Is an Annuity Death Benefit Taxable?

The proceeds from an annuity death benefit are taxable when they are received by the beneficiary. In the case where the recipient is a surviving spouse, he or she can initiate certain measures to defer the payment or taxes on the amount received.

In other instances where the recipient is not the spouse, the recipient will have to pay taxes on the money he or she receives from the annuity. Depending on who the beneficiary is, these funds may be subject to estate taxes as well.  

Before deep diving into this, it may be useful to have a clear understanding of what an annuity is. A simple way to think of an annuity is to refer to it as an insurance product that offers a certain income benefit, backed by contractual guarantees. It can be utilized as a component of a retirement benefit plan.

As an individual, you can purchase the annuity by paying a lump-sum premium payment or by making several premium payments over an extended span of time. The annuity premiums are allocated into the annuity contract, and the annuity owner receives benefits as the money grows over time. 

What is an Annuity Death Benefit? 

When the holder of an annuity contract passes away, the money and the death benefit available from the annuity come into play. Many annuity products come with the provision for the annuity holder to include a death benefit for a beneficiary, which they choose while setting up the contract.

The policyholder may choose his or her child, spouse, or any other individual as the beneficiary. In some cases, depending on the type of payout option the policyholder chooses, the insurance company may be the beneficiary. It would receive the balance of the money in the contract when the policyholder passes away.

This payout option is called “life-only,” and depending on your financial picture it may or may not make sense for your personal situation. You can ask your insurance or financial professional for more details.

The amount of the death benefit receivable from an annuity may be the entire amount left in the contract at the time of the policyholder’s death. In the case where the annuitant has made any withdrawals, the same amount and any applicable fees and/or charges are deducted from the death proceeds.

There are some types of annuities that offer a guaranteed death benefit to the beneficiary no matter the amount left over in the contract. However, in order to enjoy this death benefit rider, the annuity owner will need to pay an annual fee.  

Annuities and Income Taxes

Now, let us get back to the point where we started this discussion. Any money in an annuity contract grows tax-deferred until the annuitant decides to withdraw the same. Any payment that an individual receives from the contract throughout his or her lifespan is taxed as per income tax law.

When the annuitant passes away, the fate of the available death benefit depends on who the beneficiary is. This death benefit is not taxable as long as it remains inside the annuity.

It may be possible for the surviving spouse of a deceased annuitant to convert the available benefit into an annuity and continue to enjoy tax-deferred money growth. Some of the insurance service providers offer an option for the surviving spouse to choose between directly receiving this benefit and transferring the available money to another annuity. 

When the surviving spouse decides in favor of directly receiving the death benefits, income tax will apply on the difference between the available death benefit and the net amount. In most cases, estate taxes may not apply to any money remaining in the annuity. 

Tax Scenario for Non-Spouse Beneficiaries

If the selected beneficiary of an annuity is anyone other than the spouse, the recipient will have to pay tax on the available amount as per the normal tax rate for him or her. In order to spread out this tax liability, the recipient may choose to receive the money in payments over a period of time, rather than as a lump sum. In these cases, the annuity value is added to the estate of the annuitant and estate taxes are payable on the amount. 

Before purchasing any annuity contract, you must clearly understand what your exact benefits are. The contract terms may vary significantly across different insurance companies. As a customer, you should always carry out a detailed review of any annuity option before making any purchasing decision.

Different Annuity Contracts can Bring Different Situations

Though death benefits are available with many annuities, your annuity product selection will determine your potential tax implications in the future. To select the most appropriate annuity strategy for you, it is a good idea to seek a recommendation from a knowledgeable, experienced financial or insurance professional.

Be sure to work with someone who openly shows they provide guidance in your best interest. These experts can provide valuable insights in helping you understand how the death benefit proceeds are treated after the death of the annuitant. Their suggestions may also help you avoid paying high, unnecessary taxes on an annuity death benefit. 

As the annuity death benefit is taxable, you may also consider purchasing a life insurance policy in order to cover your estimated tax amount. This is probably one of the best ways for you to ensure that you have a higher amount for your own use.   

Ready for Personal Guidance?

You may be attracted to annuities for their ability to offer guaranteed lifetime income, a guaranteed minimum interest rate, or a guard against financial losses. If you are ready to investigate different annuity strategies and see what might make sense for you, a financial professional at SafeMoney.com can help you.

Use our Find a Financial Professional section to connect with someone directly. You can request a no-obligation initial appointment to discuss your situation and objectives. And if you need a personal referral, call us at 877.476.9723.