What is an annuity beneficiary?
A named receiver of annuity death benefits
A beneficiary is a person or entity that receives the value of the annuity or annuitization payments that remain (if any) after the death of the annuitant or owner. The annuitant or owner receives annuitization payments during his or her life (the annuitant provides the measuring life for the payments). The beneficiary(ies) is specifically named in the annuity policy. Only the owner of the annuity has the right to name the beneficiary, and he or she may have the right to change the designated beneficiary at any time during the accumulation period (unless the beneficiary designation is irrevocable). When the owner or annuitant dies, the death benefits pass directly to the beneficiary without having to go through the probate process.
Under an annuity policy
An annuity policy is a contract between you and the issuer, typically an insurance company. In its simplest form, you pay the company money, they invest it to earn tax-deferred returns, and then they pay the principal plus earnings back to you and/or your beneficiary. What most distinguishes an annuity from retirement plans is that income payments can be guaranteed for a lifetime and there is typically no limit to the amount that can be purchased in a given year. (However, contributions to an annuity do not enjoy the same tax benefits as contributions to qualified retirement plans.)
What are the beneficiary’s rights?
The beneficiary has no rights under the policy except to receive death benefits. However, a beneficiary who has the option to receive death benefits in a lump sum may be able to elect to receive installments instead. In this case, the beneficiary may elect to have the proceeds treated as installments for income tax purposes if the beneficiary elects that form of payment within 60 days after the annuitant’s death. If the beneficiary does not make such an election within the period allowed, he or she will be deemed to have received the lump sum and will be taxed accordingly.
How are proceeds received by a beneficiary treated for income tax purposes?
If the owner or annuitant dies before the annuitization starting date
If the beneficiary receives death benefits because the owner or annuitant dies before the annuitization starting date (i.e., without having received any annuity payments), the beneficiary generally receives a death benefit equal to either the accumulated cash value of the policy or the total premiums paid less withdrawals, whichever is greater. The beneficiary will be subject to income tax on the death benefit, to the extent that it exceeds the investment in the contract.
If the owner or annuitant dies on or after the annuitization starting date.
If the owner or annuitant dies before receiving the guaranteed number of payments based on the annuitization option selected (e.g., on a term certain policy), the beneficiary receives the remaining payments owed. If the beneficiary receives the death benefit as a series of payments, the beneficiary is taxed according to the general annuitization rules (i.e., each payment is part nontaxable principal and part taxable income). If the beneficiary has the option and receives the payment in a lump sum, the payment is treated as nontaxable principal until all the investment is recovered. The excess is taxed to the beneficiary as ordinary income.
Whom should you name as a beneficiary?
Yourself, if you are not the annuitant
If you are the owner but not the annuitant, you may want to name yourself as the beneficiary. The beneficiary receives the death benefits (or continuing annuity payments) when the annuitant dies. Thus, if the annuitant dies before you do, you may want the death proceeds to revert to you. You should consider having a contingent beneficiary in addition to you, the owner, as the primary beneficiary. If you, the owner, die, you may want the death proceeds to go to the contingent beneficiary instead of your estate.
Your spouse
Naming your spouse as the beneficiary has several advantages:
- Your spouse is provided for–Death benefits payable to your spouse provide for his or her welfare.
- No minimum distribution is required–Generally, the death benefit must be paid out to the named beneficiary beginning no later than one year after your (the owner’s) death. However, there is an exception to this rule if the sole beneficiary is a surviving spouse. In this case, the surviving spouse may step into the deceased’s shoes, become the new owner of the policy, and be permitted to continue the policy with no change.
- The unlimited marital deduction applies–Generally, the amount received by a beneficiary is includable in your (the decedent’s) estate for estate tax purposes. However, death benefits payable to a spouse, while included in your gross estate, are not subject to estate tax because they qualify for the unlimited marital deduction.
Children
You may want to name your children as beneficiaries. However, remember that the beneficiary receives the death benefits when the annuity holder dies. Be aware that if you have purchased an annuitant-driven contract and named your spouse as the annuitant and your spouse dies, your children will receive the death benefits, not you. (This may be a problem if you were depending on the annuity as a source of income.) And if the beneficiaries are under age 59½ they may be subject to a 10 percent tax penalty on the gain.
Minor children
If you name a minor child (under 18) as a beneficiary, you may want to use a trust or appoint an adult to act as a guardian. Otherwise, if you die while the child is still a minor, the court may have to appoint a guardian. The court’s involvement can be costly, time consuming, and intrusive. It’s best to avoid it if possible.
Trusts
You need not name an individual as beneficiary; you can also name an entity, such as a trust, as beneficiary. This may be advantageous if the beneficiaries of the trust are minors or spendthrifts (i.e., people who spend money foolishly). However, since a trust is a “nonnatural person” some distribution options may not be available.
Charity
You can name a charitable institution (such as a church, hospital, college, or university) as the beneficiary of your annuity. Generally, the amount received by a beneficiary is includable in your (the decedent’s) estate for estate tax purposes. However, death benefits payable to a charity, while included in your gross estate, are not subject to estate tax because they qualify for the estate tax charitable deduction.
How do you name or change (i.e., designate) a beneficiary?
Complete a beneficiary designation form
When you buy an annuity, the insurer will provide you with a form. Generally, the form need only be completed (i.e., name the beneficiaries), signed, and dated by you.
Specifically identify each beneficiary and the distribution he or she is to receive
Be specific when naming the beneficiaries. Make sure the designation clearly identifies to whom the death benefits are to be paid. If you want the death benefits to be distributed to your children (which may include legitimate, illegitimate, or adopted children or children from a previous marriage), specify the name of each child to be sure that the ones you want are included and the ones you don’t want are excluded. You may want to include a clause such as “and any afterborn children” to catch any children not yet born.
Specifically revoke previous designations
When changing a beneficiary, it is good to specifically revoke any previous designations (simply write this in on the change of beneficiary form).
Review every two or three years, or upon a change of circumstances
You may want to review your beneficiary designation every two or three years (things change). Additionally, be sure to check and update your designation upon certain life events (e.g., divorce, remarriage, and the birth of children or grandchildren).
Can you change a beneficiary in your will?
A change of beneficiary made in your will does not override the beneficiary designation form. If you want to change the beneficiary, execute a change of beneficiary form. Do not rely on your will to do so.
What if you don’t name a beneficiary?
If no beneficiary is named or if there is no living beneficiary, the remaining payments (if any) pass to your estate.
Whether you’re contemplating naming beneficiaries, reviewing existing designations, or navigating tax implications, don’t leave your financial legacy to chance. Let’s work together to safeguard your financial well-being and your beneficiaries.
Scarlet Oak Financial Services can be reached at 800.871.1219 or contact us here. Click here to sign up for our newsletter with the latest economic news.
Source:
Broadridge Investor Communication Solutions, Inc. prepared this material for use by Scarlet Oak Financial Services.
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances. Scarlet Oak Financial Services provide these materials for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
