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Annuity death benefits can be a good deal but only if you use them. There are some serious limitations to death benefits that you should be aware of. In particular, you should realize that these benefits are not always an alternative to life insurance.
Types of Annuity Death Benefits
There are actually two types of death benefits for annuities out there. Some plans come with just kind of benefit while others come with both.
The first benefit is the straight benefit which seem simply pays whatever funds remain in the plan to an heir if the beneficiary dies. If Jake was the beneficiary of $40,000 contract of which $22,000 had been paid out and he died. His heir would receive the $18,000 that remained in the plan.
The second is the life insurance benefit which is actually a life insurance policy attached to the plan. This benefit is designed to insure that will be some money available to cover funeral and other expenses if all the funds in the plan are exhausted. This is a standard feature on some contracts and on plans from some insurance companies.
Drawbacks to Death Benefits
The main drawback to a standard death benefit is that it can be exhausted if the funds in the plan are gone. In an annuity with a lifetime income guarantee the beneficiary would continue receiving the payments until died but his heirs would not receive anything else.
If John purchased a $50,000 plan with such a guarantee he would receive payments until he died. If he died after the $50,000 was gone his children would not receive anything from the plan. If John’s plan had a life-insurance provision his children would receive some life insurance money.
You should read the contract carefully to see what sort of death benefit is attached to it. There are some plans that may have no death benefit so no funds will be paid out. In that arrangement the funds are kept by the insurance company and used to pay other annuities.
How the Death Benefit is Paid Out
There are two difference ways that you can collect an annuity death benefit. You can collect it all at once in one lump sum or you can simply keep collecting the payments. Mr. Brady purchased a $150,000 annuity when he retired. He died a few years later and his heir Mrs. Brady elected to keep receiving the payments.
There is a big reason why you should continue taking the annuity payments. Funds in an annuity are tax-deferred so you will not have to report that money on your tax return. That can reduce your income tax rate and your income tax payment.
The money from an annuity is only taxable when it is paid out. If you take all of the funds out in one lump sum you will have to pay taxes on them. If you take the payments you only have to pay taxes on the payments.
For younger people it would pay to roll the funds over into another annuity. You could be subject to a 10% federal tax penalty on withdrawals if you are under 59½ years old. To avoid this you could roll the funds over into another annuity or into another kind of retirement plan such as an IRA.
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