Written By : Elaine Silvestrini
This page features 13 Cited Research Articles

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If an annuity has a death-benefit provision, the owner can designate one or several beneficiaries to inherit the remaining funds after death.

What Happens to an Annuity When You Die?

An annuity is an economic tool used to accrue monetary interest, secure investments and anchor financial futures of annuity owners. Annuities have a slew of benefits, so much so that lottery winners, retirees and structured settlement recipients use annuities to create a financial cushion, so they own something with the potential to provide money for the present, future and even after their death.

After the death of an annuity owner, annuities can be left to a beneficiary selected by the owner.

This means an annuity held by a parent, spouse or another loved can be willed to a person named as a beneficiary.

Annuity owners work with insurance companies to create custom contracts specifying whether money will be leftover and, if so, who will inherit it. These contracts commonly include death benefit provisions, which allow the owner to designate a beneficiary to receive the greater of either all the money left in the account or a guaranteed minimum. After an annuitant dies, insurance companies distribute any remaining payments to beneficiaries in a lump sum or stream of payments. It’s important to include a beneficiary in the annuity contract terms so that the accumulated assets are not surrendered to a financial institution if the owner dies.

Similar to setting up a life insurance policy, owners can mold the terms of their annuity agreement to support their loved ones. The amount of remaining payments left after the annuity owner dies depends on the annuity agreement details, including the type of annuity purchased and inclusion of the death benefit clause.

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Death Benefit Payout Options

Beneficiaries typically have three options for how to receive annuity payments after the contract owner’s death.

Beneficiary Payout Options
Lump-Sum Distribution
A lump-sum distribution allows the beneficiary to receive the entire remaining value of the contract in one payment.
Nonqualified-Stretch Provision
When a nonqualified-stretch provision is included in the contract, the beneficiary receives payments based on his or her life expectancy.
Five-Year Rule
The five-year rule allows beneficiaries to withdraw incremental amounts during a five-year period or withdraw the entire sum in the fifth year.

Beneficiaries that happen to be surviving spouses have an additional option to continue on with the initial agreement as the new owner and annuitant.

Financial expert Juliette Fairley explains how your annuity will be handled if you pass away before receiving the full amount of it.

Annuitant vs. Owner

It’s important to clarify that an annuity owner and an annuitant are not always the same person. Insurance companies refer to the annuity purchaser as its owner. The owner creates the annuity terms with the insurance company, designates beneficiaries, can sell the annuity and has automatic rights over the agreement. There can be co-owners of an annuity, so if one owner dies, the other will retain the rights of the agreement. Co-owners are typically spouses.

While establishing the terms of the annuity agreement, the owner has the option of naming a third party as the annuitant. The annuitant is the person on whose life expectancy the contract is based. It is common for the annuity owner to name him or herself as the annuitant. It is also possible to name a joint, or second, annuitant, thus ensuring that payments will continue for the remainder of the surviving annuitant’s life.

In addition, sometimes an annuity owner names a younger representative as the annuitant to lengthen the duration of annuity benefit payments and extend the tax-deferral period.

Pro Tip
Owners are often annuitants, and the annuity benefit payments are calculated based on the annuitant’s life expectancy.

A beneficiary is the person who receives the elected death benefits, usually the remaining contract value or the amount of premiums minus any withdrawals, upon the annuitant’s death. An owner cannot be his or her own beneficiary. If no beneficiary has been named in an annuity contract, remaining funds are surrendered to the issuing insurer.

Choosing a Beneficiary

Only an owner can designate beneficiaries, and only the owner or annuitant’s death can trigger any beneficiary action. The owner can change beneficiaries at any time as long as the contract does not require an irrevocable beneficiary to be named. They can also choose multiple beneficiaries and a contingent beneficiary – people designated to receive payments if the primary beneficiary dies before the owner.

Pro Tip
Beneficiaries can be people or organizations.

A list of beneficiaries divides the inheritance into equal shares and distributes it by percentages. Minors designated as beneficiaries can’t access their annuity inheritance until they reach the age of majority (18). By including a beneficiary in an annuity contract, owners also protect heirs from probate, the legal process of dividing a deceased person’s estate using a will. Going through probate involves court costs and time waiting. When owners fail to name beneficiaries, the annuity can go through probate and assets may be forfeited to the issuing insurance company. Owners who are married should not assume their annuity automatically passes to their spouse. Often they go through probate first.

Owners can also assign a trust to receive any remaining payments. However, because payments going to trusts are not based on life expectancy (as they are when payments are transferred to a beneficiary), the money must be paid out within five years.

Spouse vs. Non-Spouse Beneficiaries

Many policies permit a spouse to choose what to do with the annuity after the owner dies. A spouse can choose to change the annuity contract into their name, assuming all rules and rights to the initial agreement and delaying immediate tax consequences. They will have the ability to accept all remaining payments, any death benefits, and choose beneficiaries, depending on the terms of the contract. The spouse then becomes the new annuitant.

When a spouse becomes the annuitant, the spouse takes over the stream of payments. This is known as a spousal continuation. This clause allows for the surviving spouse to maintain a tax-deferred status and secure long-term financial stability. Joint and Survivor annuities also allow for a named beneficiary to take over the contract in a stream of payments, rather than a lump sum.

A non-spouse can also become a beneficiary; however, they will not have the ability to change the terms of the annuity contract. A non-spouse only has access to the designated funds from the annuity owner’s initial agreement.

Inherited Annuity Tax

Beneficiaries owe income tax on the difference between the principal paid into the annuity and the amount the annuity is worth when the annuitant dies. If they choose a lump sum, beneficiaries must pay owed taxes immediately.

The tax situation for the beneficiary is similar to that of the annuitant, in that taxes are not owed until the money is withdrawn from the annuity.

Are Inherited Annuities Taxable?

How taxes are paid will depend on the payout option selected by the beneficiary. The beneficiary of a tax-deferred annuity has several options on how to receive the benefit.

If the beneficiary is the spouse of the annuitant, the spouse can change the contract into his or her own name. If that’s done, the contract continues as if the surviving spouse had the contract since it started. It maintains its tax-deferred status, meaning the beneficiary owes no immediate taxes.

The spouse could choose to take an immediate lump sum. This is an option for other beneficiaries, as well. If this is done, the beneficiary will owe taxes on the entire difference between what the owner paid for the annuity and the death benefit. This is the option with the highest tax consequences for the beneficiary.

The beneficiary can also withdraw the money over a period of five years. Then, he will owe taxes only on the increased value of the portion that is withdrawn in the year. This option can make it less likely that the beneficiary will change tax brackets. Going to a higher tax bracket means higher taxes.

The option with the lowest tax exposure is to have the death benefits paid over the life expectancy of the beneficiary. This means it will take longer to receive the benefits.

Reporting Inherited Annuity Income to the Government

Inherited annuity income should be reported to the Internal Revenue Service, as a general rule, the same way the plan participant would have reported it. There are exceptions to this, however.

For example, a beneficiary may be entitled to an estate tax deduction if the annuitant died after the annuity starting state. According to the Internal Revenue Service, if you are a survivor under a joint and survivor annuity held by a retiree, benefits you receive must be included in your gross income reported to the government. They should be included in the same way the retiree would have included them in gross income.

The IRS advises: “If you receive guaranteed payments as the decedent’s beneficiary under a life annuity contract, don’t include any amount in your gross income until your distributions plus the tax-free distributions received by the life annuitant equal the cost of the contract. All later distributions are fully taxable. This rule doesn’t apply if it is possible for you to collect more than the guaranteed amount. For example, it doesn’t apply to payments under a joint and survivor annuity.”

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Annuity Beneficiary Options

Annuity owners provide a sum to beneficiaries that is predetermined by the type of death benefit written into the annuity contract. Primary death benefit options include standard, return of premium and riders.

Standard Death Benefit

This particular benefit has the least value, and the owner pays no extra costs for it. The insurance company pays beneficiaries the value of a contract minus any fees and withdrawals. The contract value is determined by the day the insurance company receives proof of the annuitant’s death, or when the beneficiary files a claim. For some variable annuities, this benefit can decrease in value. For example, a beneficiary might report the annuitant’s death on a date when stocks aren’t performing well.

Return of Premium

This benefit has a higher value, and may cost an additional 0.05 percent a year while some contracts include this death benefit at no extra cost. With the return of premium benefit, either the market value of the contract or the sum of all contributions minus fees and withdrawals determines the inherited amount. The insurance company pays whichever is greater.

Stepped-Up Death Benefit Rider

A rider is an attachment to a contract that can be added when the contract is created. In the case of annuity death benefit riders, there can be an annual fee over the life of the policy. The riders can be different, depending on the company that provided the annuity and the cost. The specifics of the rider will be written in the annuity contract. The insurance company determines the value of a contract at each anniversary of the annuity’s purchase. With a stepped-up death benefit rider, the beneficiary is paid the highest value amount recorded minus any fees and withdrawals, instead of the value of the annuity when the insurance company learns of the annuitant’s death. Some insurance companies add a fee of 0.20 percent or more a year for this benefit.

Additional Riders

For variable annuities, owners can pay for an additional rider. Some contracts charge 0.25 to 0.50 percent a month for this perk. The insurance company takes the highest value of the asset for the month (as it changes with market fluctuations) and then pays benefits based on that value.

Death Benefits by Type of Annuity

While different death benefits impact the total available for beneficiaries, the type of annuity (fixed, variable, immediate or deferred) changes how much the insurance company pays them. There are general guidelines for determining the benefits for variable and fixed annuities. For most variable annuities, beneficiaries receive at least the original amount the owner contributed. For fixed annuities, the beneficiary receives the present value of payments.

For some immediate annuities, like a lifetime immediate income annuity without term certain, the insurance company keeps the money when the owner dies. However, the annuitant can purchase a refund option or period certain rider and remaining payments then go to a beneficiary.

For deferred annuities, the amount paid depends on whether the payments are in the accumulation or payout phase. Annuities in the accumulation phase pay beneficiaries the total amount contributed to the account. Once the annuity is in the payout phase, the beneficiary subtracts payments already made to the annuitant.

With the extensive varieties of annuity options available and the customizable nature of contracts, the size of an inheritance greatly varies. Annuity owners can prepare for the future of a spouse or other beneficiary by comparing their options with an insurance expert.

Can You Inherit a Lottery Annuity?

If a Powerball or other lottery winner chooses to take the prize as an annuity over 30 years, what happens if the winner dies before the 30 years?

The payments will continue until the end of the 30 years in a manner decided by the lottery winner.

The rules will be different in different states. But in general, lottery winners may choose a beneficiary to receive the remaining payments of the prize.  Most states allow only one beneficiary. If this is the case in your state and you wish to leave the money to more than one heir, you could have the lottery payments made to your estate for distribution to your heirs.

Just as the lottery winner would have to report the prize to the government and pay taxes, so, too, would your estate and any heirs who inherit the lottery winnings.

Last Modified: December 2, 2019

13 Cited Research Articles

  1. Bouman, T. (n.d.). Annuities - Bouman Law Firm. Retrieved from https://www.tomboumanlaw.com/annuities.html
  2. Dias, Jr., C. (2016, June). What are the distribution options for an inherited annuity? | Investopedia. Retrieved from https://www.investopedia.com/ask/answers/09/inherited-annuity-distribution.asp
  3. Lambert, G. (n.d.). Deciphering Deferred Annuity Designations. Retrieved from https://www.investopedia.com/articles/pf/06/ownerannuitant.asp
  4. Pechter, K. (n.d.). Who's Who in an Annuity - dummies. Retrieved from https://www.dummies.com/personal-finance/investing/whos-who-in-an-annuity/
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  8. The Motley Fool. (n.d.). Do I Pay Taxes on All of an Inherited Annuity, or Just the Gain? Retrieved https://www.fool.com/knowledge-center/do-i-pay-taxes-on-all-of-an-inherited-annuity-or-j.aspx
  9. Internal Revenue Serviuce. (n.d.). Publication 575 (2016), Pension and Annuity Income. Retrieved https://www.irs.gov/publications/p575#en_US_2016_publink1000226982
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  11. the nest. (n.d.) Annuities. What Happens to Lottery Winnings if You Die Before Payments Are All Paid Out? https://budgeting.thenest.com/happens-lottery-winnings-die-before-payments-paid-out-34073.html
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  13. Investopedia (n.d.) Living and Death Benefit Riders. Retrieved https://www.investopedia.com/terms/l/living-and-death-benefit-riders.asp