When you purchase an annuity, one common question is what happens to your money after you die. While annuities can provide income during your lifetime, they also come with different rules for death benefits. Understanding these rules can help you make better decisions about structuring your contract and protecting your family.
The Basics of Death Benefits in Annuities
Unlike life insurance, which provides a tax-free lump sum to beneficiaries, annuity death benefits are taxable. The difference lies in how these products are designed. Life insurance requires medical underwriting and approval, but annuities are generally guaranteed issue—you can get one regardless of health. That accessibility comes at a cost: the payout is not tax-free.
Life Insurance vs. Annuities
If you qualify for life insurance, it usually provides the most favorable death benefit—your beneficiaries receive a tax-free payment. But many people who are older or have health issues may not qualify. In those cases, annuities step in as an alternative. While they don’t offer tax-free payouts, they do allow you to leave funds to beneficiaries, sometimes with added features through optional riders.
Death Benefit Riders on Annuities
Some annuities allow you to add a death benefit rider at the time of purchase. These riders guarantee a death benefit, which can typically be paid out as a lump sum or spread over several years, often up to five. The rider comes at an additional cost, deducted from your annuity’s value, but it ensures your beneficiaries receive something if you pass away before using all of your funds.
What If There’s No Rider?
If you don’t add a rider, many annuity contracts still provide a standard death benefit. For example, if you buy a Single Premium Immediate Annuity (SPIA), a Deferred Income Annuity (DIA), or a Qualified Longevity Annuity Contract (QLAC), you can structure the payout so that unused funds go to your beneficiaries. This ensures the money doesn’t vanish if you die early in the contract.
Think of annuitization like turning on a faucet—once it’s on, the payments continue to flow. You can set them up for just your life, for joint lives, or with a guarantee period that leaves remaining payments to your heirs.
Other Types of Annuities and Death Benefits
For annuities that aren’t immediately turned into income, the death benefit is usually the current account value.
- Multi-Year Guaranteed Annuities (MYGAs): Similar to CDs, the death benefit equals your original principal plus interest earned.
- Fixed Indexed Annuities (FIAs): These provide principal protection, and the death benefit reflects the account’s accumulated value based on index-linked gains.
- Variable Annuities: Here, the death benefit is tied to the performance of investment sub-accounts. Beneficiaries can typically take the value as a lump sum or in installments over time.
Naming Beneficiaries
Flexibility in naming beneficiaries is another key feature of annuities. You can assign primary, secondary, and even tertiary beneficiaries, and you can update them at any time. This ensures your annuity aligns with your broader estate planning goals. For example, you might name a spouse as primary, children as secondary, and grandchildren as tertiary, guaranteeing that the money passes along according to your wishes.
Final Thoughts
While annuities don’t provide the same tax-free death benefits as life insurance, they do offer ways to leave value behind. Whether through a rider, structured annuity payments, or accumulation value, annuities can still help protect loved ones financially. The key is understanding how each type of annuity handles death benefits and carefully choosing the structure that best fits your family’s needs.
