You bought your annuity because of its competitive return, tax-deferral, and safety. And you probably spent time with your advisor or annuity agent reviewing several options and having various types of annuities explained. But how much thought did you give as to who should be the "parties" to your annuity. If you're not sure why you made the choice you made, now may be a good time to dust off that annuity contract and take a closer look. Once you see annuities explained in detail, you may be surprised at what you did not know.
It's likely that until you have encountered this post, you have never had annuities explained as to who should be named as each 'party.' There are four parties to an annuity contract: the insurance company, the owner, the annuitant, and the beneficiary. The contract can be owner-driven, annuitant-driven, or a combination of both. With an owner-driven annuity, death benefits are paid when the owner dies. The owner is typically the person who made the annuity investment – it's their money.
And an annuitant-driven contract will pay the beneficiaries upon the death of the annuitant. The annuitant is usually the same as the owner but not always. A scenario is given below. In either type, owner-driven or annuitant-driven annuity, the funds must be distributed when the owner dies, which may present undesirable consequences as you shall learn as we progress with annuities explained.
Why does it matter? Here you have the mechanics of annuities explained as few understand, even the agents that sell annuities.
Let's say that you have an annuitant-driven annuity. You and your spouse are joint owners (as an example); your spouse is the annuitant, and your two children (both under 59½) are the beneficiaries. What would happen if your spouse dies? You might think that you'll keep control of the money and everything will stay the same. Wrong! The kids will get it-all of it because in an annuitant-driven annuity, when the annuitant dies, the annuitant's beneficiaries get the proceeds. Then to make bad things worse, you'll pay income tax on your part of the tax-deferred growth and possibly gift tax on any amount over $13,000 that you pass to each of your children. Plus your children won't be too happy either because they'll owe income tax on your spouse's portion of the annuity's gain.
What? No one explained annuities to you before? As we said, most people in the annuity business don't often understand the tax and inheritance aspects.
So how is your annuity contract structured? It should be arranged in a way that can result in the least amount of taxes and penalties on the death benefit, plus allow maximum flexibility on those distributions to the desired beneficiaries. As a general rule, when we explain annuities, we always recommend that the owner and the annuitant are the same person.
Now that you have annuities explained, there you have some issues you may need to discuss with your annuity agent.