What happens to an annuity when you die depends on two things: the payout option in the contract and who is named as beneficiary. If the annuity is still growing, a beneficiary usually receives a death benefit. If payments have already started, the payout option decides whether anything continues at all.
Those two settings are chosen when the annuity is purchased. Most people never look at them again. That is the part worth understanding, because at death the insurance company follows the contract as written, not what the family assumed.
The two choices that decide everything
An annuity is a contract issued by an insurance company. Life insurance companies write these contracts, and the contract governs. When the owner dies, the annuity company reads that contract and does exactly what it says. Two lines on the paperwork control almost every outcome:
- The payout option. Selected when income payments begin. It determines whether payments stop at death, continue to a survivor, or pay out a remaining balance.
- The beneficiary designation. Selected when you purchase an annuity and updated only if someone goes back and changes it. It determines who receives money and whether the annuity avoids probate.
Both are usually set once, at the start, and then forgotten for twenty or thirty years. Marriages end, children are born, beneficiaries die first, and the form stays where it was. Reviewing those two lines is the single most useful thing an annuity owner can do for the people who will handle the contract later.
Owner, annuitant and beneficiary are three different roles
An annuity contract has three roles, and they are often confused. The National Association of Insurance Commissioners glossary defines an annuitant as the “person during whose life and annuity is payable,” and a beneficiary as someone “who may become eligible to receive payment due to will, life insurance policy, retirement plan, annuity, trust, or other contract.”
- Owner. The person who purchases the annuity and paid for the annuity. The owner controls it and can change the beneficiary. Death of the owner is usually what triggers the death benefit.
- Annuitant. The measuring life. Annuity payments are calculated on this person’s age and continue for as long as the contract promises.
- Beneficiary. The person or entity named as the beneficiary, who receives whatever the annuity contract terms say is payable at death.
Often one person is both owner and annuitant, and the outcome at death is straightforward. Problems start when the roles are split. If a parent owns the annuity and names an adult child as annuitant, the death of the owner may force a payout to the beneficiary while the annuitant is still alive. If the annuitant dies but the owner is still living, some contracts pay the death benefit and end, and some do not. There is no universal rule here. Ask the insurance company, in writing, what each death triggers in your specific contract.
What happens if you die during the accumulation phase
A deferred annuity has two stages. During the accumulation phase the money grows and no income payments are being made. In the payout phase the insurer sends periodic payments. Death during the accumulation phase is the simpler case.
Most deferred annuities pay a basic death benefit. The Securities and Exchange Commission, describing variable annuities, states that if you die, the beneficiary you select “will receive the greater of: (i) all the money in your account, or (ii) some guaranteed minimum (such as all purchase payments minus prior withdrawals).” That greater-of structure is the typical design across deferred annuity products, not a legal requirement, and the exact formula varies by insurer and product.
The NAIC Buyer’s Guide to Fixed Deferred Annuities describes the same thing: a deferred annuity with a basic death benefit “pays some or all of the annuity’s value to your survivors (called beneficiaries) either in one payment or multiple payments over time.” The guide also notes that for an extra cost you may be able to choose enhanced death benefits that increase the value of the basic death benefit. Those riders are paid for through ongoing charges, so they are worth confirming rather than assuming.
The practical takeaway: if the annuity owner dies before income has started, there is usually money in an annuity for the named beneficiary. What the annuity will pay is the remaining value of the annuity or the total invested in the annuity, whichever is larger. Some contracts describe this as a guaranteed minimum death benefit.
What happens if you die during the payout phase
Once you annuitize, the rules change completely. The NAIC Buyer’s Guide is blunt about it. If you die after you begin to receive income payments, your chosen survivors “may not receive anything unless: 1) your annuity guarantees to pay out at least as much as you paid into the annuity, or 2) you chose a payout option that continues to make payments after your death.”
That is the sentence most families are surprised by. A person can pay a large premium, receive income for two years, die early, and leave nothing behind from that contract, because the payout option chosen at annuitization was life only. Nothing went wrong. The contract did what it was built to do.
Payments stop or continue based on a single election, and that election is generally irrevocable once income begins. It is chosen once, at the moment income starts, and it cannot usually be revisited later.
Annuity payout options and what each one does at death
Payout options go by different names at different insurers, but the structures are consistent. The NAIC guide groups the choices as payments for your lifetime, for the longer of your lifetime or your spouse’s lifetime, for a set time period, or for the longer of your lifetime or a set time period.
| Payout option | How the annuity pays you | What happens at death |
|---|---|---|
| Life only (straight life) | Payments for as long as you live. Highest monthly payment of the standard options. | Payments stop. Nothing generally passes to a beneficiary, no matter how little was paid out. |
| Life with period certain | Payments for life, with a guaranteed minimum number of years (often 10 or 20). | If you die inside the certain period, the beneficiary receives the remaining payments for the balance of that period. If you die after it, payments stop. |
| Joint and survivor | Payments for the longer of two lives, usually you and a spouse. | The surviving annuitant continues to receive payments for life, sometimes at a reduced percentage. Payments stop when both have died. |
| Cash refund | Payments for life, with a promise to return at least the premium paid. | The beneficiary receives a lump sum equal to the premium paid minus payments already made. |
| Installment refund | Payments for life, with the same premium-return promise paid out over time. | The beneficiary continues to receive the same periodic payments until the premium has been repaid, then payments stop. |
| Period certain only | Payments for a set number of years, not tied to your lifetime. | The beneficiary receives the remaining payments for the rest of the term. |
Every option that protects a beneficiary costs something. The insurer pays out over a longer expected period, so each payment is smaller. Life only produces the largest income and the smallest legacy. Joint and survivor produces the opposite. There is no better answer, only a trade you should make on purpose.
IRS Publication 575 describes the refund structure this way: a contract has a refund feature if payments are for life and “payments in the nature of a refund of the annuity’s cost will be made to your beneficiary or estate if all annuitants die before a stated amount or a stated number of payments are made.”
What annuity beneficiaries can do with the death benefit
A beneficiary who inherits a deferred annuity generally has choices, and those choices matter for taxes. A death benefit payout can be taken as a lump sum, as regular payments spread over a limited period, or by converting the remaining annuity value into a stream of annuity income over the beneficiary’s own life expectancy. Inherited annuities are handled differently for designated beneficiaries who are spouses than for everyone else, so the annuity type and the relationship both matter.
Federal tax law sets outside limits on how long an inherited annuity can stay in force after the annuity holder dies. Internal Revenue Code section 72(s) requires that if the holder dies before the annuity starting date, the entire interest generally be distributed within five years of death, with an exception for payments made over the beneficiary’s life or life expectancy that begin promptly. If the holder dies on or after the annuity starting date, the remaining interest must be distributed “at least as rapidly as under the method of distributions being used as of the date of his death.” The specific windows and elections in your contract are set by the insurer within those rules, so confirm the deadlines with the annuity company before choosing.
Spousal continuation
A surviving spouse who is the sole designated beneficiary gets an option no one else has. Section 72(s)(3) provides that where the designated beneficiary is the surviving spouse, the distribution rules are applied “by treating such spouse as the holder of such contract.” In practice this is called spousal continuation. Rather than taking the death benefit, the spouse steps into the contract, keeps it in force, keeps the tax deferral, and names new beneficiaries.
So yes, a spouse can inherit an annuity, and usually with the most flexibility available. Contracts have to offer the option and the paperwork has to be filed correctly, which is why the beneficiary designation naming the spouse individually, rather than a trust or the estate, matters so much.
Non-spouse beneficiaries
Children and other non-spouse beneficiaries cannot continue the contract as their own. They can typically take a lump sum, opt for periodic payments over a limited period, or elect payments over their life expectancy if the contract and the timing allow it. The annuity funds come out on a schedule, and the only real question is how fast.
Spreading payments out is often the reason to avoid a lump sum. A single large distribution stacks all of the taxable gain into one year and can push a beneficiary into a higher tax bracket. Periodic payments spread that same income across several years.
Different types of annuity beneficiaries: trusts, charities and estates
A beneficiary is a person in most cases, but not always. A trust, a charitable organization or the estate itself can be named. These designations can serve real planning purposes, and they also remove the life expectancy option, since a non-person has no life expectancy. Naming a trust as annuity beneficiary is a decision to make with an attorney before the fact, not a form to fill in casually.
Are annuity death benefits taxable to beneficiaries?
Generally, yes, on the gain. This is where inherited annuities differ sharply from inherited stocks or real estate, and where most people’s assumptions are wrong.
Inherited property usually receives a stepped-up basis. Internal Revenue Code section 1014 sets the basis of property acquired from a decedent at fair market value at the date of death. But section 1014(c) states that the step-up “shall not apply to property which constitutes a right to receive an item of income in respect of a decedent.” Annuity gain falls into that category. There is no step-up in basis, and the untaxed growth stays taxable.
That untaxed growth is income in respect of a decedent, or IRD. IRS Publication 559 explains that income in respect of a decedent is taxable income to the person who receives it, and that the character of the income carries through to the recipient. Annuity gain was ordinary income to the owner, so it is ordinary income to the beneficiary. It is not capital gain, and the lower long-term capital gains rates do not apply.
How much is taxable depends on the type of annuity. With non-qualified annuities, bought with after-tax dollars, only the earnings above the owner’s cost are taxable. With qualified annuities held inside a retirement account, distributions are usually fully taxable because nothing in the contract was taxed on the way in. IRS Publication 575 addresses the survivor side, noting that a single-sum distribution received because of the death of the owner or annuitant is generally taxable only to the extent it exceeds the unrecovered cost of the contract.
Publication 559 also describes an estate tax deduction available to a recipient for federal estate tax attributable to IRD included in the decedent’s gross estate. That is a genuinely valuable deduction and it is frequently missed. We are not tax advisors. Anyone who has inherited an annuity should take the contract and the Form 1099-R to a qualified tax professional before deciding how to take the money. For background on the owner’s side of this, see our overview of how annuities are taxed.
What happens if no beneficiary is named
If no beneficiary is named, or if the named beneficiary died first and no contingent beneficiary was listed, the death benefit typically defaults to the owner’s estate under the terms of the annuity contract.
That has two consequences. First, the money goes through probate instead of passing directly, which adds time, cost and public record. Second, the estate is not a person, so the life expectancy payout option disappears and the money generally has to come out faster. A designation that took five minutes to complete can cost the family months.
Three things prevent it:
- Name a contingent beneficiary. This is the single most common gap, and it costs nothing to fix.
- Confirm the designation after any major life event. Marriage, divorce, a birth, or the death of a named beneficiary.
- Request a written confirmation from the insurer. Do not rely on memory or on a copy of the original application. Ask the company what it currently has on file.
Do all annuities have a death benefit?
No. Deferred annuities in the accumulation phase almost always do. Income annuities that have already annuitized may not, depending entirely on the annuity payout option elected. A life only payout has no death benefit by design. That is what the higher payment amount is buying. Both the annuity type and the payout option affect the death benefit.
Some annuity products also offer enhanced death benefit riders, which raise the amount payable at death in exchange for an ongoing charge. Whether a rider is worth its cost depends on the contract and the situation, and the only way to know is to read the specific annuity terms of the contract you own.
What to review, and when
The useful work happens while the annuity owner is alive. A short review covers it:
- Confirm who is listed as owner, annuitant and beneficiary, and that the roles line up with your intent.
- Confirm a contingent beneficiary is named.
- Confirm which annuity payout option applies, and whether income has already started.
- Ask the insurer, in writing, what the contract pays at the death of the owner and at the death of the annuitant.
- Ask whether spousal continuation is available and what has to be filed to use it.
If you are the beneficiary and the death has already happened, do not rush the election. Contact the insurance company, ask for the death benefit options in writing along with the deadline for each, and speak with a tax professional before choosing. In most cases nothing forces a decision in the first week. Lifeworth Insurance Agency reviews existing contracts as part of our annuities work, including reading the payout and beneficiary provisions of a contract you already own.
Frequently asked questions about annuity death benefits
Can my wife or husband inherit my annuity?
Yes, if your spouse is named as beneficiary. A surviving spouse who is the sole designated beneficiary can usually elect spousal continuation and keep the contract in force in their own name, which preserves the tax deferral. If income payments have already started under a life only option, there may be nothing left to inherit, so the payout option matters as much as the designation.
Can my children inherit my annuity?
Yes, if they are named as beneficiaries. Children cannot continue the contract the way a spouse can. They generally choose between a lump sum, payments over a limited period, or payments over their own life expectancy where the contract allows it. Naming children individually rather than leaving the death benefit to your estate is what keeps those options open.
Do beneficiaries pay taxes on an inherited annuity?
Generally yes, on the gain. There is no step-up in basis, and the untaxed growth is taxed as ordinary income to whoever receives it. How much is taxable depends on whether the annuity is qualified or non-qualified and on the payout method chosen. Take this to a qualified tax professional.
What happens to an annuity if the annuitant dies but the owner is alive?
It depends on the annuity contract. Some contracts pay a death benefit at the annuitant’s death and terminate. Others allow the owner to name a new annuitant and continue. Because the outcome varies by insurer and product, confirm it with the company rather than assuming.
How much will a $100,000 annuity pay each month?
There is no single figure. The monthly amount depends on your age when payments start, whether one or two lives are covered, the interest rates in effect when you buy, and the payout option you select. The pattern is consistent, though: options that protect a beneficiary produce a lower monthly payment than a life only payout on the same premium, because the insurer expects to pay for longer.
What are the disadvantages of annuities?
Before buying an annuity, weigh these. The relevant ones at death are limited liquidity, surrender charges during the early contract years, ongoing costs for riders including enhanced death benefits, the loss of the step-up in basis for beneficiaries, and the fact that a life only payout leaves nothing behind. Guarantees also depend on the financial strength of the issuing insurer.
Disclosures
This article is general information and is not tax, legal or financial advice, and it is not a recommendation to buy, hold or surrender any annuity or other product. Annuity contract terms vary by insurer and by product, and the governing terms are those in your own contract. Questions about beneficiary taxation should go to a qualified tax professional, and questions about wills, trusts, probate and estate planning should go to a licensed attorney.
Annuity guarantees rest on the claims-paying ability of the issuing insurance company and are not FDIC insured. Sources cited include the U.S. Securities and Exchange Commission, the National Association of Insurance Commissioners, IRS Publication 575, IRS Publication 559, the SEC’s variable annuities publication, the NAIC Buyer’s Guide to Fixed Deferred Annuities, and Internal Revenue Code sections 72 and 1014.
Lifeworth Insurance Agency is a trade name of Lifeworth Financial Group LLC, National Producer Number 21228343, licensed in Florida.