Like other investments, most annuities can be passed along to your heirs in the event of your death. However, it's important to remember that annuities are fundamentally a life insurance product, which alters how they're handled for taxation and inheritance purposes. Before making annuities part of your estate planning, be sure you understand those quirks.
You can pass down most types of annuities to your heirs, but it is important to understand the tax consequences of doing so.
Joint Spousal Annuity
Annuities can be owned jointly by two people. Ordinarily they are spouses, since joint ownership otherwise has little benefit. If one spouse dies during the accumulation phase of the annuity, while it's growing but before payouts begin, the other becomes the sole owner of the annuity and can re-register it, to continue using it for long-term, tax-sheltered growth.
If the death occurs after payouts have begun, the surviving spouse can take ownership of the contract and continue receiving income. Alternatively, if the spouse is also the beneficiary of the contract, it might be advantageous to take a death-benefit payout instead. This avoids a potential tax penalty, if the survivor is younger than 59 1/2.
Naming a Beneficiary
For policies that aren't jointly owned, naming a beneficiary is a crucial step in the process. Like the beneficiary of a life insurance policy, the annuity's beneficiary will receive any outstanding funds in the contract at the owner's death. This is paid directly by the insurance company, without the time and expense of probate.
The money must be taken either as a lump sum, as five equal payments or as a lifetime income. It's taxed as ordinary income under each of these scenarios, rather than as capital gains. There is an exception to this rule for the surviving spouse, who can opt to take over ownership of the annuity.
Children and Annuities
Leaving the proceeds of your annuity to your children can be complicated. If they're adults, you only need to specify how the funds are to be divided. However, if they're minor children, a responsible adult must be appointed to receive the funds in trust. In most states a surviving parent can fill that role automatically, if the amounts are small enough, but typically a court hearing is required to appoint a suitable person. That can be avoided by naming an adult trustee in the annuity contract's benefit provisions, in accordance with the provisions of your state's Uniform Transfer to Minors Act.
Naming Contingent Beneficiaries
If there's no surviving beneficiary when the annuity owner passes away, the contract's death benefits are paid into the estate and go through probate in the conventional fashion. If you'd like to retain control of your annuity's final destination, you can avoid this by naming contingent beneficiaries to receive the proceeds if your primary beneficiary is deceased. You can make this automatic by specifying a "per stirpes" beneficiary designation, so if your beneficiary dies first the funds go to your beneficiary's heirs. You can also name a trust or a charitable organization as your beneficiary.