A person who buys a tax-deferred annuity must name his beneficiary, his annuitant, and his annuity account’s owner. It is the owner who makes the initial fund investment and decides when to start the payouts. He also has the right to change the beneficiary anytime he wishes. The life of the annuitant forms the basis in determining how much the payouts will be while the beneficiary will receive the payouts in case the annuitant dies. In general, the annuitant and the owner are one and the same person. If these are two different persons and anyone of them dies, the beneficiary will have to pay a huge income tax on his share of the payouts.
If the annuity is non-qualified, meaning that it is not invested in a retirement plan or individual retirement account, the beneficiary will have to pay ordinary income tax on the annuity account’s capital gains. However, if the contract is annuitized, a part of each payout may be tax-free. This is possible by computing the exclusion ratio and divides it by the tax liability over time.
A spousal beneficiary is a surviving spouse, who can be the new owner in case the annuitant dies. Income taxes can be deferred until the spouse dies. A non-spousal beneficiary can’t assume ownership of the annuity contract if the annuitant dies. Any benefits from the fund must be taken within 5 years but it is possible to annuitize the annuity within 2 months of the annuitant’s death. Payouts will begin within one year of the annuitant’s death.
If both spouses own the annuity for Medicaid planning purposes, the spouse who isn’t in the nursing home can annuitize the contract based on the life expectancy of the stay-at-home spouse. The annuity is exempted when determining whether the spouse is qualified for Medicaid. However, if any of the spouses dies before the annuitization of the contract, the Internal Revenue Service may require the beneficiary to withdraw the proceeds upon the death of the owner. The beneficiary will also have to pay the taxes while the surviving spouse won’t receive anything.
Some financial advisors suggest that the owner names a younger annuitant so that the payouts will be stretched out as well as the income tax liability for a longer period. However, if the younger annuitant dies before the owner, the beneficiary must withdraw the money from the annuity fund. For example, the husband is the owner, the wife is the beneficiary, and the son is the annuitant. If the annuitant dies, the beneficiary has to receive the proceeds and pay the necessary income tax like a non-spousal beneficiary. However, if the owner dies, the beneficiary can assume the annuity and continue to take advantage of tax deferral benefits for the annuity. If the spouse remarries, the new spouse must be named as beneficiary. If the original spouse dies, the new spouse can assume the annuity and continue the tax deferral.
If the owner of the annuity names a beneficiary who is not his spouse but maintains his son as his annuitant, the sister must withdraw the money from the annuity fund like the a non-spousal beneficiary in case the owner of the annuity dies.
If the person is the annuity’s owner, he must keep a record of his contributions. He must also check the annuity’s beneficiary, annuitant, and owner. It is best to review the annuity contract for any interpretation of the provisions on beneficiary distribution. There may be surrender charges if the non-annuitant owner dies but no charges when the annuitant dies. In addition, there may be a waiver on surrender charges if the annuitant, who isn’t the annuity’s owner, enters a nursing home.
If the person is the annuity’s beneficiary, he must check with the insurance company how much payouts he is entitled to receive under various payout systems like 10-year, 20-year, and lifetime options. He can also ask the insurer for the exclusion ratios so that he can find out about the after-tax consequences. He then compares the amount with the lump sum he may receive from the annuity. In addition, it is possible to claim a deduction for the estate tax equal to the value of the annuity fund.