of premiums — the insurer promises to make regular periodic payments to you or your designated beneficiary. These payments will begin right away with an immediate annuity, or they will begin at some point in the future with a deferred annuity.
Fixed-Period vs. Lifetime Annuities
There are two general ways that annuities can be paid out: fixed-period or lifetime. A fixed-period annuity (also known as a period-certain annuity) guarantees payments for a specific number of years, commonly 10, 15 or 20 years. A lifetime annuity promises to make regular payments for the rest of the policyholder's life. In addition to these general categories, there are several payment variations. These include life with period-certain annuities and joint-life annuities.
Fixed, Indexed and Variable Annuities
Additionally, you also can choose how the money in your annuity will grow. With a fixed annuity, you receive a fixed, guaranteed interest rate no matter what the market is doing. With an indexed annuity, there is a guaranteed minimum interest rate, plus the potential for additional gains based on the performance of your chosen market index. And a variable annuity has no guaranteed interest rate but fluctuates based on the market, meaning you could see high potential returns or the opposite. No matter which type you choose, make sure your insurer offers principal protection so that you will not lose the premiums you paid into the annuity even in the event of a market drop.
These are just the start of the choices you will need to make when you purchase an annuity. You will also have several other decisions to make to ensure both your guaranteed income in retirement and how your beneficiaries will inherit your annuity, if at all.
How Do Annuities Work After Death?
How your annuity will work after your death first depends on whether you have an immediate annuity and began receiving guaranteed payments right away, or a deferred annuity, which means you put off payments until a later date. With a deferred annuity, there is generally an accumulation phase, during which time the insurance company invests your premiums. If you pass away before you begin to receive your deferred annuity payments, most insurance companies will offer a death benefit for your beneficiaries. This is usually a lump-sum amount that is either the greater of the account balance or the total you paid in premiums.
If you have begun to receive annuity payments before you die, what happens to your annuity after your death depends partially on which payment option you have chosen. Here is the basic breakdown of how each payment option works after the policyholder passes away.
When you purchase a fixed-period or period-certain annuity, you are signing up for guaranteed payments for a specific period of time. If you pass away before the end of the fixed period, then your designated beneficiary will receive your remaining payments for the period. For instance, if a policyholder with a 15-year fixed-period annuity passes away after eight years of receiving payments, the designated beneficiary will then receive payments for the remaining seven years of the fixed-period annuity.
However, if you outlive the fixed-period annuity, the payments will cease for you, and your designated beneficiary won't receive any payments. Outliving the term means an end to your annuitized benefits.
Under this type of annuity, the payments will continue for the entire life of the policyholder. How much you receive in payments depends on a number of factors, including your age, current interest rates, and the account balance of your annuity. If you are expected to live a long life, your payments will be smaller. But no matter what your payments are, your lifetime annuity will continue to make payments to you for the entirety of your lifetime.
What happens to your annuity after you die depends on which type of lifetime annuity you have chosen.
- Lifetime only: This type of contract will not pay out anything to your heirs upon your death.
- Life with refund: With this option, you will receive payments for your entire life. You or your beneficiary are guaranteed to at least receive the amount you paid in, even if you die before your principal is paid out. In that case, your beneficiary will receive the refund.
- Life with period-certain: You will receive lifetime payments with this annuity, and the period-certain rider promises to make payments to your beneficiary if you pass away before that period. For instance, if you purchase a lifetime annuity with a 20-year certain period and pass away in year 16, your beneficiary will automatically receive the four years of payments remaining on your annuity. If you pass away after the 20-year period is up, your beneficiary won't receive any payments.
- Joint-life annuity: Many married couples choose this option, which continues payments until the second person passes away. The amount the second person receives could be the same as the original amount or a decreased payment, depending on which option you choose. If both people covered by a joint-life annuity pass away early, some insurers allow for a third beneficiary to receive payments.
Lifetime annuity options can be mixed and matched to create the income you need. For example, you and your spouse could choose a joint-life annuity with refund or a joint-life annuity with period-certain.
How Do Annuities Work for Your Beneficiaries?
Your beneficiary will generally have four options for claiming your annuity after you have passed away:
- Lump sum distribution: The beneficiary will receive the annuity's remaining value in a lump sum. Annual income taxes will be due on the entire amount.
- Five-year rule: The annuity will be paid to the beneficiary over a period of five years of equal payments. Taxes are due yearly based on each year's payout.
- Nonqualified stretch: Payments will be made annually based on the beneficiary's life expectancy, which means a young beneficiary will receive much smaller annual payouts compared to someone who is already well into retirement. Taxes are paid each year based on the annual payout.
- Spousal continuance: If the beneficiary is the surviving spouse of the original policyholder, they can become the new owner of the annuity policy and continue receiving payments (and paying taxes) as the original policyholder did.
- Annuities promise guaranteed income for either a term or your entire life.
- If you pass away during the accumulation phase of a deferred annuity, most insurers offer a death benefit to your heirs.
- A fixed-period annuity allows you to designate a beneficiary to receive your payments if you die before the period ends.
- Lifetime annuities may or may not provide your beneficiaries with a payment after your death, depending on whether you have a lifetime-only, life with refund, life with period-certain or joint-life annuity.
- Your non-spousal beneficiaries may receive your annuity as a lump-sum distribution, five-year payment or a nonqualified stretch payment.
- If your beneficiary is your spouse, they can take over the annuity.
No matter which type of annuity you choose, it's important to be aware of what will happen to that annuity after you pass away. You may decide to choose a different kind of annuity based on how it will affect your beneficiary or spouse.