Annuity Death Benefits: How Are They Paid?

Today, we're talking about annuity death benefits. You buy an annuity, and you die—what happens? Let's dive right in.

The Basics of Annuity Death Benefits

Let’s talk about death benefits and how they are paid with annuities. Life insurance companies offer the best death benefit out there—lump sum, tax-free to the beneficiaries. If Stan The Annuity Man dies, my family would get rich. I love life insurance (I don’t sell it), but it’s the best death benefit available. Best return on investment you'll never see because you're dead, right?

Life Insurance vs. Annuities

Now, don’t panic. Life insurance companies issue annuities; I know it sounds weird, but annuity death benefits are not tax-free. In life insurance, you must go through underwriting—fill out forms, get medical records, and then the nice nurse visits to take blood and collect a sample. Don't fill up the cup too much. They only need a little bit. I digress. But with annuities, you don’t need approval. You could be smoking Lucky Strikes with no filter and drinking a bottle of Jim Beam daily and still get approved for an annuity. Annuities are guaranteed issue, meaning they’ll issue it to you regardless of health. But it’s not tax-free.

Comparing Life Insurance and Annuities for Death Benefits

So, which one is better? Well, if you qualify for life insurance, it’s better. Life insurance gives a tax-free lump sum to your beneficiaries. But many of you Baby Boomers turning 65 every day, living a hard life, may not qualify. That's where annuities come in. With annuities, you can attach a death benefit rider.

A death benefit rider is an attached benefit you can add to your annuity at the time of application. Right now, a few companies offer a guaranteed issue death benefit rider. It’s paid out differently than life insurance: you can get it as a lump sum or a five-year payment. Some companies even offer annuitization, but most people go with lump sum or five-year payouts.

Annuity Death Benefits Without a Rider

What if your annuity doesn’t have a death benefit rider? If you buy a Single Premium Immediate Annuity (SPIA) and set it up so that 100% of unused money goes to the beneficiaries, that’s a death benefit. This would apply to products like Qualified Longevity Annuity Contracts (QLACs) and Deferred Income Annuities (DIAs)—all annuitized products. Annuity means creating payments, like a water faucet.

A caller the other day asked, "What is annuitization?" I said, "Picture a water spigot attached to your house. You turn it on, and water flows. If you rip the knob off, the water keeps flowing." That’s annuitization—payments flow regardless. You can structure it for your life or joint life or set it so any unused payments go to the beneficiaries.

Death Benefits in Other Annuity Products

Now, let’s look at other death benefits for non-income annuities like Multi-Year Guaranteed Annuities (MYGAs), Fixed Indexed Annuities (FIAs), or Variable Annuities without a rider. In these cases, the death benefit is the accumulation value—the principal and any growth. Here’s a breakdown:

• MYGAs: These are like CDs, so the death benefit is whatever the interest rate has grown over time. The principal is protected, and the growth is based on interest rates.
• FIAs: These aren’t market products but are similar to CDs. The death benefit is the growth in the index options, typically at CD-type rates.
• Variable Annuities: The death benefit is based on the growth of the mutual funds (separate accounts) inside the policy. This can be paid out as a lump sum or over five years.

Choosing the Right Death Benefit Option

So, life insurance offers the best death benefit, but if you’re looking for one with an annuity, you can either buy a death benefit rider or structure your annuity to ensure 100% of unused money goes to your beneficiaries.

There is a fee for those riders that comes out of the accumulation value, but you can also set up your annuity types so that unused funds go to beneficiaries, which acts as a death benefit.

Understanding Beneficiaries

People often ask about beneficiaries, either for their own policy or for an inheritance. You can list as many beneficiaries as you want—primary, secondary, tertiary—whatever you choose. These beneficiaries are revocable, meaning you can change them whenever needed.

One client recently called, wanting three levels of beneficiaries for their Fixed Rate Annuity. His spouse was the primary beneficiary, his kids were secondary, and the grandkids were tertiary. Here’s how that works: if he dies, the spouse gets everything. If both the spouse and he die, the kids split it. If everyone dies, the grandkids split it.

Closing Thoughts

People pass away, and annuities are often passed down. Understanding how death benefits work within annuities is crucial. If you have any questions, I encourage you to look at my Inherited Annuities Video to learn more about how that process works.

Now, I’ve written six owner’s manuals on all different annuity product types, and you can get them free! Go to The Annuity Man or click this link to get all the information.