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Inheriting an annuity could cost beneficiaries in taxes

When purchasing an annuity, there are typically one or more goals that the buyer has in mind. These could include growing the account on a tax-advantaged basis, ensuring that income will arrive regularly in retirement, and/or leaving a legacy for loved ones.

Many annuities will include a death benefit so that the initial contributions may be returned to a named beneficiary upon the death of the annuitant. There are actually several different options for inheriting an annuity, though, so knowing all of the possible alternatives can help you to choose which one is best for you and your loved ones.

Does the Insurance Company Keep Your Annuity Money When You Die?

After an annuitant (i.e., the person upon whose life an annuity is based) dies, many annuities will pay out the remainder of his or her contributions via a death benefit. These funds will go to a named beneficiary (or more than one beneficiary) who is named in the contract.

Unlike the proceeds of a life insurance policy, though, there are a few differences when someone inherits an annuity. One of the biggest of these is the potential taxation of the annuity death benefit.

Annuity Payout Options

Depending on the type of annuity you have, there can be several different payout options to choose from. These may include:

  • Life Only – The life only payout option will continue to pay an income stream for the rest of the annuitant’s life – regardless of how long that may be.
  • Period Certain – Period certain pays income for a set period of time, such as 10 or 20 years. Once the time period is up, the payments from the annuity will stop. If the annuitant dies before this time has elapsed, the remaining funds will be paid to an annuity beneficiary.
  • Life with Period Certain – The life with period certain is a “combination” of the Life Only and the Period Certain options. In this case, income will be paid for the life of the annuitant. However, if he or she dies before the selected time period ends, the payments will go to the beneficiary for the remainder of the period.
  • Joint and Survivor – With the joint and survivor income option, payments will continue until the death of the second income recipient. This alternative is oftentimes selected by married couples so that both spouses are assured of ongoing income for life.

Oftentimes, an annuity contract will allow the annuitant’s spouse to decide what to do with the funds when the owner dies. For instance, a surviving spouse could:

  • Change the annuity into his or her own name
  • Become the new annuitant and assume the original contract
  • Continue to receive income payments from the annuity (if the annuity’s income payout option is set up as “joint and survivor”)

Taxes and Annuity Payouts

When an individual inherits a life insurance policy’s death benefit, they typically will not have to pay any income taxes. But this is not the case when inheriting an annuity death benefit. Rather, the annuity beneficiary(ies) will owe income tax on the difference between the contributions that were made to the annuity and the value of the annuity contract at the time the annuitant passes away.

If a lump sum payout option is chosen by the annuity’s beneficiary, all of the tax will be due for that year. However, if the beneficiary opts to receive the benefit payments over time, they will only owe taxes on the portion of the payment that is considered gain.

What to Consider When Naming Your Annuity Beneficiaries

It is up to the annuity owner to name the beneficiary(ies). In many cases, the owner and the annuitant are the same person – but they don’t necessarily have to be. Likewise, the owner also has the right to change the annuity beneficiaries (unless they are irrevocable) if their situation changes.

Similar to a life insurance policy, annuities can have primary and contingent beneficiaries. For example, if the primary beneficiary(ies) predeceases the annuitant, the contingent beneficiary will inherit the annuity funds.

Annuity beneficiaries don’t necessarily have to be human. Rather, a trust, charity, or various other entities could inherit the money when the annuitant passes away. Who is named as the annuity’s beneficiary will depend on your specific objectives, as well as your intention for leaving a legacy.

Need More Guidance on Naming Annuity Beneficiaries?

Annuities can have many moving parts. So, before you make a long-term commitment to purchase one, it can be helpful to discuss your needs – as well as all of your potential options – with an annuity specialist. That way, you and your beneficiary(ies) will know what to anticipate.

At Annuity Gator, our focus is on educating consumers and financial advisors on how annuities work, and how they can be incorporated into a tax-advantaged savings and a retirement income plan.

So, if you’d like more information on whether or not an annuity is right for you, feel free to reach out to us directly by phone at (888) 440-2468, or email us your questions, We look forward to assisting you.

Inheriting an annuity could cost beneficiaries in taxes

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