Annuities and Death

One thing to consider with annuities is that if you don’t have any stipulations in place, your pension funds return to your provider upon your death. For people who want to pass on their inheritances, they may have to resort to riders (attached benefits that you can add to some policies).

We often get asked about these annuity death benefit options, as well as what happens to an annuity when they die.

In this article, we’ll be looking at the following:

What happens to an annuity when the annuitant dies?

An annuity does not form part of a person’s estate. It is money invested with an institution in exchange for an income for a period of time or until death.

So, the funds don’t return to the annuity provider when the holder passes away. It’s not unlike like pre-paying on a mobile phone deal. You buy 100 hours of talk time, for example. Whether you use all 100 hours or not, you don’t get your money back – and it’s the same concept with annuities.

You can, however, make arrangements before taking out an annuity to ensure that your income goes to a nominated beneficiary.

How to pass on your annuity to your beneficiary

If you want to take out an annuity with death benefits, many insurance providers can offer you a product with features that may help you pass your remaining funds to your beneficiaries. Products with these features include…

Joint life with last survivor annuity

A joint survivor annuity is an annuity where you (the annuitant) nominates a beneficiary (e.g. spouse, partner, family member etc) to receive your annuity after you pass away, and the payments will continue as long as either person is alive. The annuity holder can also opt to give a remaining portion to a third-party beneficiary.

Value protected annuity

This is also referred to as annuity protection. You buy this feature to ensure your remaining funds revert to your nominees after your death.

For example, if you bought a fixed-term annuity for £30,000 and were awarded only £20,000 before you died, the provider would give your nominated beneficiaries the remaining £10,000.

Guaranteed term

This option allows you to buy an annuity for a guaranteed amount of time, anywhere from one to 10 years. Some providers may expand your annuity to a 30-year term. The longer your term, the less income you receive each year, but more may be paid out overall. If you die mid-term, your nominated beneficiaries get the remaining funds.

For example, if you exchange £100,000 for a guaranteed term annuity and you choose a five-year term, your net annual income would be £5,110, and the total amount received at the end is £25,550. If you set your term for 30 years, you could receive £4,345 per annum, though you may get £130,350 in total.

Will my annuity be taxed after I pass away?

Your annuity may be taxed once it goes to your chosen beneficiaries, though it depends on how old you are when you pass away.

• Before age 75: Your designated beneficiaries receive your leftover annuity, usually tax-free.
• Age 75 and over: Your beneficiaries will pay income tax on continuing annuities. Lump sum or income payments will be taxed at the beneficiary’s marginal rate of tax,  so recipients who are basic rate taxpayers pay 20%, higher rate payers are charged 40%, and additional rate individuals pay 45%.

Pension schemes and annuity death claims

Annuities are policies bought with defined contribution pensions where both you and your employer contribute to your pension funds.

Defined benefit schemes, on the other hand, are solely stocked by  your employer. Some defined benefit plans also carry scheme pensions, where the member is given the chance to buy a lifetime annuity. If they doe so and then die, regardless of at which age, the recipients pay tax at their marginal rate on all inheritance received.

If you’re uncertain whether you have a scheme pension, make an enquiry.

Annuity death benefits: How do your beneficiaries receive the annuity?

Most insurance companies use the following process to pass on annuities (or other assets):

• They contact the deceased’s legal personal representative, usually the person named as executor in the deceased’s will.
• If the annuity is executed by a trust, payment is made to the trustees or to a solicitor nominated by all the trustees.
• Payment is made according to the scheme’s provisions, so if the deceased chose an uneven amount to be distributed among four adult children for a limited amount of years, the scheme administrator or trustee will deliver that payment according to those rules.
• Most claims are paid within 10 business days.

If the deceased died outside the UK, there are certain rules his dependents must follow to file a Grant of Representation, or to prove that they died in order to receive the funds. Please contact us and we will tell you what to do.

How are annuity death benefits passed on to beneficiaries?

Beneficiaries can receive their inheritance in one of three ways:

• Lump sum distribution – beneficiaries receive the annuity as a lump sum amount.
• Phased payments – beneficiaries receive certain designated payments stretched out over their lives
• Five-year rule – beneficiaries can either withdraw annuity income during a five-year period or withdraw the entire annuity sum at the end of the term, in its fifth year.

Beneficiaries who happen to be surviving spouses can also choose whether they wish to claim control over the annuity after death as the new owner and/ or new annuitant.

Uncertain on your annuity death options? Make an enquiry to be referred to an independent pensions advisor who can help.

Note: Annuity owners and annuitants are not always one and the same. The annuity owner is the person who controls the annuity. They can designate beneficiaries, sell the annuity, create and control its terms and so forth.  The annuitant, meanwhile, is the person who benefits – receives income – from that annuity after death.

Setting up an annuity trust for your beneficiary

Dependents who receive your funds if you’ve passed away after age 75, will have to pay tax on income withdrawal. Depending on their tax brackets, they may have to pay hundreds of pounds.

A trust can help you control those assets, so tax and income is distributed and utilised efficiently.

The risks of the trust are that:

• You would need to pay for legal advice and service
• Money in the trust is taxed differently than in the pension and your investment may be less tax-efficient.

On the other hand, the trust can give you more control on managing your leftover annuity after you die, prevents misuse of funds, and saves your dependents from the trouble and expense of managing them.

The types of trusts for annuity death benefits

The kind of trust you choose depends on what you want it to do. Some are more complex and therefore more expensive than others. Here are some options you may wish to consider:

• Bare trust. This is the simplest kind of trust. The beneficiary receives your annuity once they turn 18.
• Interest in possession trust.  The beneficiary can get income from that trust but has no claim to the underlying annuity. That underlying annuity can then pass on to the children.
• Discretionary trust. This is where the trustees are given absolute decision-making powers on how to invest and distribute the funds. For instance, you could nominate your parents as the trustees, giving them the power of control on how to divide the assets between your children.
• Mixed trust. This combines elements from different kinds of trusts. For example, you can combine it with the features of the discretionary trust where parents have power of control over their children. Once they reach 18 (per the bare trust), your children receive the funds.
• Special needs trust. This is for a vulnerable person, say a child with special needs.  You’re tax exempt on the income and profits from this trust
• Non-resident trust. The trustees reside outside the UK. The trustees may pay less or no tax on income from the trust.

How to set up a trust for your annuity beneficiary

Make sure you cover these three things:

• Specify the kind of annuity you’re holding in the trust with all relevant details
• Be specific when you designate your trustees and beneficiaries. You can choose multiple trustees if you wish
• Specify when the trust becomes active. Is it immediately, or after you die?

Trusts are often a viable option for those with an immediate needs annuity, which is typically converted into an immediate lump sum of cash for a relative’s residential, hospice or nursing care. The annuity is handed directly to the care provider and is exempt from tax.

Money held in trusts can also be useful for deferred annuities, where you decide to put off your annuity for a later time. Such annuities are typically tagged to the immediate needs annuity, where the estate pays for, say, the first two years of the patient’s nursing care, while the annuity holder defers to pay subsequent long-term costs. Meanwhile, the holder expects the patient to live no longer than two years.

How to handle annuity beneficiary designations

Although naming beneficiaries may seem like a no-brainer, there are many factors that you may wish to consider to ensure that your annuity goes to the right people:

Know the basics.

You can name almost anyone or anything your beneficiary, with the exception of children under 18. This includes individuals (outside of your family, too) as well as entities, organisations, charities, or even animals that you want to protect. You will need an executor or administrator to ensure your funds get deployed correctly

Familiarise yourself with your beneficiaries.

Your nominated beneficiaries can override  aspects of your will. For example, if you wanted your 16-year old daughter to use a percentage of your joint-life annuity for her education, and you nominate your brother as the designated beneficiary, the brother can override that part of the will, if he chooses.

Be specific in how you want your money allocated.

Your designated beneficiaries may be reliable, but unless they know precisely how you want your assets distributed, they may make an error.

Most annuity beneficiary designation forms allow you to name multiple primary and contingent beneficiaries and to specify the percentage of assets you’d like each person to receive after you pass away.

Consider the tax ramifications.

Anyone other than your spouse will have to make mandatory annuity withdrawals and add tax on that income. In the case of your spouse, they can roll over your assets into their own pension policy and won’t have to pay tax until they choose to withdraw annuity income. If your beneficiary is a charity, charity directors are exempt from tax on your annuity.

Furthermore, if your spouse was not living in the UK after your passing but you had been, your spouse could receive a capped £55,000 tax exemption from your annuity benefits.

Also, keep inheritance taxes in mind. If you designate anyone other than your spouse as your beneficiary, they may have to pay inheritance taxes on your benefits. This is because estate that exceeds a certain value incurs tax. The value of your annuity may add to their own, which may result in their paying an unwanted hefty inheritance tax.

Special needs dependents

If you have a dependent with special needs, they may be unable to manage your estate. An annuity income, particularly if large, could affect their government benefits. Make an enquiry to discuss this further with one of the experts we work with.

Keep your annuity beneficiary designations up-to-date

Your workplace pension plans may change and some designated beneficiaries on the old plan may not be able to transfer to the new, so it’s always best to keep on top of your designations

Additionally, major life events such as marriage, birth, or the death of a nominated beneficiary may affect your designations.

Speak to an annuity death benefits advisor

If you want more information on what happens to your annuity after you die, or want an expert to talk you through your annuity death benefit options, call us on 0808 189 0463 or make an enquiry online.