Understanding Annuity Beneficiary Payout Options

You may have invested a fair amount of time crafting your retirement plan. Your financial plan might include an annuity that could both maximize your lifetime income and maximize the potential payout to your chosen beneficiaries. But you may not have focused on the options that your beneficiaries have when choosing how to take their payout.

So, what are the annuity beneficiary payout options and how do they work? Let’s find out.

One Exception Applies

Before we dig into the details, there is a caveat. The information on payout options does not apply if you elected to annuitize your annuity at the start of your contract with the insurance company (that’s not confusing, right?).

When you “annuitize,” you trade your paid premiums in the contract for a guaranteed income stream for a set period. That leaves no cash value to inherit. And if there is a beneficiary payout option available, you select how it will be taken.

Some annuitization options include:

1. Life Only: No inheritance or beneficiary because payments end when you (the annuitant) pass away.
2. Life with Period Certain: You choose a guaranteed number of payments, typically for 10 or 20 years. Payments continue until you pass away and then are made to your heirs if there are years left in your “period certain.”
3. Joint and Survivor: Payments are received by your surviving designated beneficiary (usually your spouse). They end when your beneficiary passes away.

Even these annuities have additional options or “riders.” So, considering the above payout options, any additional death benefit rider might offer a payout, but could limit options in receiving it.

That being said, it’s important to recognize that the holders of deferred annuities often don’t choose to annuitize their deferred contracts. They may choose from other annuity payout options to supplement their retirement income needs.

Payout Options to Beneficiaries

As you consider this part of your legacy wishes, it’s helpful to know the basics of what happens to an annuity when someone deceases.

Your first order of business should be making sure you have your beneficiary or beneficiaries designated. Just as with a life insurance policy, you can define the terms of your annuity agreement to support your loved ones. The amount of payments remaining after you pass away depends on the annuity agreement details, including the type of annuity purchased and whether there is a death benefit clause.

A skilled financial professional can help you make sure you don’t miss this step. Otherwise it could mean any remaining benefits would be surrendered to the insurance company. And nobody wants that!

Now that the proceeds of your annuity are flowing to the beneficiary you intend, they will usually have three options to receive annuity payments:

• Lump Sum Distribution – they receive the benefits in one payment.
• Non-Qualified Stretch – this stretches minimum payments over their life expectancies.
• Five-Year Rule – they can choose to withdraw amounts during a five-year period or take the entire sum in year five.

Special Rules for Your Surviving Spouse

Knowing different payout options for a surviving spouse is an important part of a retirement income plan. When your surviving spouse is your beneficiary, they have an additional option to continue on with your initial annuity contract as the new owner and annuitant.

Your spouse can change the annuity contract into their name. By doing this, they assume all rules and rights to the initial agreement and delay immediate tax consequences.

This will give them the freedom to accept all remaining payments, any death benefits, and choose their own beneficiaries. That depends on the terms of the contract, of course. Your spouse becomes the new annuitant, taking over the stream of payments. This is known as spousal continuation and gives your spouse the chance to maintain a tax-deferred status.

When your beneficiary is not your spouse, they cannot change the terms of the annuity contract. They simply have access to the designated funds from your initial agreement.

Lump-Sum Distribution

Just as it sounds, your beneficiary gets the total payout as one sum. This also means someone else gets their share all at once—the Internal Revenue Service. All that income will be included in that tax year. As a result, consulting with a tax specialist will be critical to your beneficiary managing their tax bill.

Non-Qualified Stretch

Under this scenario, your beneficiary can spread the inheritance distribution over their lifetime. The payment is based on an annual calculation of the value of the annuity and the beneficiary’s remaining life expectancy.

Why this can be an attractive strategy for both qualified and non-qualified annuities: The tax obligation is spread over many years. This lessens concern about a windfall kicking your beneficiary into a higher tax bracket.

The investment continues to grow. Smaller distributions going out mean more of the money is staying invested. This could have the triple benefit of increasing the inheritance, extending it and saving taxes. By taking at least the minimum distribution, your beneficiary avoids adverse tax consequences.

Five-Year Rule

Just as it sounds, this distribution option requires the entire balance of the annuity to be taken within five years of your death. Your beneficiary has the flexibility to take all the proceeds in any of those five years. They can also choose to spread out the distribution over each of the five years.

What’s the Ideal Strategy for You… and Your Heirs?

Obviously, there are many factors at play when you—and your beneficiary—strategize payouts from your annuity. And while death benefit options are important, they are just one part of an annuity contract.

It’s prudent to work with a knowledgeable financial professional — someone who guides in your best interest and can help you find an annuity strategy that is right for you. They can help you discern your needs, evaluate your goals, and see how any annuity contracts may enhance your specific financial plan.

When you are ready for personal attention, financial professionals stand ready to help you. Use our “Find a Financial Professional” section to connect with someone directly. And should you need a personal referral, call us at 877.476.9723.