How Are Annuities Used in Estate Planning?

May 1, 2019

A variable annuity, while not designed as an estate planning tool, does offer some benefits in this area. An annuity avoids probate, provides flexibility when passing on assets to heirs, and can potentially increase the likelihood of leaving a larger estate in some circumstances.

Variable Annuities Avoid Probate—A variable annuity is a contract between an owner and an insurance company. The contract requires that a beneficiary be named. When a contract owner dies, there is a payout directly to the beneficiary. As a result, the annuity assets do not go through the probate process.

Probate, or the distribution of a deceased’s assets via the court system, can be costly and time consuming. There are attorney fees, court costs, and administrative expenses, and the process slows the distribution of proceeds. Plus, probate proceedings are a matter of public record. Assets held in a variable annuity bypass this process and go directly to the beneficiary.

Variable annuity proceeds will be subject to probate only if the estate is named as beneficiary, when no beneficiary is named, or when a death benefit is disclaimed by the beneficiary and no contingent beneficiary is named.

The Restricted Beneficiary Option Offers Advantages

Naming a restricted beneficiary is a unique option available to an annuity owner. This enables the owner to direct the amount, frequency, and timing of the distributions. Choosing the restricted beneficiary option provides the added benefit of continued tax-deferral over the life expectancy of the beneficiary. The individuals named as beneficiaries get payouts over a period of time, during which the proceeds grow tax deferred and compound over time, potentially providing many times more from the investment than a lump-sum payout. An individual must be directly named as beneficiary to take advantage of this treatment. It is necessary to complete paperwork instructing the insurer how to distribute the death benefit proceeds.

A Variable Annuity Offers a Death Benefit

Most variable annuities offer a death benefit, which guarantees that if the annuity owner dies at a time when the market value is less than the money they put into it because of market declines, the beneficiaries will get the original purchase amount, minus any withdrawals that may have made. In some cases, the beneficiaries can receive more than was invested via an enhanced death benefit, which steps up the death benefit payout based on positive performance of the investments, or a fixed percentage increase annually in the promised death benefit payout. A beneficiary must often recognize income and pay taxes on the earnings portion of the death benefit payout. The earnings enhancement death benefit can help offset a higher tax bill. Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values.

Overall, annuities are not designed as estate planning tools. But these products can help a person protect his or her financial security and can often lead to a larger estate if an annuity is invested in a retirement portfolio.

If you are considering an annuity purchase, be sure to fill out our quote form to research suitable options available.

The materials are for informational purposes only and not for the purpose of providing legal advice.