How Does An Annuity Death Benefit Work?
The Annuity Man
News flash...we are all dying. How’s that for an opener! As our population grows older, those of us entering that “2nd chapter’ of our lives start to think about legacy and taking care of our families after we are long gone. Some annuity types do provide a guaranteed death benefit, so it’s important to know how they work so you can possibly consider them in your overall financial and estate plan.
Life Insurance Wins
Every commercial annuity type is issued by a life insurance company. However, life insurance as a stand alone product is very different than annuities. Confusing?
To break it down, life insurance products primarily provide benefits when you are dead. I know that a lot of agents are pushing cash value, index garbage potential, etc...but the true reason you should buy life insurance is for the death benefit. That death benefit passes lump sum to the listed beneficiaries on the policy, and is probate free and tax free. Yes, I said TAX FREE.
Life insurance is the best ROI (Return on Investment) you will never see, because you will be dead! In my opinion, the way to buy life insurance is to use as little money as possible to buy the highest guaranteed death benefit. That’s called a “term” policy. It’s a pure transfer of risk legacy product, and will always be the best death benefit strategy on the planet.
There’s only one catch with buying life insurance, you have to medically qualify for it and go through a full underwriting process for approval. That means blood tests, medical records, and typically an in home visit by a nurse type examiner. This is a non-event if you are healthy, but a serious hurdle if you have some health issues.
This is where annuities can be a solution from a death benefit standpoint.
The good news about annuities is that they are guaranteed to be issued, regardless of your health status. You could be drinking a bottle of Jack Daniels whiskey every day while smoking a carton of non-filtered Camel cigarettes, and you would get issued an annuity. That’s good news as well for people with serious health issues that want to provide a legacy benefit for their families.
The annuity contract and the type of annuity you have will determine how the death benefit will work for that specific policy. Many annuity types are designed for lifetime income. Those types are Single Premium Immediate Annuities (SPIAs), Deferred Income Annuities (DIAs), and Qualified Longevity Annuity Contracts (QLACs)...and are what I refer to as “annuitized” strategies. They are transfer of risk policies for lifetime income.
All annuity income is a combination of return of principal plus interest. With annuitized policies, the death benefit can be structured so any unused money upon your death will go in full to the beneficiaries. You can also customize the structuring to leave a percentage of the initial premium as a death benefit. Remember that annuities are customizable, but the more benefits you add to the policy at the time of application....the lower the payments. You can also structure these “annuitized” strategies so that there is no death benefit (i.e. “Life Only”) at all.
In my opinion, Income Riders attached to a deferred annuity policy like a Variable Annuity (VA) or Fixed Index Annuity (FIA) offer the best death benefit options when using annuities.
Income Riders are typically used to provide lifetime income payments to enhance your overall retirement income plan. The guaranteed growth percentage grows tax deferred and provides an annual step up in benefits until you decide to start the payments. It’s a good way to guarantee future lifetime income and know to the penny how much those payments will be.
However, some Income Riders can also be used as Death Benefit Riders with enhanced death benefits that are built into the policy. With most policies, those death benefit options grow at a guaranteed minimum percentage that locks in every year on the contract anniversary date. In essence, it’s a phantom account (i.e. monopoly money) that can only be used for the lifetime income stream or a death benefit.
Currently, there are less than 20 carriers that offer an Income Rider/Death Benefit Rider type combination. Most contracts offer only income benefits, so you need to find an object annuity calculator to shop all death benefit riders available in your state of residence. Because annuities are commodity products, all carriers should be shopped for the highest contractual death benefit guarantee for your specific situation.
Paying The Tax Piper
Regardless of how you have the policy structured, when the annuitant dies or the contract owner dies...there will be taxes owed on that annuity death benefit. That tax liability is determined by the type of annuity and type of account where it is held. These owner or annuitant type questions can be handled by your agent, but ALL legitimate tax questions should be answered by a qualified tax professional concerning the standard death benefit choices that are available.
If you happen to be one of the annuity beneficiaries of an annuity or actually inherit an annuity, you need to have your CPA or tax lawyer sign off on any distribution decisions that you make. Never take tax advice from an agent, advisor, or financial professional who is not qualified to give tax recommendations.
Annuity Death Benefit Realities
If there is no death benefit rider attached to or on an annuity you inherit or that you are listed as a beneficiary on the policy, the actual death benefit you receive will depend on the type of annuity. For example, with deferred annuities like Variable Annuities (VAs), Fixed Index Annuities (FIAs), and Multi-Year Guarantee Annuities (MYGAs)...the death benefit is the accumulation value (i.e. real money/walk away money) of the policy.
So remember that life insurance is still the best death benefit product available. But if you can’t qualify, then annuities do have their place as an efficient legacy strategy.