As part of any long-term financial plan, deciding what will happen to your wealth after you are gone is an essential component in planning for your retirement. There are several options for the distribution options on inherited Annuities one needs to be mindful of when planning retirement. We all have loved ones, and while it’s important that we not outlive our financial resources, most of us would rather have any remaining funds in our annuity go to a named beneficiary.
It is important to note that not all annuities are structured in a manner that provides for a beneficiary. If you don’t have anyone to leave your funds to, you could structure your annuity to provide higher payouts based solely on your own life expectancy and nothing else, without any provisions for inheritors at all. Should you die before you have had the value of your investment paid out to you (i.e. the total value of the premiums you paid), any funds remaining will be [intlink id=”129″ type=”page”]forfeited[/intlink] to the insurance company. If you were to decide on a guaranteed lifetime income annuity for only yourself, with no death benefit, you would receive a higher payout than an individual who has structured their annuity to provide for heirs.
Insurance companies attempt to determine how long you will live and then use that information in their calculations to determine how your payments are structured. This means you could do quite well if you happen to live a long time. If you live longer than average the insurance company will eventually be making your payments without returning any principal because in the preceding years your payouts were structured in such a manner as to return a portion of your principal along with some interest gains. This is all based on how long the insurance company perceives you will live. If you were 70 years old when you started to receive your lifetime income payments, and you live to be 90, you will ultimately have gotten more out of your annuity simply because you lived longer than was statistically likely. You probably aren’t really costing the insurance company any money because it spread’s the risk of these “long-lived” people across a very large pool of individuals. Some of them will die earlier than expected while others will live longer thus evening-out in the end. Also note that lifetime income annuities pay-out less than do term-certain annuities. Using our last example, our 90 year old would have received a higher payout from a 20 year term-certain annuity than he would have from an income-for-life product. However, the additional income could easily be recouped if this 90 year-old lives on to an even greater age.
For individuals who are married the choices are somewhat simpler as many couples choose “joint-lifetime” annuities. In this case surviving spouses are known as the “primary” beneficiary and will continue to receive payouts from the annuity until they too have died or for whatever length of time the annuity contract specifies. Most annuities include a “contingency” beneficiary. This simply means that the contract holder has specified a “back-up” beneficiary. If both spouses died at or near the same time, then their “back-up” would inherit. Depending on the type of annuity product chosen, there may be tax concerns for the primary and/or contingency beneficiary. For example, if you have a joint-life, single-premium annuity that features income for life for you and your spouse, your contingency beneficiary may only benefit from the “period certain” clause that is often included in this type of annuity contract. This means if you and your spouse die after 8 years, and the “period certain” is only 10 years in length, your beneficiary will continue to receive payments for the two remaining years or receive a lump-sum payout of equal value. A large payout could well put your beneficiary’s income for that year into a higher tax bracket and thus more tax will be owed. As always here at HQ, we recommend that you consult with a trusted financial advisor for more detailed explanations and advice.
Variable annuities carry their own death benefits which are slightly different from other types of annuities. (See a full explanation of variable annuities here.) This death benefit, at its most basic, provides the value of your account, including any earnings, minus any withdrawals made. You could also purchase additional features that are designed to protect the value of your account for your beneficiaries. These “stepped-up” death benefits do have added costs associated with them, and this will affect the value of your account. If you are particularly concerned, you can purchase additional protection for your variable annuity, and these options can be quite useful. For example, you could purchase, via a rider, a stepped-up death benefit with a “high-water” mark feature. This means that in any given year your account value is pegged at its highest value. Should you die, your beneficiaries will inherit your account at its “high-water” mark. As previously stated, these options can be expensive so make sure you really need them.
As you can see, there can be many options available to you. Thoroughly discuss this with your loved ones and your financial advisor to insure you aren’t paying for something you don’t need, or worse yet, something you not only don’t need but could provide for less expensively some other way. Annuities are a form of insurance designed to protect against living longer than you have financially provided for and should always be considered first in that light. However, if a large portion of your legacy is tied-up in an annuity, you can be assured that there are methods and practices available to ensure your beneficiaries inherit as you want.