Death Benefits in Annuity Contracts
One commonly overlooked aspect of annuities is the guaranteed death benefit they offer. As discussed above, when the contract is annuitized (i.e., changes from the accumulation phase to the annuity phase) the contractholder may select a number of different payout options. With the exception of the straight life payout, all of the lifetime payout options include provide for continuing annuity payments (or in the case of cash or unit refund payouts, a lump sum) to a designated beneficiary.
But what happens if the annuitant dies during the accumulation phase? All annuities provide for payment of the annuity's accumulated value to a beneficiary. In the case of fixed annuities, the amount payable to the beneficiary is simply the premium payments paid into the contract plus the interest credited to the contract, less any withdrawals the contractholder may have taken. In a fixed annuity, the beneficiary simply receives the "current value" of the contract.
In the case of variable annuities, the basic death benefit is the greater of the owner's investment in the contract (less any withdrawals) or the current value of the sub-account(s). Remember that in a variable annuity the value of the account is based on investments in the separate (or sub) account, and this value may go up or down. The basic death benefit of a variable annuity guarantees that a beneficiary will receive, at a minimum, the monies invested in the account and could receive far more, if the sub-account values increased. This is a comforting feature for investors wishing to conserve the principal they may leave to their heirs. (It also explains why, in a bear market, investors are more likely to liquidate shares of mutual funds that do not have a death benefit feature, rather than variable annuity contracts that do provide this added measure of protection.) Some variable annuity contracts offer the investor the option of purchasing enhanced death benefits (these are discussed below).
The death benefit feature of an equity indexed annuity is less clear. Some contracts will provide beneficiaries with return of the full investment plus whatever interest has been credited to the contract to date; others will return the investment plus the minimum guaranteed rate (but not the higher index rate). Each EIC is different, so it is important to read the fine print carefully.
Most annuity contracts, in the event of death, will waive any surrender charges that may apply. It is important to note that in all annuities fixed, indexed, or variable the minimum death benefit is designed to simply conserve the initial investment for beneficiaries. In this way annuities do afford some protection for beneficiaries, but if the goal is to maximize the amount left to beneficiaries, life insurance, not annuities, offer the greatest protection.
The tax treatment of annuity death benefits depends on a number of factors -- whether the death benefits are triggered by the death of the contractholder or the annuitant, how the benefit is paid to the beneficiary, the relationship of the beneficiary to the deceased, and whether the beneficiary is a "natural person". These factors, and their implications, will be explored in greater detail in later chapters.
Remember, the guaranteed minimum death benefits are payable only if death occurs during the accumulation phase. Once the contract is annuitized, payments will continue according to the method selected by the contractholder (which may or may not include eventual payments to a beneficiary, depending on the selected payout option.)