We hope you find this article helpful.
If you want Safe Wealth Plan to assist you with your safe wealth strategy, click here.

What You Need to Know About Annuity Beneficiaries

Annuities allow people to receive steady payments after they retire. These payments can be sizable, especially if the annuity has been given ample time to mature. Besides regular payments, annuities also grow despite how the markets perform, unlike pension funds or 401Ks. In short, annuities benefit their owners in more ways than one. However, many owners of annuities are left wondering what happens to their annuity when they pass away. 

When the owner passes, the annuity is inherited by beneficiaries. Annuity beneficiaries are part of any annuity contract; they are entitled to the remainder of the annuity payments once the owner of the policy has passed. Annuity beneficiaries can receive these payments along with other monetary benefits, depending on how the annuity contract was set up. 

At a glance, being an annuity beneficiary seems straightforward. However, there is actually a lot to clarify, especially with how the lines can blur between annuitants and beneficiaries. 

In this article, we’ll clarify what it means to be an annuity beneficiary, the kinds of annuity beneficiaries can receive, and whether or not these are taxable.

Why Is it Important to List Annuity Beneficiaries in Contracts?

The reasons for buying annuities and life insurance policies are clear; it’s all about having a financial safety net during retirement. Of course, there will come a time when the annuitant will pass on. If nobody is entitled to receive the benefits in the annuity contract, there is only one way to reallocate the benefits — probate.

Probate is the process by which assets and heirlooms undergo redistribution. The redistributed assets can include anything left by the deceased, including annuities. 

The annuities can even go to parties or individuals who the annuitant may not know. Some annuity owners are fine with this arrangement, but others, on the other hand, are not. 

Those who wish for their annuities to carry over to their children or spouse can list them as beneficiaries. By doing so, not only does the annuity policy owner exercise control over who gets the benefits, but it also protects the annuities from redistribution when the owner passes away.

Who Are Annuity Beneficiaries? 

Annuity beneficiaries inherit an annuity contract. By inheriting annuities, the beneficiaries become entitled to receive payments that the deceased annuitants were receiving. Beneficiaries can receive payments either in a lump sum or as regular payments over a period of time; it depends on the terms and conditions of the annuity contract. 

Beneficiaries can be family members, like the annuitant’s spouse and children. However, the annuitant can also select non-family members as beneficiaries. The parties below are possible beneficiaries of the annuity: 

The Annuitant’s Spouse

If the annuitant is married, they can list their spouse as the initial beneficiary. At times, listing is not necessary, as contracts will have the spouse as a beneficiary listed by default. Of course, as the owner of the annuity, the annuitant can override this and list other people in the family or outside of it as beneficiaries. 

When a spouse inherits the annuity, the spouse will have full control of the execution of the annuity contract. As the spousal becomes the new annuitant, they then need to list their own beneficiaries. 

The Children

Besides the spouse, the annuitant’s children are likely annuity beneficiaries. The annuitant does not have to list all of their children as beneficiaries; they have the choice to list one or all. 

Children then receive the remainder of the annuity payments that the annuitant was receiving before death. However, there is a catch. If the listed beneficiaries are minors at the time of inheritance, the children will not be eligible to directly receive annuity benefits. They will only be eligible once they reach the age of consent, which is 18 years old. 

In such situations, the annuitant can list the legal guardian as a beneficiary. The alternative would be a party or individual that can be tasked with managing the monetary benefits conferred by the annuity — the trust. 

A Trust 

A trust, or a revocable living trust (RLT), is a document that contains the terms and conditions for how the annuitant’s finances will be handled after their death. By listing a trust as a beneficiary, the annuity of the deceased remains in effect even if the children cannot claim the payments yet.

Setting up trusts to be annuity beneficiaries is a safe choice because it protects the annuity from probate long enough for the children to claim it once they become adults.

Organizations or Institutions

Sometimes, annuity beneficiaries can be organizations or institutions. If an annuitant does not have children or isn’t married at the time of purchasing the annuity policy, organizations can be listed. 

With organizations or institutions as beneficiaries, the payouts remain the same. If the annuity beneficiaries are non-profit organizations, the annuities (which count as income) may not be taxable

What Do Annuity Beneficiaries Receive? 

If a contract or policy contains a list of beneficiaries, the beneficiaries are entitled to death benefits. The execution of the contract’s death benefit provision takes place only after the owner of the annuity has passed away. 

There are different types of death benefits. Often, beneficiaries will receive the following types of monetary benefits once the annuitant passes away: 

Standard Death Benefits

Standard benefits come as a default benefit provision in nearly all annuity contracts. Because standard benefits come part and parcel of annuity contracts, the owner pays no extra fees to the insurance company. However, the economy of standard death benefits has several downsides; one is that this death benefit can dip in value.

Premium Return Benefits

Premium return benefits have higher values than standard death benefits. Of course, the benefits payable are higher because of how much the owner of the annuity paid. 

Insurance providers determine the amount in two ways. Insurance companies often derive the benefits payable based on the value of the annuity contract. By value, we mean the value of all investments that profit towards the contract. Alternatively, insurance companies simply add up the total amount of premiums the annuitant has paid. 

Insurance companies can calculate both values. In almost all cases, insurance companies will pay annuity beneficiaries the calculated value that turns out higher. 

Death Benefits with Riders

Riders are additional stipulations included in an annuity contract at the time of its drafting. Riders often contain added benefits and stipulations that can vary from one contract to another. Adding riders to an annuity contract can yield large returns because the added premiums allow insurance companies to diversify and multiply investments.

Because of this, when annuity beneficiaries inherit annuities with riders, they can receive larger amounts. 

Do Annuity Beneficiaries Get Taxed? 

Annuities may confer the benefit of tax deferral. However, tax deferrals are not the same as tax exemptions. Tax deferrals only allow annuity owners to delay the payment of taxes. Annuity owners pay taxes as soon as they make a withdrawal or receive payment from the annuity. This is because of how the Internal Revenue Service (IRS) classifies annuity payments. 

According to Publication 575 by the IRS, annuities, along with pensions, are considered income-generating. Because annuities generate income, it is subject to income tax requirements. In other words, annuitants need to pay taxes with each withdrawal or annuity payment. 

Inheriting an annuity means inheriting all the benefits and tax obligations part and parcel of the benefit. In other words, annuity beneficiaries need to pay income taxes as soon as they withdraw money or receive annuity payments from the insurance company.

The amount of income tax to be paid depends on several factors, though the main two are the amount payable and the payout scheme of the annuity.

Payout Schemes

The income tax requirements for annuity beneficiaries depend on the payout option, as mentioned earlier. Once beneficiaries inherit an annuity, they can choose from one of three payout schemes: 

Five-year Distributed Payouts

Under this scheme, annuity beneficiaries can receive the remaining annuity benefits along with the death benefit. They can choose to withdraw the benefits in regular intervals or withdraw the entire amount in the fifth year. What matters most is that the beneficiaries get the total sum within the five years. 

Stretch Provisions

Stretch provisions allow beneficiaries to receive regular payments within a certain timeframe. The exact amount will be based on the annuity beneficiary’s life expectancy.

For example, if a beneficiary has a 12-year life expectancy at the time of inheritance, the payout will take place within this period, and the insurance company will deposit the same amount with each payment. 

Lump Sum

Here, the annuity beneficiaries receive the remaining annuity benefits as one large payment. The amount is the remaining balance of the annuity along with the gains generated by rider provisions, if any. 

Key Takeaways

Annuity beneficiaries inherit the deceased annuitant’s annuity contract. While an annuity beneficiary is often the annuitant’s spouse, it can be other people and parties. Annuity beneficiaries can be children, trusts, or even organizations. 

By inheriting annuities, annuity beneficiaries are entitled to the benefits stipulated within the annuity. However, the beneficiaries also inherit the tax obligations of the annuity, contingent upon the payout option selected.

Looking for help? Reach out to us and we’ll connect you with an annuity pro!

Need help?
Schedule a consultation with a Safe Wealth Plan Agent today

In this article

Subscribe to updates

Download our FREE guide to understanding annuities