Annuity death benefit proceeds are taxable in the hands of the recipient. When the beneficiary is a surviving spouse, he or she can take steps to defer paying taxes on the amount received.
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In a case where the beneficiary is someone other than a spouse, the recipient will pay income taxes on the amount received from the annuity. The funds from the annuity may also be subject to estates taxes, depending on who the named beneficiary is.
An annuity is a financial product that provides a certain level of income and may be used as part of a retirement plan. An individual buys the annuity with either a lump sum of cash or by making a series of deposits over a period of time. The funds in the annuity are invested and the money grows over time until the plan starts paying out a benefit.
The annuity may pay out funds for a certain time or provide a guaranteed payout for the purchaser’s (annuitant’s) life.
The details of the plan are contained in the contract the annuitant signs with the insurance company.
Annuity Death Benefit
When the individual who owns an annuity dies, the funds in the plan, or the death benefits from annuities, must be dealt with. Often, the insurance company is the beneficiary. However, some plans include a death benefit that is paid to the beneficiary chosen by the annuitant when the plan is set up. The beneficiary may be the annuitant’s spouse, child or any other individual the annuitant chooses.
The death proceeds from annuities may be all the funds remaining in the annuitant’s investment account as of the date of death or the amount of all deposits less any withdrawals made by the annuitant during his or her lifetime. Some annuities offer a guaranteed death benefit for the beneficiary that is not based on the amount held in the annuitant’s investment account. Customers who choose this option need to understand that they will be paying higher fees to provide for their beneficiaries in this manner.
Income Tax and Annuities
So are death benefits from an annuity taxable? The funds deposited into an annuity grow on a tax-free basis until they are withdrawn. The payments received by the annuitant during his or her lifetime are taxed at his or her normal tax rate.
When the annuitant dies, the death benefit is handled differently depending on whom the beneficiary is and the insurance company holding it. As long as the death benefit remains inside an annuity, it is not taxable. The annuitant’s surviving spouse may be able to roll the death benefit into an annuity in his or her name and the funds will continue to grow on a tax-free basis. Some insurance companies require the surviving spouse to choose between receiving the death benefit directly and transferring the funds into an annuity.
If the surviving spouse elects to receive the death benefit directly, he or she will pay income tax on the difference between the death benefit and the amount invested in the annuity (less any withdrawals made from the plan). In most cases, the money in the annuity would not be included in the estate for tax purposes.
When the Beneficiary is Not a Spouse
In a situation where the beneficiary selected for the annuity is not a spouse, the funds in the plan are taxable to the recipient at his or her normal tax rate. Rather than receiving the money as a lump sum, the recipient may wish to receive payments over time to spread out the tax liability. The value of the annuity is also included in the annuitant’s estate for tax purposes and estate taxes will be paid on this amount.
Before buying an annuity, an individual needs to understand exactly what he or she is getting. The terms of the investment will vary, depending on the insurance company offering the investment, and the customer needs to review them in detail before making a decision about whether to buy one.
Different Types of Annuity
Some annuities may offer a death benefit, but the amount payable depends on the plan selected. To make the best decision about which type of annuity to choose, consulting a financial planner and an attorney is recommended. The attorney can discuss how the proceeds from the death benefit are treated when the annuitant dies and offer suggestions for how to avoid paying more tax than necessary on these funds.
Since the death benefit from an annuity is taxable, the account holder may wish to consider buying a life insurance policy that will cover the estimated amount of tax payable on these funds. That way, the beneficiary will be able to receive a higher amount for his or her own use. Enter your zip code and get FREE online annuity quotes right now!