Owner, annuitant, beneficiary: how three roles change what happens at death

Every annuity contract names at least three roles, and the same person often fills two or all three of them. When one person holds every role, the arrangement is easy to read. When the roles are split among two or three people, the answer to "what happens when someone dies?" changes with who died. This post tests the question on four hypothetical households and then pulls out the general lessons. The households and numbers are invented for illustration, and the contract in your hands controls the real answer.

The three roles in plain words

The owner (see policy owner) is the person or entity who controls the contract. The owner decides how the money is invested, takes withdrawals, can surrender the contract, names the beneficiary and pays any tax on gains. In a retirement account the owner is the account holder.

The annuitant is the person whose life is used to measure the contract. In a deferred annuity, the annuitant's age helps set the death benefit rules and the date by which income must start. Once the contract is turned into income, the annuitant's lifetime is what a life-based payout is built on. See annuitant for the definition.

The beneficiary is the person who receives money when the contract pays at death. A contract can name a primary beneficiary and a contingent one, and a surviving spouse may have special options.

The difficulty comes from the word "death". A contract may pay a death benefit at the owner's death, at the annuitant's death, or at the first of the two. Federal tax law adds its own rules for the owner of a non-qualified annuity. The contract's death benefit provision and the tax rules do not always point the same way, which is why many insurers' contracts spell out the combinations. The wording matters more than any summary here.

Before the households, one more distinction. Money in an IRA annuity (a qualified contract) follows retirement-account rules, and in most such arrangements the owner and the annuitant are the same person. The splits below mostly arise in contracts bought with after-tax money, called non-qualified annuities. The guide on annuity beneficiaries and inherited annuity options covers the tax rules for each.

Household 1: one person in two roles, a spouse as beneficiary

Say Ruth, 66, buys a deferred annuity with $150,000 of savings. She is the owner and the annuitant. She names her husband, Paul, 68, as beneficiary and her adult daughter as contingent beneficiary.

Seven years later the contract is worth $190,000. Ruth dies. What happens?

• Owner and annuitant died together. Because Ruth held both roles, there is no one left to carry the roles, so the contract's death benefit is triggered. The insurer pays a death benefit to the beneficiary. In a typical contract this is the account value or, if higher, a return-of-premium amount. Say the account value of $190,000 is higher.
• Paul has choices. A surviving spouse who is the beneficiary can usually continue the contract as its new owner, which keeps the tax deferral going, or take the money in another form. The insurer calls this spousal continuation. See a spouse inherits an annuity: continue it, cash out or take payments for the choices.
• The tax. Ruth's cost basis was $150,000, so $40,000 of the $190,000 is gain ($190,000 minus $150,000). If Paul takes it all as a lump sum, the $40,000 is ordinary income to him in that year and the $150,000 comes back as a return of basis. If he continues the contract, no tax is due until he draws money out.
• If Paul had died first. Ruth would still own the contract and could name someone new. The contingent beneficiary, the daughter, would matter only if Paul were also gone at Ruth's death.

The lesson from household 1 is that when the owner and the annuitant are the same person, the death of that person is the single trigger. This is the arrangement most people have, and it is the easiest to follow.

Household 2: a parent owns, an adult child is the annuitant

Say Helen, 78, buys a deferred annuity with $100,000 and names her son Marcus, 45, as the annuitant. She remains the owner and names her granddaughter Elise as beneficiary. People sometimes arrange this because the annuitant's age affects the contract's terms, such as how far in the future the contract must start paying income, or because the owner wants a younger life measuring the contract.

Two events can happen, and they give different results.

Case 2A: Helen, the owner, dies first. Federal tax law for non-qualified annuities treats the owner's death as the event that starts a clock. The contract generally has to be paid out within five years of the owner's death, or paid over the beneficiary's life or life expectancy if payments begin within a year. Marcus is still alive, but his survival does not stop the clock. Elise, as beneficiary, steps up as the person who must receive the money or continue the contract as the rules and the contract allow. Many contracts pay the death benefit to the beneficiary when the owner dies, even though the annuitant is alive.

Case 2B: Marcus, the annuitant, dies first. Helen is alive and still owns the contract. Contracts differ here. Some pay the death benefit to the named beneficiary when the annuitant dies, which would send the money to Elise while Helen is still living. Others provide that the owner becomes the annuitant, and the contract continues. Which one applies depends on the contract's wording and sometimes on whether the owner is an individual.

The difference matters. Helen may not want a payout to Elise before she has finished with the money, but the contract might require it. This is a good example of why the annuitant is not just a name on a form.

A practical check: before choosing a different annuitant, ask the insurer in writing to describe what happens when the annuitant dies before the owner, and what happens when the owner dies before the annuitant. Ask for the contract page that says so.

Household 3: joint owners who are spouses

Say Daniel, 70, and Marisol, 68, buy a deferred annuity together for $200,000 and list themselves as joint owners. Daniel is the annuitant. Each is named the other's beneficiary.

Joint ownership is common between spouses and works in a predictable way, but the annuitant still matters.

• If Daniel, the annuitant, dies first. Marisol, the surviving joint owner, would usually become the sole owner. Because Daniel was the annuitant and the contract has not started paying income, many contracts treat the annuitant's death as a trigger, and the surviving spouse can continue the contract and replace the annuitant with herself. That continuation is the benefit spouses receive that other heirs do not.
• If Marisol dies first. Daniel remains the owner and the annuitant. The contract may note the death of a joint owner as a trigger for the death benefit to be paid to the surviving owner, who then chooses to continue or take the money.

The details turn on the contract. Some insurers do not allow joint ownership at all, and others allow joint owners only if they are spouses. Joint owners who are not spouses face a harder time: the death of either owner can require a payout, and the survivor cannot continue the contract the way a spouse can.

Marisol and Daniel should also check how the beneficiary form fits with joint ownership. When there is a surviving joint owner, the contract often treats that person as the beneficiary at the first death and applies the written beneficiary designation only at the second death. The post on annuity beneficiary form mistakes that send money to probate shows how easily those layers go wrong.

Household 4: payments have started

Everything above assumes the contract is still growing, which is called the accumulation phase of a deferred annuity. Once the owner converts the contract to income, which is annuitization, the roles change. The question becomes: what remains after the annuitant dies?

Say Wendell, 72, turns $120,000 into a lifetime payout of $1,000 a month. He is the owner and the annuitant, and he names his niece as beneficiary. The payout option he chooses decides what the niece receives.

The arithmetic for the second row: by the end of year 4, Wendell has received 48 payments of $1,000, or $48,000. A 10-year period has 120 monthly payments, and 120 minus 48 leaves 72 payments, or six years. At $1,000 a month the niece receives $72,000 in total over those six years, assuming nothing else changes. For the third row, the refund equals $120,000 minus $48,000, or $72,000, which in this simple illustration happens to be the same total. In real contracts the payout for a given option differs, because the insurer prices the options differently.

The life-only option pays the largest monthly check, because the insurer keeps what is left of people who die early to fund the payments to those who live long. A joint-and-survivor option, chosen when the annuitant has a spouse, keeps paying after the first death. How payout options end is covered in the guide to what happens to an annuity when you die, and the tax treatment of the payments is in how annuities are taxed.

In the payout phase, the beneficiary form still matters, but what it controls is smaller: only the leftover guaranteed payments, if any. The owner's death after income has started generally does not reset the clock, but the remaining payments must be made at least as fast as under the method already in use.

When the owner is not a person

A fifth arrangement, not a household but a trap, is an owner that is not an individual, such as a corporation or a trust. Under federal tax law, an annuity held by a non-natural person generally loses its tax deferral: the yearly growth is taxed as ordinary income to the owner instead of building up untaxed. The exception, for a trust that holds the contract as an agent for a natural person, is real, but it depends on how the trust is set up and on its facts. If an estate attorney recommends a trust as owner, ask the attorney and a tax professional to confirm in writing that the tax deferral will survive.

For the same reason, the annuitant in such an arrangement is a named living person. Federal rules treat the death or change of the primary annuitant as the death of the owner when the owner is not an individual. The contract then pays out as if the owner had died.

Changing a role after you buy

Roles are not always permanent. Many contracts let the owner change the beneficiary at any time, and some let the owner change the annuitant or add a joint owner, subject to the insurer's rules. Each change has side effects worth checking before you sign.

Changing the beneficiary is the easy one: it affects only who is paid, and it can usually be done with a form. Changing the owner is different. Handing a non-qualified contract to another person can be treated as a taxable event, because the gain that has built up may be taxed to the person who gives the contract away, with exceptions for transfers between spouses or incident to a divorce. Changing the annuitant can affect the death benefit amount, the date by which income must begin, and any rider that depends on the annuitant's age. A tax professional should look at an ownership change first, and the insurer should confirm each change in writing.

If an ownership change follows a divorce, the post on dividing an annuity in a divorce: ownership, tax and paperwork pitfalls covers the paperwork pitfalls.

What the four households teach

Looking across them, a few patterns emerge.

1. Whose death triggers the payout is a contract question. Owner-only, annuitant-only and either-death triggers all exist. Read the death benefit section and ask the insurer to confirm in writing.
2. The owner's death has a tax clock; the annuitant's death has a contract clock. The five-year and life-expectancy options come from tax law and apply to the owner's death in a non-qualified contract. The annuitant's death is a matter of what the contract says.
3. Spouses are treated better. A surviving spouse who is the sole beneficiary, or a joint owner, usually has the right to continue the contract. Other heirs generally do not.
4. Splitting roles adds options and risks. A younger annuitant may suit a specific plan, but a different annuitant also creates a second event that can set off a payout.
5. The payout option controls what is left after income starts. Life-only leaves nothing; period-certain and refund options leave something.

A short list of questions to ask the insurer

Whether you are buying or holding a contract, ask these in writing and keep the answers with the contract.

1. If the owner dies first, what is paid, to whom, and by when?
2. If the annuitant dies first and the owner is alive, does the contract pay a death benefit or continue?
3. Can the annuitant be changed after purchase, and what happens to the death benefit if it is?
4. Is there a spousal continuation provision, and does it apply to a spouse who is a joint owner as well as a sole beneficiary?
5. If there are joint owners, which death triggers a payout?
6. Does an enhanced death benefit rider, if any, depend on the age of the owner or the annuitant?
7. After income starts, what does the beneficiary receive under my payout option?

An estate attorney can tell you how the roles fit into the rest of your plan, and a tax professional can say how the five-year and life-expectancy options would apply to your heirs. If an insurer's explanation seems to conflict with the contract, the state insurance department takes questions and complaints.

Key takeaways

• The owner controls the contract, the annuitant measures it and the beneficiary is paid; one person can hold two roles or all three.
• A death benefit can be triggered by the owner's death, the annuitant's death, or the first of either, depending on the contract's wording.
• For non-qualified annuities, tax law starts a payout clock at the owner's death, but the annuitant's death is governed by the contract.
• Spouses can often continue a contract; most other beneficiaries must take payments within a set window.
• Once income has started, what the beneficiary receives is set by the payout option: nothing for life-only, the remaining guaranteed payments for a period certain.