Investors like annuity policies for a lot of reasons, but a new feature is adding even more certainty to these guaranteed products. Some companies are now offering a death benefit rider on their contracts to assure policy growth every year.
This optional feature allows your death benefit to grow each year by a guaranteed rate no matter how the contract performs. This is a great benefit for those who are most interested in leaving a legacy for their beneficiaries.
How Do Annuity Death Benefit Riders Work?
With this innovative rider, you will have a second annuity value at work. A sub-account is created that will increase for a guaranteed number of years – usually 10-15. At passing, this value is available to your beneficiaries in a lump-sum or over a longer period of time if desired. Most accounts are required to pay the full amount over 5 years, but a lump sum option will always be available
It’s common for these riders roll-up at a 5-7% rate each year. This could be a simple interest credit, while others will compound your interest. We help our clients compare all scenarios to see which plans offers the largest guaranteed death benefit.
Death benefit riders will have some stipulations. Most will only roll-up for a maximum of 15-20 years. And they are only available to annuitants/owners who are 75 years or younger. But in some cases, these contracts can stack policy interest growth on top of you rider. This means your death benefit value can be even higher than the guaranteed amount.
Do I Pay Taxes On My Annuity Death Benefit?
The short answer is, yes. Almost all annuity growth in a non-qualified account is taxable as ordinary income. And annuities that are in an IRA or 403(b) (referred to as qualified accounts) are taxable in full. But non-qualified accounts only tax the growth of the principal – whether it’s through a death benefit rider or regular interest and/or investment growth.
Life insurance is the only product that pays out income tax-free at passing. This is why a lot of consumers use life insurance for wealth transfer and estate planning. However, you cannot exchange an annuity account for a life insurance policy through a 1035 tax-free exchange.
Thus, if you already own an annuity with sizable gains, a death benefit rider might be your next best option for capturing those gains and then guaranteeing future growth for several more years to come.
Many of our clients also ask about probate. We don’t give legal advice, but generally speaking, annuities are not subject to the probate process. So long as your beneficiary status is up to date and in good order, probate is not required.
What If I Surrender The Annuity Before Passing?
The other account with these types of annuities is what’s called, the walkaway value. It might be more or less than the death benefit value, but in many cases it will be lower. If you surrender your annuity before passing, you’ll get the walkaway value and the death benefit will be void.
There is almost always a cost to add a death benefit rider to a contract. It’s usually close to 1% of the contract value each year. While this is deducted from your walkaway value, it does not decrease the value of your death benefit. Thus, it’s disadvantageous to surrender your contract before passing unless you simply have no other choice.
In other words, it’s unwise to spend 1% of your contract value each year for a rider that was not used. However, if the walkaway value outperformed the death benefit valu, then it might be a good idea to exchange your annuity for a new one. This is something you should speak to an experienced agent about before making an exchange.
Many of our clients are using the 1035 exchange rule to transfer, on a tax-free basis, their underperforming fixed and indexed annuities. The death benefit roll-up is a great way to rescue an old policy that might only be paying 2-3% each year. Guaranteed growth for your beneficiaries makes good sense in many cases.
Contact Us To Learn More About Your Annuity Options
Let’s face it: If you’ve ever shopped for annuities, you know there are many options. One size does not fit all. Some are designed for growth, others are for income, and still others can be used to account for long term care needs.
An annuity with a guaranteed death benefit is more designed for growth and wealth transfer. It might be more suitable for owners who do not intend on accessing their money, but are most interested in passing on the largest amount possible to their beneficiaries. No matter your needs, we can help. Contact us today to review your best options.