Variable Annuity Death Benefit

(Retirement planning is not just about retirement)

Reviewer: Jeffrey Green Written by Jeffrey Green
Reviewer: Jeffrey Green
Written by Jeffrey Green

Jeff Green has held a variety of sales and management roles at life insurance companies, Wall street firms, and distribution organizations over his 40-year career.  He was previously Finra 7,24,66 registered and held life insurance licenses in multiple states. He is a graduate of Stony Brook University.

Reviewed by Neel Lane
Reviewed by Neel Lane

Neel Lane is an independent contract paralegal who specializes in Medicaid and VA benefits. He helps people access and maximize the benefits that they're entitled to. He has over 30 years of experience in this area.

Variable annuities death benefit

Variable annuities are designed to do two things: accumulate money for retirement and create lifetime retirement income. Pretty simple, isn’t it? There is more to the story though. Part of smart retirement planning is making sure you know where the money goes after your death. All annuities, including variable, have death benefits. That’s part of the reason they are considered to be insurance and receive favorable tax treatment. 

Have some  questions about annuities? Independent insurance agents are experts when it comes to annuities. They’ll help guide you through all your options, weigh the good and the bad, and even see you through it all from start to signature.

Inheriting a Variable Annuity

Non-qualified annuities are typically inherited as a death benefit paid to a named beneficiary. The death benefits are includable in the estate of the owner. The big picture is that any proceeds in excess of the contributions made by the owner are taxable to the beneficiary.

When you die makes a difference. Variable annuity death benefits after annuitization are determined by the income option that the owner selected. Beneficiaries have more options available if the owner dies while the annuity is still accumulating money. Whatever option the beneficiary selects dictates when the income tax is paid. 

Qualified variable annuities follow the rules of inherited retirement plans. Generally, all proceeds from an inherited retirement plan are 100% taxable.

When you inherit a variable annuity, your relationship to the annuity owner makes a difference. Spouses have options that other beneficiaries such children, for example, don’t have.

All variable annuity death benefits  pass directly to the named beneficiary. The proceeds don't  go through the probate court first.

Variable Annuity Guaranteed Death Benefit

Most variable annuities on the market today have a guaranteed minimum death benefit equal to the larger of purchase payments made, or the account value. There is no additional charge for the minimum guaranteed death benefit. The Mortality and Expense charge (M&E)  that is part of every variable annuity covers the cost of the death benefit.  A typical M&E charge is 1.25% of the account value. Of course the charge can be higher or lower depending on the insurance company and product.

Remember, the value of a variable annuity rises and falls with the value of the underlying investments selected. It is possible for the account value to be less than the payments made. That’s why the minimum guaranteed death benefit is a valuable feature.

Variable Annuity Death Benefit Riders

Most variable annuities offer enhanced death benefits as optional riders at an additional cost. Benefit bases are used to track the value of the enhanced death benefit. Benefit bases usually start out at the amount of the purchase payment. The death benefit increases from time to time by a formula, or is equal to the account value, whichever is larger. The rider is often called a rollup death benefit. The cost of the rider is a percentage of the death benefit, commonly .65% or more.

Why pay for an enhanced death benefit? Even though the value of the underlying investments can be higher or lower than the purchase payment, the beneficiary will always receive a death benefit that has increased over time.

Tax-Free Variable Annuity Death Benefits

Non-Qualified Annuities: Tax-free death benefits are limited by the total contributions made to the annuity by the owner. Beneficiaries don't pay tax, however, until they have received an amount that is equal to the total contributions. Any withdrawals made by the owner treated as principal will be subtracted from the calculation.

Qualified Annuities: Taxes on qualified annuities follow the rules of inherited IRAs and retirement plans. Death benefits are fully taxable. It's just a question of when the tax gets paid.


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Taxable  Death Benefits: Non-Qualified Variable Annuities

Non-Qualified Annuities: Uncle Sam doesn’t want to let the proceeds sit in a tax-deferred account forever. The rules are that annuity death benefits must be distributed at the death of the owner. If you are a surviving spouse, you can take ownership of the annuity, including any riders and death benefits within one year of your spouse's death. There is no income tax due until distributions begin.

Other options for beneficiaries are:

Five-year deferral: Take up to five years from the owner's death to withdraw the inheritance. Taxes are not due until withdrawals are taken. The money will continue to accumulate tax deferred.

Lump-sum distribution: Taxes are due in the year taken.

Stretch distribution: The distribution is taken as a percentage over time. Taxes are due as you receive the payments. The distributions may be partially or fully taxable.

Annuitization: The assets are converted into income. The payments will be partially taxable according to exclusion ratio.

Your beneficiary can decide what option to take based on their immediate needs and tax situation.

Variable Annuity Death Benefits in IRAs and Qualified Plans

Death benefits of variable annuities that are in IRAs and qualified plans (qualified variable annuities) follow the rules for inherited IRAs and qualified plans.

The SECURE act passed by Congress and signed by the president in 2019 takes effect January 1, 2020. The SECURE act, among other things, changed the age that minimum required distributions begin from age 70 1/2 to age 72. The SECURE act also eliminated stretch IRAs for non-spouse beneficiaries. Non spouse beneficiaries must distribute the entire inherited IRA within ten years.

A surviving spouse has a lot of flexibility when they inherit a retirement plan. The options are different when the owner dies before age 72 (the age required minimum distributions begin), or after age 72.

Distribution options for ROTH plans are the same as the options for traditional plans when the owner dies before age 72. The chart below summarizes beneficiary options for inherited IRAs and qualified plans.


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Withdrawals and Death Benefits

Insurance companies use one of two methods to reduce the death benefit by the withdrawal: dollar for dollar and proportional. When the death benefit equals the account value, as it often does, the calculation method makes no difference.

The dollar for dollar method is very straightforward. The death benefit is reduced by the amount of the withdrawal. The proportional method reduces the death benefit by the percentage of  the account value the withdrawal represents.

When the death benefit is greater than the account value, then the proportional method will result in a lower death benefit paid to the beneficiary. Remember, the minimum death benefit of a variable annuity is usually the higher of the account value or the purchase payment. If you are unfortunate enough to die in a down market (think 2008 to 2009), or you purchased an enhanced death benefit rider, your death benefit could well be above the account value. That’s why it’s important to know what method the insurance company uses.

Why Choose an Independent Insurance Agent?

Variable annuities can be a valuable part of your retirement plan. They're a complicated mix of insurance and investments, and they're not for everyone. 

Independent insurance agents help folks just like you everyday make smart decisions. They can help you decide if a variable annuity is right for you. 

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Required Minimum Distributions for IRA Beneficiaries IRS.Gov

Key SECURE Act Provisions and Effective Dates


IRS publication 575

Advisors Guide To Annuities Olsen