Some annuities are to die for
The best solution for a guaranteed death benefit will always be life insurance. However, some people cannot pass the underwriting requirements or just don’t like life insurance for whatever reason. This is where some unique annuity legacy strategies can provide the desired contractual death benefit guarantees, while allowing you to retain full control of your money.
Death benefit proceeds from a life insurance policy passes to the beneficiaries tax free, and this an obvious and primary value proposition of that strategy. Even though annuities are actually a life insurance product, the death benefit lump sum from an annuity doesn’t share the same tax-free status. With that important distinction established, let’s explore how annuities can be a positive addition to your legacy planning.
Death benefit riders
A rider is an attached benefit that can be added to an annuity policy at the time of application. With most annuity death benefit riders, there is an annual fee for this benefit for the life of the policy, and the contractual guarantee typically provides an annual growth rate that can be left to the listed beneficiaries. The fee is taken out of the accumulation value, and not the actual death benefit amount, with both of those being separate calculations within the same annuity.
For example, a death benefit rider might guarantee an increase of 6 % that will compound annually. That amount will be distributed to the listed beneficiaries at the time of the annuity owner’s passing. Some policies pay out the full amount at death, and some pay that total over a five-year period. The dream the agent sold is that the accumulation value “could” exceed the contractual death benefit total — but that normally doesn’t happen so it’s best to make your decision to buy on just the rider guarantee only.
Most current annuity death benefits guarantee the annual percentage increase to a specific age or specific period. Typically, that age is 85 and the time period is usually 10 years. However, every death benefit rider is different, so you need to fully understand the guarantees as well as the contractual limitations with each product.
Some of the newer death benefit riders guarantee a smaller annual guaranteed percentage, with potential growth added to that amount. Indexed annuities are a product type that is using this “stacking” method for death benefits. For example, a current indexed annuity death benefit rider guarantees a minimum annual growth percentage of 3 % and adds to that compounding yield any indexed growth amount for that contractual year. Because indexed annuities were designed for CD type returns, those return expectation levels would apply when considering this stacking death benefit strategy.
It’s also important to point out that some death benefit riders guarantee a simple interest annual growth, and some provide compounding interest growth. That’s an important detail when it comes to deferring, because an 8% simple interest guarantee might not be as attractive as a 6% compounding number. Some carriers offer an upfront bonus at the time of issue, and it’s important to fully understand if that bonus is vested or available immediately as a death benefit.
Remember that there are only 100 pennies in the dollar, so if a carrier gives something in one area of the contract then they are probably taking it away somewhere else. There’s no free lunch or free money, especially when it comes to annuities.
Leaving an income legacy
In addition to guaranteed death benefits, you can also leave an income stream to your listed beneficiaries as part of your overall legacy plan. For all of us “A” personalities out there, it’s an attractive thought to control things from the grave and save your heirs from themselves by preventing them from accessing your death benefit proceeds in a lump sum.
A single-premium immediate annuity (SPIA) can provide a lifetime income stream for you and income for your beneficiaries at the time of your death if you structure the contract properly. For example, a 70-year-old male could buy a SPIA structured “Life with 30-year certain.” That means that it will pay a guaranteed income stream regardless of how long the 70 year old lives. If he lives to over 100, the income stream will continue. If he lives to 125, the payments are guaranteed. Lifetime payments have no limitations.
However, if the 70 year old dies five years into the “Life with 30 year certain” SPIA contract, then 25 years of payments would go to the listed beneficiaries. That’s because the 30-year-certain clause is contractually attached to the lifetime guarantee. Depending on the owner’s age, that period certain can be structured as long as 40 years.
That is just one example of how you can use annuities to contractually leave an income legacy, and every plan can be customized to meet your specific goals. Single-premium immediate annuities (SPIAs) and deferred-income annuities (DIAs) are the most efficient products for this type of legacy income planning because of their simple design, no fee structure, and the ability to contractually add annual COLA increases for the life of the policy.
Trust might be an issue
For all legacy planning, it’s vitally important to run your legacy strategies by a lawyer or CPA to make sure that you are addressing your specific state laws as well as federal guidelines. This especially applies when a trust is involved in the final distribution of your money that you want to happen on your terms. For example, within a trust you can dictate that a lifetime income annuity can be established in lieu of a lump sum, or that the death benefit proceeds from a deferred annuity be used to buy a single premium immediate annuity (SPIA).
One of my friends that only sells life insurance always says “one out of one of us is going to die.” Let’s just say he isn’t a sought after motivational speaker. However, his simplistic outlook on life (and death) should serve as a reminder that legacy planning comes in many forms and is specific to every person’s situation.
Annuity legacy strategies might actually provide the contractual death benefits you’re looking for, and the overall control over your money that you desire.
Originally published 6.24.14 by MarketWatch.com – http://www.marketwatch.com/story/some-annuities-are-to-die-for-2014-06-24