Annuity death benefit

What it means

Annuities are two different products wearing one word, and what happens at death depends on which one it is and which phase it is in.

A deferred annuity that has not started paying is an account with a death benefit: usually the greater of the value or the premiums paid, sometimes more where a rider was bought. It goes to the named beneficiary directly, without probate.

An annuitized contract is paying an income, and what happens at death was fixed at the moment it started. A life-only annuity stops. A joint-and-survivor annuity continues, often at a reduced rate. A period-certain annuity keeps paying to a beneficiary for the balance of the term. Nothing about this can be changed after the fact.

The tax treatment is the part that surprises. An annuity does not receive a step-up in basis, so the growth is taxable to the beneficiary as ordinary income as it is received. A spouse can usually continue the contract; a non-spouse generally has to take the money out within a set period.

Why it matters

A family expecting an inheritance from an income annuity may find it stopped at the death, and the answer was in an election made years earlier.

The tax bill on an inherited annuity is often the largest surprise in an estate, because everything around it — the house, the shares — did get a step-up.

When you are likely to meet it

• When a monthly payment stops after a death.
• When an insurer's claim pack asks the beneficiary to choose how to take the money.
• When working out what an estate actually holds and what passes outside it.

Related terms

• Beneficiary designationA named person on an account or policy who receives it directly on death, without it passing through the will or probate.
• Non-probate assetSomething that passes to a new owner automatically, without a court.
• Required minimum distributionThe amount that has to be taken out of a retirement account each year once the rules require withdrawals to begin.
• Retained asset accountAn account an insurer opens in the beneficiary's name instead of sending a check, holding the life insurance proceeds until they are drawn.
• Step-up in basisThe tax rule that resets an inherited asset's value to what it was worth on the date of death.
• Survivor annuityA continuing pension payment to a surviving spouse, if that option was chosen when the pension started.

Sahvelo guidance that uses this

• Investment accounts after a death