Annuity Beneficiary Payout Options Explained

If you’re reading this, it’s likely that you are on the threshold of creating a retirement plan or you have already invested a significant amount of time putting a solid retirement plan together. Your retirement plan may include one or more annuities that could maximize your lifetime income and also maximize a payout to your beneficiaries when you die. But what if you didn’t spend much time reviewing and understanding the options available to your beneficiaries?  If not, you should do it now.

What are annuity beneficiary payout options and which ones will work best?

First Things First

You need to understand that any information on annuity payout options is not applicable if you already elected to annuitize an annuity when the contract was issued by the insurance company.

When you “annuitize” an annuity, you swap the premium you paid for a guaranteed stream of income for a specific time period. Doing so leaves no cash available to inherit. However, if there is a beneficiary payout option, you need to select which one best meets your needs. Here are some annuitization options available to you:

• Life Only – with this option there is no inheritance available and no beneficiary because when you die the payments cease.
• Life with Period Certain – with life with period certain, you will select a guaranteed number of payments, usually ten or twenty years. The payments will continue until you die but are then made to your beneficiaries if you died before the “period certain” was exhausted.
• Joint and Survivor – The joint and survivor option provides for payments to be received by your surviving beneficiary (typically a spouse) and they will end when the beneficiary dies.

It’s important to note that many owners of deferred annuities don’t always choose to annuitize their deferred annuity contracts. Some are likely to choose from other annuity payout options to supplement their retirement income.

Beneficiary Payout Options

When you are researching and thinking about this portion of your legacy preferences, it’s important and helpful to understand the basics of what happens to an annuity when someone dies.

The first step you will need to take is to make sure that your beneficiary is properly designated. Similar to a life insurance policy, you have the right to define the terms of the annuity contract in order to support your surviving loved ones. Any available payments after you die will depend on the details of the annuity agreement, which includes the type of annuity you purchased and whether there is a death benefit clause in the agreement.

This is when it’s advisable to have a financial professional help you so you don’t forget or miss this step. Not doing so could result in the balance of any remaining benefits would revert back to the insurance company.

Once you have made certain the proceeds of your annuity will be paid to your beneficiary, the beneficiary will typically have three ways in which they can receive the payments from the insurer:

1. Lump Sum Payment – the beneficiary receives their benefits in a lump sum payment
2. Non-Qualified Stretch – this option stretches payments over their life expectancy
3. Five-Year Rule – the beneficiary or beneficiaries can elect to withdraw payment amounts during a period of five years or take the entire payment amount in year five.

RULES FOR A SURVIVING SPOUSE

There are also special rules for your spouse if he or she is your beneficiary:

• Your spouse can continue on with your original annuity as the new owner and annuitant.
• Your spouse can change the contract so it’s in their name. If they put the contract in their name, they assume the rights to the original agreement and delay any immediate tax liability. This means they will be able to accept all remaining payments and death benefits, and they can choose their own beneficiaries.

Lump Sum Payment

This election allows your beneficiary to get the total payout in a lump sum. Unfortunately, this selection also provides for the IRS to get their share in a lump sum as well since all of the income will be included in that year. This is when consulting with a tax professional should be a priority for your beneficiary.

Non-Qualified Stretch

Using this election, your beneficiary may spread their payout over their lifetime. The payment they receive will be based on an annual calculation of the annuity’s remaining value and the life expectancy of the beneficiary. This is considered an appropriate strategy because the tax liability is spread over many years and mitigates the risk of your beneficiary being thrown into a higher tax bracket.

Over the years, the investment in the annuity will continue to grow because more of the money continuing to be invested.

The non-qualified stretch option actually provides a triple benefit to the beneficiary by increasing the inheritance, extending the inheritance, and reducing the tax liability.

Five-Year Rule

As the name of the rule implies, this option requires the beneficiary to take the balance of the annuity within five years of the annuitant’s death or spread the proceeds out over each of the five years.

In most cases, annuities are fairly simple agreements between the annuitant and the insurance company. It’s the options that can lead to stress and indecision. Rather than making a guess about payout options that could have a detrimental effect on your loved ones, consult with a specialist who will ask the right questions and help you provide the best answers.

In most cases, annuities are fairly simple agreements between the annuitant and the insurance company. It’s the options that can lead to stress and indecision. Rather than making a guess about payout options that could have a detrimental effect on your loved ones, consult with a specialist who will ask the right questions and help you provide the best answers.