What Happens to Your Annuity When You Die? A Guide for Beneficiaries

An annuity is a tool you can use to help you save for your retirement. It's an insurance product that provides an income based on your contributions and the agreement you make when you sign the contract with the insurance provider. But you might wonder what happens to your annuity contributions if you die before or while you're receiving payments. The answer depends on the type of annuity you have and how you set it up when you signed the annuity contract.

Not all annuities continue to pay out after you die. However, there are ways you can ensure your annuity benefits don't end if you die before your annuity expires. Knowing how to set up your annuity to include beneficiaries who can receive its remaining value when you're deceased can provide you and your loved ones with peace of mind and financial security.

What is an annuity beneficiary?

The beneficiary of an annuity is a person or entity you name that you want to receive any remaining payments or value from your annuity after your death. Adding a beneficiary to your annuity contract makes the transition of annuity payments easier if you die before income begins or your income period ends. Without a designated beneficiary, the annuity contract may become tied up in probate with the rest of your estate.

Often, the beneficiary for annuity payments is a spouse or relative of the annuity owner, but in some cases it can be a trust, charity, or other entity. You can also choose to name a secondary beneficiary to receive the annuity payments. This person or entity will be next in line to receive payments from your annuity if your primary beneficiary dies before you do.

Your annuity must have a death benefit option if you want to allow a beneficiary to receive the benefits of your annuity upon your death. Your annuity may have a standard death benefit, but you might want to pay for an improved death benefit that offers better protection and payout options for your beneficiary. Consider the person you want to name as your beneficiary carefully, as the payments they receive can have tax implications that affect them in unexpected ways.

Spouse vs. other beneficiaries

Typically, a spouse is the ideal person to have as the beneficiary of your annuity. Under the right circumstances, which are laid out in your annuity contract, your spouse can determine what happens with your annuity when you die if value remains in the agreement. For instance, your spouse can put the annuity in their name to become the new annuitant and/or annuity owner. Additionally, a spouse can name new beneficiaries or make changes to the contract because they now own it.

The other bonus to having a spouse as the beneficiary is that they can keep the tax-deferred status that comes with having an annuity for retirement income. If your spouse wants to receive the rest of the annuity benefits as a lump sum, this is also an option. However, they will have to pay taxes on whatever the difference is between what the owner paid for the annuity and the lump-sum amount.

You can also choose to name someone other than your spouse as the beneficiary of your annuity, such as a sibling, child, or any other individual you want to receive the annuity payments when you're deceased. It's important to note that someone other than a spouse won't be able to make changes to the annuity contract. This means they can't name another beneficiary, and they can only receive the payments as agreed in the original contract.

Your death benefit can name a nonperson as the beneficiary of the annuity contract. Some people choose to make the beneficiary a trust, which controls the distribution of the annuity payments but has tax complications that you should discuss with a tax advisor before setting up your annuity with this type of beneficiary. If you name a charity as your beneficiary, the payments are distributed tax-free.

Naming more than one person as beneficiary may be a possibility as well. With multiple beneficiaries, the remaining value of your annuity can be paid out to each person evenly or as you see fit. You can add, remove, and change beneficiaries at any time during your annuity contract as long as you don't have an irrevocable beneficiary clause, and reevaluating your beneficiaries periodically is advisable.

Types of annuity payouts for beneficiaries

When you initially set up your annuity and provide your contribution, you'll choose the payout option for your income. How the funds of your annuity are distributed to your beneficiary will depend on whether your annuity is in the accumulation phase or the annuitant phase.

If you die during the accumulation phase, or while you're still making contributions, the value of the annuity is usually paid out as a lump sum. But if your death occurs while you're receiving annuity payments, known as the annuitization phase, the beneficiary can also receive payments based on the contract. Let's explore these payout options in more detail.

Lump-sum payout

A lump-sum payout is the standard death benefit for beneficiaries if you die before the annuitization phase of your annuity. In some cases, your beneficiary may be able to take any remaining balance of your annuity as a lump-sum payment after the annuitization period. They will have to pay taxes on the amount they receive as a lump sum, which depends on their tax bracket based on their income level, including the annuity lump-sum payout.

Guaranteed payout

If your spouse is a joint annuitant on your life annuity — a type of annuity that provides an income for life —, they can continue to receive payments until their death. These payments may be the same amount you received, or less – depending on how you structure your annuity. Joint annuitants for a life annuity are typically spouses, but they don't have to be.

Fixed period payout

Fixed period, or period certain, annuities provide an income for a specified period. Your beneficiary can receive payments for the time remaining on your fixed annuity, but – like you – they will have to pay income tax on the amount they receive. The fixed annuity term can be anywhere from five to 30 years, depending on how you set up the contract.

So, if your fixed annuity has a 15-year term and you die after only 10 years of receiving payments, your beneficiary will have the option of taking the remaining five years of payments. This option can have less tax implications than if they choose to take the remaining annuity value as a lump sum.

How to choose a beneficiary for your annuity

Selecting a beneficiary for your annuity requires careful planning and consideration. Inheriting an annuity can provide financial security for the beneficiary, but it can also come with a tax burden if the recipient is in a lower tax bracket. When you name a beneficiary on your annuity, think about how the income may affect them. While the income may give them the financial stability they need when you're gone, it could also put them in a higher tax bracket that causes them to lose out on some tax breaks or credits they normally receive.

You may have the option to change the beneficiary on your annuity, but this takes time and requires paperwork. If you get divorced, have a death in the family, or simply change your mind about who you want as the beneficiary, it's important to make changes to your annuity right away. You never know what might happen to you, and you don't want complications with annuity payouts to cause issues with your family or estate.

One of the many benefits of having an annuity as part of your retirement plan is that your beneficiary won't have to wait for probate or challenges to your will to begin receiving payments. Contesting an annuity contract is very difficult because you set it up with an insurance provider and it's separate from the rest of your estate and will.

Choosing an annuity with death benefits

What happens to your annuity when you die depends on how you set up the contract. You'll want to choose an annuity with death benefits and name a beneficiary at the start of the contract. Annuities have options for death benefits, so make sure to consult with an advisor to ensure your annuity meets your needs and provides the financial security you desire for your family.

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