Annuity Beneficiary Help

Annuities have long been the preferred investment vehicle for people who seek the peace-of-mind of a secure, lifelong income stream.  For many annuity owners, buying an annuity is a straight forward process facilitated by a high quality life insurance company that allows them to buy it and forget it.  The problem is that if special care isn’t given to the naming of a beneficiary and the periodic review of the beneficiary designation, the annuity owner’s peace-of-mind could lead to legal or financial nightmare for the intended beneficiaries.

An annuity is a contract, and, as such, it should be reviewed carefully and entered into with caution as contracts cannot be changed once the annuity owner has died.  Although annuities are purchased for the benefit of the annuitant, the designation of a beneficiary is critical, because at the death of the owner the benefits of the annuity pass by contract.  If the owner/annuitants’s financial or life situation changes substantially between the time of the purchase of the annuity and the death of the owner, it’s possible that the original beneficiary designation no longer reflects the intent or wishes of the owner.

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Important to get it Right the First Time

Even though the beneficiary designation can be changed at any time by the owner, it is important to fully understand the options and their financial ramifications before making the designation, especially if there are to be multiple beneficiaries.  Designations begin with a primary beneficiary, and there can be more than one. The primary is simply the person or persons who are first in line to receive the benefits.  It can be a person, a trust, the estate of the owner, a partner or a charity. If more than one primary is named, then the percent of distribution needs to be stated. For instance, it could be stated as “in equal shares”, or 2/3 and 1/3 shares. 

Contingent beneficiaries are often named for the possibility that one or more of the primary beneficiaries dies before the benefits are paid.  The contingent beneficiaries are often the children or surviving family members of the primary beneficiary.  If, after the primary beneficiary begins to receive payments from the annuity, he or she dies, the benefits will be paid to the contingent beneficiaries.

It’s important to note that, in contracts where the owner and the annuitant are not the same person, it is the death of the annuitant that triggers the beneficiary payments.  If the owner dies, the annuitant remains as the contracts intended recipient of annuity proceeds or payments. In this instance, it is often recommended that the owner be the named beneficiary.

Important to Update Designations

Throughout a person’s lifetime, there could many life events that would alter the way beneficiaries are designated.  Divorce, re-marriage, deaths of family members, critical illnesses, new births, child adoptions, can all impact the beneficiary decisions of an annuity owner. Designation changes should be made immediately and reviewed often to ensure that they reflect the intentions of the owner.  Contingent beneficiaries are often changed or added as well.  If designations are changed properly, there could be serious unintended consequences for the surviving family. 

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Important to Inform the Beneficiaries

Although the beneficiaries stand to gain when the annuitant dies, there are also some tax implications that they should know about so are better prepared financially.  When an annuity owner or annuitant dies, the beneficiaries will receive either the proceeds of the investment account or the remaining income benefits if the option of guaranteed payments was chosen at the time of annuitization.

If the annuitant dies prior to annuitization, the beneficiaries receive the amount that has accumulated in the investment account.  They are taxed just as the annuitant would be taxed with the amount in excess of the principal investment taxed as ordinary income. 

If the annuitant dies after annuitization, that is after income payments have commenced, then the beneficiaries will receive the remaining income payments guaranteed in the contract (If the owner did not select the guaranteed payment option, the payments will not continue and the balance of the annuity will be kept by the insurance company).   These are taxed in the same way that they would be if they were received by the annuitant. The portion of the payments that are considered principal would be received tax free while the portion that is considered to be interest earned is taxed as ordinary income.

Important to Align with Will and other Assets

Many times an annuity owner will own other assets that will pass by will or by contract.  IRAs and other qualified retirement plans also pass by contract based on named beneficiaries.  It is important that all designations be reviewed so that they are in alignment as any disparities can cause confusion for the surviving family.  It seems like a lot of work, however, it takes just one form for each asset. 

Summary

Annuity owners are generally concerned about their financial security.  When purchasing an annuity, the beneficiary designation is one of the most important decisions that need to be made.  If an annuity contract is neglected in so far as the beneficiary designation is concerned, either at its inception or as life events unfold, the unintended consequences could seriously disrupt the financial security of the surviving family. It is important to get it right and to keep it right.

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