What Is An Annuity Beneficiary?

An annuity beneficiary is a person or entity that receives the benefit of an annuity after the death of the annuity owner. Who you choose to be the beneficiary of your annuity depends on several factors, including the type of annuity you own and your financial goals for it.

What Is an Annuity?

Unlike retirement investment accounts like 401(k)s or individual retirement accounts (IRAs), annuities are contracts between you and an insurance company.

With an annuity, you make a lump sum payment or a series of payments over a designated period to the insurance company. In exchange, the insurance company agrees to pay out a stream of income in retirement or at a predetermined future date, depending on the type of annuity purchased.

The benefits of annuities are numerous, including predictable income in retirement, tax-deferred growth and even a death benefit if you pass away.

Types of Annuities

There are several different types of annuities, but they can be divided into three main categories:

• Fixed annuity. If you purchase a fixed annuity, the insurance company commits to paying you a minimum rate of interest and a fixed amount of periodic payments. These are the safest type of annuity, since you know the minimum you’ll earn.
• Indexed annuity. An indexed annuity combines features of annuities and investment securities. The insurance company’s payments are based on the performance of a stock market index, such as the S&P 500. When the index performs well, the value of the indexed annuity increases. However, it can also decline along with the index’s performance.
• Variable annuity. With a variable annuity, you can use your annuity payments for investment products like mutual funds. Your payout is dependent on the performance of how much you invest and the rate of return on those securities. Variable annuities can be risky, but they also have the potential for higher returns.

Who Owns an Annuity?

Whoever signs an annuity contract is considered the owner of the annuity. The annuity owner chooses how the annuity will be funded, how payouts will be made and who will receive the payouts. They also select beneficiaries, control withdrawals and hold the power to cancel the contract.

In some cases, two people might jointly own an annuity. However, joint ownership of an annuity no longer offers the tax advantages that it once did.

An annuitant is the person who receives income payments from an annuity contract.

What Is an Annuity Beneficiary?

Some annuities have death-benefit provisions, meaning that you can select someone to inherit the remaining annuity payments if you pass away before it’s been fully paid.

The designated recipient of that benefit is known as the annuity beneficiary. The beneficiary can be an individual, such as a spouse or sibling, or an entity, such as a trust or charitable organization.

The death benefit of an annuity is usually the remaining contract value or the amount of premiums, minus any withdrawals, upon the annuity holder’s death.

Why Do You Need an Annuity Beneficiary?

Although you aren’t required to name a beneficiary when you purchase an annuity, it’s highly recommended.

If you don’t have a designated beneficiary in the annuity contract, the annuity must go through probate—the legal process for recognizing a will and distributing the assets within an estate. Probate proceedings can be expensive and time-consuming, and it could be six to 12 months before everything is resolved and the heirs receive their inheritance.

Going through probate can also incur hefty attorney fees and court fees, which are paid from the estate. Once the probate process is complete, you may find that there is less money since a large portion had to be used for legal expenses.

Worse, failing to name a beneficiary can have more significant consequences. There are some cases where the annuity can go through probate and the assets end up forfeited to the issuing insurance company.

Even if you’re married and intend to leave everything to your spouse, it’s critical to name your partner as your beneficiary. Depending on your state’s laws, the annuity may not automatically go to your spouse. Instead, they have to go through probate—unless your spouse is the designated beneficiary.

How Your Annuity Beneficiary Impacts Taxes

Who you choose as the annuity beneficiary may impact how the annuity income is taxed if you pass away.

If the beneficiary is your spouse, your partner can take over ownership of the annuity and receive payments under the annuity schedule. The annuity would be tax-deferred, and your spouse would only owe taxes on the distributions when they take them.

The rules are different if your beneficiary is someone other than your spouse. A non-spouse has three options when inheriting an annuity:

• A lump sum payment. The beneficiary receives the annuity’s remaining value as one upfront payment. The beneficiary must pay income taxes immediately on the lump sum.
• Nonqualified stretch. The annuity payouts—and the required income taxes—are stretched throughout the beneficiary’s lifetime.
• Five-year rule. Beneficiaries can withdraw smaller amounts from the annuity during a five-year period after the annuity holder’s death, or they can withdraw the entire amount in the fifth year. This approach can be a good option if the lump sum payment or higher distributions would push the beneficiary into a higher tax bracket.

If you choose a charitable organization as the annuity beneficiary, the amount the organization receives is normally included in your estate for estate tax purposes. However, the death benefit isn’t usually subject to estate taxes since it will qualify for an estate tax charitable deduction.

Who Chooses an Annuity Beneficiary?

Only the annuity owner can designate a beneficiary. You can change beneficiaries at any time, as long as the annuity contract doesn’t require you to name an irrevocable beneficiary.

You can also choose multiple beneficiaries, designating a percentage of the annuity to each person. For example, you may give 50% to your children and 50% to other family members.

Annuity contracts often allow you to name a contingent beneficiary—a designated person to receive the annuity payments if the primary beneficiary dies before the annuity owner does.

Planning Ahead

Naming an annuity beneficiary is a crucial step in the estate-planning process. It can help your heirs avoid probate and legal delays, and helps them access the money faster.

Your choice of beneficiary also has a significant impact on how taxes are handled, so taking the time to document your wishes can save your loved ones from headaches down the road.

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