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Annuity Beneficiaries: What You Need to Know

Key steps for beneficiaries of annuity contracts:

  1. Request death claim forms from the issuing insurance company
  2. Discuss your goals regarding the assets
  3. Consult with your Stifel Financial Advisor to determine all available options

Why do we need the issuing insurance company’s death claim forms?

In order to understand the options available to you as a beneficiary, you must have the death claim forms from the insurance carrier. These forms describe the options that are available on that specific annuity contract. While theIRS code provides guidance on the options an insurance carrier can offer (see Appendix A below), it does not force insurance carriers to offer every possible option. Therefore, the only definitive resource for the available options isthe insurance carrier’s death claim form.

Appendix A – IRS-Allowed Annuity Death Claim Options
Annuity Death Claim Payout Options When Income Taxes Need to Be Paid With Each Option
(Taxable amount of the distribution may be affected by the amount of cost basis in a non-qualified contract)
Lump Sum The beneficiary will owe income taxes on the entire death claim amount distributed.
Five-Year Rule The beneficiary will owe income taxes on the amount distributed from the death claim each year.
Annuitization The person who receives the annuity payment will owe income taxes on the taxable portion of each payment.
Stretch The beneficial owner of the “stretch” contract will be forced to take “stretch” required minimum distributions beginning immediately but will only owe income taxes on the amount distributed from the contract each year.

Note: For qualified contracts, the ability to “stretch” based on life expectancy may be limited under the SECURE Act. In most cases, the “stretch” will be limited to a 10-year rule.
Spousal Continuation Upon continuation of the contract, the spouse will continue tax deferral on contract earnings and will owe income taxes only when funds are distributed from the annuity.

How do the death claim options differ?

As you can see in Appendix A, the main difference between the various death claim options is when the beneficiaries are going to incur an income tax liability. Some options force beneficiaries to incur the entire income tax liability in the near term (lump-sum or five-year rule), whereas others allow an extension of that liability over a much longer period of time (annuitization and stretch). There is no way to completely eliminate the income tax liability associated with annuity death claims; however, the “stretch” option can often be exchanged to another annuity contract on a tax-free basis in order to reduce expenses while maintaining tax-deferred growth. Keep in mind that rarely do insurance carriers allow beneficiaries to put any lifetime income guarantees on “stretched” assets, so the only financial benefit to an exchange would typically be a reduction in contract expenses.

Does it matter if the funds are qualified versus non-qualified?

Generally, annuities in qualified accounts and non-qualified accounts will have the same death claim options. The key considerations still center on the taxation of the death claim assets. With qualified funds, beneficiaries will pay taxes on 100% of the proceeds, whereas with non-qualified funds, some cost basis may be returned to the beneficiaries income tax-free. When looking at the “stretch” option, we generally see IRA annuity beneficiaries moving those assets out of annuities and into a Stifel Beneficiary IRA account, especially with changes due to the SECURE Act introducing the 10-year rule that would limit most beneficiaries from stretching over their life expectancy. However, non-qualified contracts do not have the same “stretch” limitations and may offer an opportunity to explore doing an exchange to a new contract in order to reduce expenses while maintaining tax-deferred growth.

Annuities are not insured by the FDIC or any other government agency. Taxes will be due upon withdrawal, and withdrawals prior to age 59 ½ are subject to a 10% penalty. Withdrawals prior to the end of the guaranteed period are subject to a surrender charge and market value adjustment. Guarantees are based on the claims-paying ability of the insurance company. Please note that you should consider carefully the fees and charges of features associated with new annuity contracts against the costs of existing contracts. Also, you may be assessed a surrender charge for terminating an existing contract while also starting a surrender period for the new contract. Stifel does not provide legal or tax advice. You should consult with your legal and tax advisors regarding your particular situation.