A Guide to Understanding Annuity Settlement Options at Claim Time

When the owner of a tax-deferred annuity passes away, there are several settlement options available to a beneficiary. In this short blog, we’ll go over the basics and explore the most common annuity settlement options.

What is an Annuity?
Interestingly, the concept of annuities goes back in time between AD211 and AD222.  European monasteries raised funds by selling life annuity products and used acclaimed mathematicians from their scientific communities to support the refinements of pricing models.  

​Today, an annuity is generally defined as a financial product offered by insurance companies, which after growing tax deferred at a fixed, variable, or indexed rate of return, they can also offer a guaranteed income stream as well as death benefits.  Tax deferred annuities are often used for retirement income, estate planning, or even funding for long-term care.   

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What type of Annuity Settlement Options are available?
It is important to note, that once a settlement option is elected by the claimant, it is typically irrevocable, meaning, the option is locked in and cannot be changed. Choosing an annuity settlement option can be influenced by individual circumstances, risk tolerance, income needs, life expectancy and tax brackets.  There can also be several other additional factors such as the beneficiary named/type of beneficiary named, the contract tax disposition, product type, date of death, etc. that can also come into play with annuity claim Settlement Options.  Your role as a claims professional is to be aware of these options and to be able to speak confidently about them so that the beneficiary may make their own informed decision on what is the best for them.  Read on to learn more about the most common types of claim settlement options for deferred annuities:

Spousal Continuation – If the contract owner is married, this option allows the decedent’s spouse to “take over” and continue the existing contract at point of claim.  The contract will continue to grow tax deferred until it reaches the maturity date.  If the spousal beneficiary dies prior to the maturity date, then their beneficiaries will choose from the available settlement options dependent on the type of contract and/or the named beneficiary (i.e. 5- or 10-year deferral, beneficiary stretch, lump sum benefit, annuitized payout, etc).


Lump-Sum Payment
The beneficiary may choose to receive their benefit in a single lump sum payment. If sent directly to the individual, this option provides the beneficiary immediate access to the full amount of the death benefit, which can be useful for large expenses or investments.  However, when sent directly to the beneficiary, taking all the benefit at one time may result in significant tax implications as it will be taxed as ordinary income.  On the other hand, if the beneficiary wishes to continue the tax deferral status of the benefit and elects to do a tax-qualified rollover/transfer of their benefit to an eligible Inherited IRA or 1035 exchange (dependent on the beneficiary, product and tax disposition), they would not be subject to income tax penalties in this arrangement. 


Deferral Options

5 Year Deferral: The beneficiary of a non-qualified tax deferred annuity may elect to defer taking receipt of the funds for up to five years from the original owner’s death.  During this time period, partial withdrawals and a full lump sum surrender are allowed by the beneficiary, but ultimately, the contract must be liquidated at the end of the five-year period.

10 Year Deferral: The Setting Every Community Up for Retirement Enhancement, known as the SECURE Act was signed into law on December 20, 2019 and became effective January 1, 2020, changed the rules for distributing inherited retirement accounts, including IRAs, for non-spouse beneficiaries. A key change is the 10-year rule, which requires the entire inherited balance to be distributed by the end of the tenth year after the owner's death on qualified contracts. However, there are exceptions for certain eligible designated beneficiaries (EDBs) like surviving spouses, the deceased’s minor children, someone no more than 10 years younger than the deceased, or those chronically ill or disabled as of date of death. The beneficiary of a tax-qualified deferred annuity may elect to defer taking receipt of the funds for up to ten years from the original owner’s death.  During this time period, partial withdrawals and a full lump sum surrender are allowed by the beneficiary, but ultimately, the contract must be liquidated at the end of the ten-year period.

Life Expectancy (Stretch): The beneficiary of a non-qualified tax deferred annuity may elect to receive payments over their life expectancy based on IRS tables.  The beneficiary must withdraw at least the required minimum amount each year but may withdraw more if desired.

Payout Option (Annuitization):  The beneficiary may elect to annuitize and receive periodic payments for a guaranteed number of years and/or their lifetime.  Whichever option is chosen, the first payment to the beneficiary must be disbursed within one year of the original annuity owner’s date of death.  Rules and features may vary from company to company on this option.  The payments that the beneficiary receives from an annuitization may be taxes as ordinary income in the year in which it is received. 


Choosing the Right Settlement Option
As a claims representative, we must be objective when assisting claimants, meaning, we can provide them with the necessary details to make an informed decision, but we cannot advise or persuade them on one option versus another.  Claimants should be advised that they should consult with their financial or tax professional for any tax-related guidance or advice as needed.  Understanding each option, the benefits and potential risks is essential in allowing you to tailor the approach of your interactions with the claimant.  


Blog Content Authored By: 
Mark-James Gill (Swiss Re)                   Will Stahn (Everlake Life)
Erin Brown (Nationwide)                       Brian Anderkin (MassMutual Ascend)