Annuity Beneficiary – Payout Structure, Death Benefits & More

Annuity owners can designate beneficiaries in their annuity contracts, and it needs to include a death-benefit provision. Then, when the annuitant dies, the annuity beneficiary can inherit the remaining money, i.e., annuity payments.

An annuity beneficiary - named in the annuity contract - inherits the annuity, any remaining payments, and the death benefit, be it a lump-sum payment or a series of payments over five years. Click To Tweet

If you are the beneficiary of an annuity, many questions may come to your mind, such as:

  • How inherited annuities work?
  • What happens to the annuity after the annuitant’s death?
  • What can you do with the death-benefit provision after the owner dies?
  • Do you have to pay taxes?
  • What are your options for the remaining payments?
  • Is an inherited annuity taxable? If so, can you avoid paying taxes?

We know that understanding an inherited annuity and the status of a beneficiary can be complicated. So, we’ve explained everything regarding the annuity death benefits, taxes owed on an inherited annuity, and more.

Also, we can help you find the right insurance company if you’d like to include this life insurance product into your income or retirement planning.

So, let’s begin!

What Happens When You’re The Beneficiary Of An Annuity?

After an annuitant’s death, the beneficiary receives the death benefits, similar to a life insurance policy. The funds of an annuity will be paid to a beneficiary who was named in the annuity contract.

If there’s no beneficiary, the death benefit can be surrendered to the financial institution the annuity owner purchased it from, i.e., an insurance company, after it goes through probate.

Additionally, annuity contract terms won’t change after the annuitant’s death. You can choose to either annuitize the contract to receive the remaining payments in increments, receive a lump-sum payout, or have it paid out over the next five years.

Alternatively, a surviving spouse listed as a beneficiary can become the new annuity owner. They can also choose a lump sum payment or specify a contingent beneficiary and decline the inheritance in favor of them.

You can’t completely avoid paying taxes on an annuity you inherited, but there are still possibilities to continue to benefit from tax deferral – which we will explain below.

Choosing A Beneficiary Of An Annuity Contract

An owner can add beneficiaries to their annuity contract at any time. In case the annuitant dies, their primary beneficiary will receive a lump-sum distribution or payments.

The designated beneficiaries – that is, those that have been named in the annuity – are protected from legal probate, i.e., analysis of the deceased person’s estate.

Typically, this is how the whole process goes: Annuity owners choose between one and multiple beneficiaries, and they can also specify the fixed amount or percentage that the stated beneficiaries will receive.

Suppose there isn’t a predetermined list of beneficiaries after the annuity owner dies. In that case, it will go through probation that ensures that the deceased person’s estate goes to someone who should inherit it. But as you can imagine, the process is time-consuming – and can be expensive.

Also, the death benefit of an annuity can be forfeited to the insurance company if no beneficiaries are stated.

Primary Vs. Contingent Beneficiary?

What’s the difference between a primary and a contingent beneficiary in an Annuity Contract?

A primary beneficiary is the main beneficiary who will receive the death benefit – or someone who is stated in an annuity.

On the other hand, contingent beneficiaries are specified as backup beneficiaries who will receive the death benefit only under certain circumstances.

This set of circumstances can require that the primary beneficiary is deceased, that they refuse the inheritance, or that they cannot be located at the time.

Here, let’s put it in perspective:

In the annuity owner’s initial agreement, his wife is listed as the primary, and their children as the contingent beneficiaries. When the owner dies, his wife will receive the death benefit. But in case the wife also passes away, the children will receive the death benefit.

Also, in case that the beneficiary is a minor and inherits an annuity, these funds can only be accessed after they reach the age of 18, with the possibility of receiving a lump-sum payment. Learn more about beneficiaries here.

What Is The Difference Between Spouse Vs. Non-Spouse Beneficiaries?

Whereas a non-spouse beneficiary cannot change the terms of an annuity owner’s initial agreement, a spouse can retain the tax-deferred status by changing the annuity contract to their name.

That is known as “spousal continuation.”

In essence, it means that a spousal beneficiary can collect the proceeds and remaining payments, and decide who will further receive them. Therefore, spousal beneficiaries can use tax-deferred annuities to achieve financial stability for a long time, not only as a means of initial annuitant’s retirement planning or death benefits.

Joint And Survivor Annuity

Unlike regular annuities, joint and survivor annuities are owned by two people. In other words, as the name suggests, a joint-life annuity is jointly owned.

Therefore, even though the death benefit is triggered after the first annuitant dies, the person who will receive the proceeds and payments is not a beneficiary – but a joint owner.

Married retirees most commonly use these annuities because they guarantee that the other owner (i.e., their spouse) will have a reliable income.

However, unlike regular annuities with a beneficiary, this type of annuity doesn’t allow for lump-sum payments, which may be a worry for some, as burial expenses can be very high.

What Are The Beneficiary Payout Options?

Standard annuity death benefits can be payable in a series of payments or one lump sum payment.

Beneficiaries in an inherited annuity usually have three options, and the original contract of the annuity owner will dictate which ones they can use. Alternatively, a spouse inheriting an annuity can opt for spousal continuance.

Lump-Sum Distribution

Lump-sum distribution means that the beneficiary can receive payments in a single lump-sum distribution after the annuitant dies.

In other words, this means that the remaining value of the annuity is paid out in a large lump sum payment.

Nonqualified-Stretch Provision

In case a nonqualified-stretch provision is a part of the contract that the annuity owner has signed, the beneficiary’s life expectancy will influence the payments.

That is only possible with non-qualified contracts (i.e., those purchased with post-taxed dollars, e.g., by using IRAs).

So, depending on his or her life expectancy, the beneficiary can stretch out payments and reduce the tax burden over their entire life expectancy.

Five-Year Rule

If the five-year rule is included in the contract of an annuity owner, the beneficiary can gradually withdraw incremental annuity amounts over five years. Alternatively, they can withdraw the whole amount in the fifth year as a lump sum.

Spousal Continuation

In the event that the annuity owner dies and their spouse is the beneficiary, they can continue the contract and become the new annuity owner.

Therefore, the contract is extended as if the surviving spouse owned the annuity.

Inherited Annuity Tax: Are Inherited Annuities Taxable?

The simple answer to “Are inherited annuities taxable” is: Yes, inherited annuities are taxed as gross income, which means that the beneficiaries owe taxes.

However, the way in which the tax consequences will be processed depends on the payout structure, and the beneficiary – that is, whether it is a spouse or someone else.

For example, in the event that the beneficiary is the spouse of the annuity owner, they can change the ownership into their name and keep the tax-deferred status. That means that they extend the tax liability and don’t owe taxes immediately.

Other beneficiaries can choose to withdraw a lump sum, which means they will have to pay tax on the difference between the annuity death benefit and the premiums that the owner had paid for, which is treated as gross income.

That might be the fastest option, but it has higher tax consequences than withdrawing money gradually.

Alternatively, the beneficiary can withdraw money during the course of five years, meaning only the increased value of the portion withdrawn in the year will be taxed. In this scenario, they will have more lenient tax consequences and avoid a higher tax bracket.

Can You Avoid Paying Taxes On An Inherited Annuity?

What’s the best thing to do with an inherited annuity?

Well, you cannot completely avoid paying at least some taxes after the annuitant dies. That said, there are ways to minimize the taxes the beneficiary owes, either in the form of enhanced death benefits, joint payout, or the spouse who can retain the status of tax-deferred annuities.

Enhanced Death Benefits

If the annuity owner purchases an annuity with an enhanced death benefit, it’s possible to diminish the future taxes of the beneficiary.

While it doesn’t directly influence the taxes that the beneficiary owes, it ensures that they get the highest death benefit value.

That is typically used in a variable annuity that fluctuates with the market, so the value would otherwise go down at the time when the owner passes away.

An enhanced death benefit annuity is written without any medical underwriting and typically comes at an additional cost.

Surviving Spouse

Spouses have more freedom about changing the terms of the annuity agreement after the annuitant’s death.

Therefore, if they become the new annuity owners – as if the surviving spouse owned the contract – they can avoid paying the owned taxes at one time.

Joint Payout and Survivor Annuity Contract

An annuity owner can choose a joint payout that will enable their spouse to receive payments after the initial owner dies for the rest of their life.

In that case, the spouse isn’t a beneficiary but a co-owner of the contract and can extend the tax liability.

Annuity Amount & Death Benefit Options

The sum of annuity that someone inherits depends on the type of annuity death benefit. These options encompass standard, riders, and return of premium.

Standard Annuity Death Benefits

The standard death benefit means that the owner did not incur extra costs for death benefits when they paid for the annuity.

The beneficiary receives the value of the contract minus the fees and withdrawals. The insurance company needs to receive proof of the annuitant’s death and will then determine the inherited amount.

Return Of Premium

Usually, an annuitant can pay an additional percentage per year (around 0.05). These death benefits guarantee that the beneficiary will receive a return of the remaining premium if the annuitant dies before they pay out the contract fully.

Stepped-Up Death Benefit Rider

A benefit rider can be added to an annuity contract as a provision, and it pays the most to the beneficiary.

Namely, the amount paid is equivalent to the highest value amount that has been recorded – of course, minus any fees and withdrawals – instead of the value on the date when the insurance company is notified about the annuitant’s death like it would be the case with standard benefits.

Type Of Annuity

A type of annuity should also be taken into account to understand what the beneficiary will get.

These are the main types of annuity:

For instance, as fixed annuities have a guaranteed interest rate, it’s easier to get an estimate of how much a beneficiary will be paid.

On the other hand, the value of variable annuities depends on the market as it doesn’t have a fixed rate, so it’s less predictable. For instance, on the day when the insurance company learns about the owner’s death, the value can happen to be down.

Because of this risk, owners can pay for additional riders in variable annuities, which means that the insurance companies will pay based on the highest value for the month. That serves as a means of protection against market fluctuations.

Find The Best Annuity Rates Online

Suppose you’re looking for affordable annuity rates. In that case, finding the right insurance company won’t be simple because there are just so many types of annuity contracts and insurance companies that offer different terms.

That’s where we step in:

We allow you to find the best annuity rates for free if you use our annuity rate calculator. The only thing you need to do is fill our annuity quote form, and we will connect you to rates from over 30 carriers to help you find the right insurance company for you.

It won’t take more than 60 seconds – you’ll just have to tell us some basic data about yourself, such as your address and the insurance product you’re looking for right now.

The rates are instant and real-time, as we are partnered directly with the carriers, so you can get a close estimate of how much you’d pay for your annuity premium.

What after you get the quotes? 

No obligations – whatever you want. You can continue with shopping if you’d like to purchase an annuity through us – and we can guide you throughout the process, too.

An independent insurance agent working at Insurance Geek is also available for any inquiries you may have regarding annuities or other insurance-related matters. We are also experts in home, life, and auto insurance.

Frequently Asked Questions

Q: How Long Does A Beneficiary Have To Claim Annuity Payments?

A: The default period during which the beneficiary should take out the proceeds of the annuity is five years. That is referred to as “the 5-year rule.” In practice, this allows the beneficiary to take the payments out gradually until the fifth anniversary of the death and avoid a higher tax bracket. Alternatively, if they don’t want to spread payments out, they can receive a single lump sum and take all the money out at once. If the beneficiary is a spouse, they can become the new owner of the annuity. If the annuity contained the non-qualified-stretch provision, the beneficiary could stretch out the payments based on their life expectancy. And if it’s a joint-life annuity, the other person in the contract – so, not a beneficiary, but the co-owner – will continue receiving payments for their lifetime.

Q: Who Gets Annuity After Death?

A: If there’s a beneficiary, they will inherit the annuity and usually have the option to take out the remaining sum and death benefits. If the surviving spouse is the beneficiary, they can become the new annuity owner and continue growing funds in a tax-deferred way. If it’s a co-owner joint annuity agreement, the second owner of the policy will keep receiving payments for the rest of their life. For example – a married couple obtains a joint annuity, and person A passes away. Person B will get paid for the remainder of their life, known as the survivor benefits.

Final Words

Now you know what you can expect as a beneficiary of an annuity in the event that the annuity owner passes away. We’ve also explained what options the owner can use for beneficiaries and death benefits and what tax obligations beneficiaries will face.

Got any more questions?

Please reach out to Insurance Geek, and we’ll be happy to help shed light on anything that seems complicated about annuities and other insurance products. Last but not least – use our free instant annuity rate calculator to find the insurance company that has the best deal for you!