Many a married couple is going to be in for a surprise. When one of you dies, the annuity may not behave the way you think. These contracts are complicated, with lots of moving parts. Unless you buy right—and title the annuity correctly—you might not get all the benefits that you thought you paid for. Its even possible that the money invested in the annuity will bypass your spouse and go to your kids. A 2007 study by Advanced Sales Corporation, a variable- annuity research firm, found that more than one-third of VAs are titled incorrectly and could create serious problems for heirs. One of those VAs may be yours.
To get the inheritance questions right, it helps to know the parties to the contract:
- The contract owner—the person who buys the annuity (that’s you) and
chooses the annuitant and the beneficiaries. There can be joint owners, or the annuity can be owned by a trust.
- The annuitant—the person on whose life the future payments are based. You can be both the owner and the annuitant, or someone else can be the annuitant. When payouts are made, the annuitant’s life expectancy rules. If the owner dies, the annuitant’s beneficiaries collect.
- The beneficiary—the person or persons entitled to inherit the money contained in the annuity if the owner or annuitant dies.
What can go wrong? Try these examples:
- Say that you buy one of the hot, new annuities with minimum withdrawal benefits guaranteed for your single life. That’s the way that most annuities are sold. If you die, your spouse will get the value of the annuity (perhaps with a death benefit, depending on what the contract says). He or she will be able to keep the investment, letting it grow tax-deferred. But your spouse will probably not be able to continue the lifetime withdrawals that you signed up for. That may come as an unwelcome surprise.
A quick example may be helpful here. Say that a husband invests $100,000 in an annuity, with a guaranteed withdrawal of at least $5,000 a year for life. Then he dies. The wife inherits the underlying investment at whatever value the contract assigns. She can keep the annuity, exchange it for another one, or withdraw the money—whatever she wants. But she cannot continue to withdraw $5,000 a year for life unless the annuity benefit includes a spousal continuation option.
The husband may have thought that his wife would get that monthly withdrawal because he named her as beneficiary. But all that does is give her the right to the contract’s proceeds. Without a spousal continuation option, the wife is out of luck.
- Say that you buy an annuity, naming yourself as owner, your spouse as the annuitant, and your children as beneficiaries. If you die, the money invested in the annuity goes to your children, not your spouse. Some contracts dictate that if your spouse dies, the children get the annuity money right away. You lose the investment you made.
- Say that you buy the annuity, naming yourself as owner and your spouse as an annuitant. Then your spouse dies. In some contracts, the annuity has to be paid out to you. You can’t continue it as a tax-deferred investment.
- Say that you own an annuity and decide to put it into an irrevocable trust. To do so, you have to retitle it, making the trust the owner. This particular change of ownership triggers income taxes and has to be recorded as a taxable gift as well. (It’s safe, however, to put the annuity into a revocable, or living, trust.)
- Say that you buy an annuity in the name of your revocable trust, with the proceeds payable to the trust When you die, the trust pays out to your spouse. Your spouse will owe taxes on the money immediately. The investment cannot be continued tax-deferred.
These are only a few examples of the horrors that potentially await.
So how do you preserve the annuity’s options and proceeds tax-deferred?
If you want to be sure that your spouse inherits, both spouses should be named on the annuity as owners, as annuitants, and as primary beneficiaries. Your children or other heirs should be designated as secondary beneficiaries if both of you die.
If you buy an annuity with guaranteed lifetime withdrawal benefits and want your spouse to have those benefits too, get a contract that allows for spousal continuation.
Don’t mess around with putting annuities into trusts without talking to a lawyer who specializes in the field.
On everyday transactions, question the salesperson carefully:
- What happens if I die or if my spouse dies?
- Can the annuity investment be continued?
- If not, who gets the proceeds? When are taxes paid?
- What do we need to do to get the money to the proper beneficiary?
- Write down exactly who should receive the annuity’s proceeds if you die, and what should happen to any lifetime withdrawal benefits.
Ask the salesperson to run it through the insurance company’s legal department, so you’ll know exactly how to fill out the beneficiary forms. Don’t take the salesperson’s word on what to do. He or she might have the right answer, but you can’t be sure and should have written confirmation from the company. Don’t buy if the salesperson balks.
Laura Bushnell is Editor in Chief for National Review Brand Foundation of Consumer Updates and based in Boston. Previously, she held senior VP level positions in corporate finance and consumer financial planning firms.