People purchase annuities for many reasons, but most often, it is to financially provide for their loved ones after they’ve died.
For an annuity to transfer to a specific person, the annuity owner must designate that person as an annuity beneficiary, which the annuity owner can do when purchasing the annuity or at some point after.
Unfortunately, just because someone is designated as an annuity beneficiary, it does not mean that is whom the owner of the annuity intended to designate.
For example, what if the designated beneficiary used undue influence, coercion or other deceptive tactics to be named? Similarly, what if the annuity owner was not of sound mind when designating a beneficiary or did so by mistake?
In the aforementioned scenarios, can annuity beneficiaries be contested? The answer to that question is yes. If you plan to contest an annuity beneficiary, it is best to hire a probate attorney to assist with the process.
Continue reading to learn about what makes inheriting an annuity different from inheriting other assets.
What Is an Annuity?
Annuities are investment options that not only guarantee a stream of income to the annuity owner (called the annuitant) during their retirement years, but also can serve as a means for the annuitant to provide financial support to their loved ones after their death.
When a person enters into an annuity contract, they are agreeing to make either a lump-sum payment or a series of payments to a financial institution (usually an insurance company) in exchange for that institution making payments to them at fixed intervals for the specific period of time agreed upon in the terms of the annuity contract.
Because an annuity is a type of contract, it’s necessary for the annuitant to have the capacity to contract when signing it or making changes to it. In other words, they should understand the nature of the contract they are signing and its implications.
What Is an Annuity Beneficiary?
If you’re aware that a loved one died with an annuity, you may be wondering: Do annuities have beneficiaries? The answer generally is yes.
The person or organization the annuitant designates to inherit their annuity upon their death is called an annuity beneficiary.
It, however, should be noted that there are some annuity contracts that do not allow for beneficiaries to be designated. In such scenarios, if the annuitant dies before the value of the annuity is distributed, proceeds may be rerouted back to the provider.
It generally is permitted for an annuitant to designate multiple annuity beneficiaries, and it’s not required for them to be related to the annuitant (although annuity beneficiary payout options can vary based on a beneficiary’s relation to the annuitant). The annuitant also can generally specify the amount or percentage they want each annuity beneficiary to receive.
Similar to wills and revocable living trusts, annuities usually allow for the annuitant to not only change beneficiaries during the time the annuity contract is active, but also to name contingent beneficiaries (i.e., beneficiaries who will inherit if one or more of the primary beneficiaries die before the annuitant, cannot be located or refuse their payouts).
How Does an Annuity Work After Death?
After the death of an annuitant, the annuity will be disposed of in the manner dictated by the terms of the annuity contract. If you are unable to interpret the terms of an annuity contract on your own, a probate attorney can help.
Most annuities have beneficiary designations, which means they generally will bypass the probate process and transfer directly to the beneficiary or beneficiaries designated in the contract. But for an annuity to be transferred, certain steps will need to be taken.
First, the executor or administrator of the annuitant’s estate or an annuity beneficiary will need to notify the annuity provider of the annuitant’s death. Along with the notice, they will also need to send a certified copy of the annuitant’s death certificate.
Once the annuity provider has verified the annuitant’s death, it will look to the terms of the annuity contract to determine how to proceed. For example, if the annuitant had made annuity beneficiary designations, the annuity provider will notify these beneficiaries about the amount that is to be distributed to them.
If no annuity beneficiaries had been designated in the contract, but there are proceeds to distribute, it’s possible proceeds will be payable to the annuitant’s estate. Note that if annuity proceeds become a part of the annuitant’s estate, they will have to pass through probate in the same way other estate assets do.
What Is an Annuity Death Benefit?
An annuity death benefit refers to the payment(s) an annuity beneficiary will receive once the annuitant dies. It is usually left up to the annuity beneficiary to decide how they would like the annuity death benefit to be paid out.
An annuity death benefit generally equals the value of the annuity at the time of the annuitant’s death, although death benefits can vary based on the terms of the annuity contract.
Note that not all annuities will have death benefits. Some annuity contracts, for instance, expire at the time of the annuitant’s death. There also won’t be death benefits for an annuitant who outlives the length of their annuity contract. As an example, if an annuity contract calls for the annuitant to receive monthly payments for a span of 10 years, but they proceed to live 15 years, then the full value of the annuity likely had already been paid out to the annuitant.
If you are an annuity beneficiary who stands to receive an annuity death benefit, you generally will have a say in how you want proceeds from the annuity to be distributed to you. Refer to the following subsection to learn about inherited annuity distribution rules and payout options.
Annuity Beneficiary Payout Options
If you know you will be inheriting an annuity, it’s worth taking the time to understand inherited annuity distribution rules and payout options to maximize your earning potential. As previously mentioned, interpreting the annuity contract to determine the type of annuity you are dealing with and its specific terms is an essential first step of this process.
Annuity payout options for beneficiaries can also be influenced by your relation to the annuitant and the way in which the annuity is owned. For example, annuities are often jointly owned by two people, which amounts to each annuitant owning 50% of the annuity.
If you’re inheriting an annuity, you may be wondering: Are annuities taxable to beneficiaries? The answer is that annuity beneficiary taxes will depend on whether the annuity was funded with pre-tax dollars or post-tax dollars, and on whether your annuity payments contain new earnings (i.e., earnings beyond the amount of the initial premium).
Continue reading to learn about annuity beneficiary distribution options, and the advantages and drawbacks of each. Remember that the payout options available to you will depend upon the type of annuity contract entered into by the decedent and your relationship to the decedent, so it is important to consult with a probate attorney, tax professional or financial adviser if you need help understanding what a particular annuity contract entails.
Lump-Sum Annuity Payment
When an annuity beneficiary opts for a lump-sum distribution, it means they want the remaining value of the annuity contract or the value guaranteed by the annuity contract to be provided to them as a single, consolidated payment.
Accepting a lump-sum annuity distribution can be beneficial, particularly if you are planning on making a substantial investment or purchase (e.g., a home); however, keep in mind that withdrawing the full amount of the annuity all at once means that you may also will have to pay the required taxes on that amount all at once, which potentially could kick you up to a higher tax bracket.
Annuity Payments Over 5 Years
The inherited annuity “five-year rule” allows you to postpone annuity payments for up to five years or spread your payments out over that time period. With this option, it is required for beneficiaries to collect the entirety of their annuity payments before the close of the fifth year.
Many annuity beneficiaries prefer this option because their overall tax burden would be spread out over five years, which potentially could help them steer clear of higher tax brackets.
“Stretch” Annuity Payments
As the name implies, a “stretch” provision gives you the option to extend annuity payments and their associated tax obligations over the span of your life expectancy, which is determined by the IRS. If you are a non-spousal beneficiary, you generally will have one year from the date of the annuitant’s death to set up a stretch distribution plan if the option is available to you.
Stretch annuity payments are beneficial, not just because of the minimal tax consequences, but because they can help beneficiaries receive some form of income for many years to come, if not for the remainder of their lives.
Surviving Spouse as Annuity Beneficiary
If you are a surviving spouse who was designated as a beneficiary of an annuity by a deceased annuitant, you may have the option to continue the original annuity agreement by converting it into your name. By going this route, you will become the new annuitant and receive annuity payments in accordance with the terms of the contract your spouse signed.
On the other hand, if the annuity agreement does not provide for spousal continuation of the annuity or if that is not a route you wish to go down, you can always collect the remaining value of the annuity as a lump-sum payment or decline annuity payments altogether to allow a contingent beneficiary (if one was designated) to receive payments in your place.
With that said, it’s important to consider whether community property laws apply to the annuity you are inheriting. In California, any property acquired over the course of a marriage (with limited exceptions) is presumptively considered community property, so if your spouse purchased an annuity during marriage using community funds, then a portion of the annuity may be regarded as being jointly owned, or owned equally by both spouses.
Annuity With Estate as Beneficiary
Distribution options generally are limited when it comes to annuities with an estate as beneficiary. More specifically, the estate generally will have to collect the remaining value of the annuity as a lump-sum payment because probate deadlines don’t allow for annuity payments to be stretched out.
When an annuity becomes part of an estate, it’s usually because the annuitant had failed to designate a beneficiary for their annuity or had designated a beneficiary who predeceased them or cannot be located.
If an annuity is part of an estate, it will have to be distributed in accordance with the terms of the decedent’s will (if one exists) or in accordance with the laws of intestate succession (if no will exists).
Under What Circumstances Can Annuity Beneficiaries Be Contested?
It sometimes happens that the persons designated as annuity beneficiaries are not whom the annuitant would have designated under normal circumstances. If this is the case, can annuity beneficiaries be contested?
The answer to that question is yes, but because annuities often have beneficiary designations that allow them to transfer directly to annuity beneficiaries, it can be difficult to recoup annuity proceeds if they’ve already been distributed without help from an experienced probate attorney.
That being said, annuity beneficiaries can only be contested on specific grounds. Contesting an annuity beneficiary because you believe you are more deserving of an inheritance, for example, is not a valid ground for bringing a contest.
The grounds for contesting an annuity beneficiary are similar to the grounds for contesting a will or trust. The only difference between contesting an annuity beneficiary vs. a will beneficiary or trust beneficiary is that will contests and trust contests generally are litigated before any distributions are made to beneficiaries. This is not always the case with annuity beneficiary designations, especially if the designated beneficiary opted to collect annuity proceeds as a lump sum immediately following the death of the annuitant.
Valid grounds for contesting an annuity include:
- Lack of Capacity: If the annuitant designated an annuity beneficiary at a time when they were mentally incompetent (e.g., due to old age, dementia or another cognitive disability), and this can be proven with testimony and documentation from their medical providers, the beneficiary designation likely can be contested. Designating annuity beneficiaries or changing designated beneficiaries requires the capacity to contract.
- Undue Influence: If an annuity beneficiary used excessive pressure in order to persuade the annuitant to designate them as a beneficiary of their annuity, the beneficiary designation likely can be contested. For undue influence to be proven, you will have to demonstrate that the annuitant’s free will was overridden by the influencer when designating an annuity beneficiary.
- Fraud: If an annuity beneficiary used deceptive tactics (e.g., they lied about their financial situation) to be designated as a beneficiary of the annuity, the beneficiary designation may be able to be contested as the product of fraud.
- Forgery: If the designated beneficiary on an annuity agreement was changed using a falsified signature, the beneficiary designation likely can be contested; however, keep in mind that forgeries can be difficult to prove, so you will want to hire a lawyer to help with this process.
- Ambiguity/Mistake: If the annuitant signed an annuity agreement by mistake or designated an annuity beneficiary by mistake, the beneficiary designation may be able to be contested. An annuity beneficiary likely can also be contested if the annuity agreement is ambiguous in some way and gives rise to uncertainty regarding who the intended beneficiary is.
There are other miscellaneous circumstances under which an annuity beneficiary designation potentially can be contested. For example, if an annuitant purchased an annuity while married using community funds, but then designated a beneficiary to inherit all the annuity proceeds (instead of the 50% of the proceeds they are entitled to dispose of), their surviving spouse likely has a claim to ownership of a portion of the annuity benefits.
Contesting an annuity beneficiary can be an uphill battle because the burden of proof rests with the person bringing the contest. You will have a much better chance of succeeding if you have a probate lawyer on your team who can argue your case for you.
In the same vein, if you are an annuity beneficiary who is at risk of losing your inheritance from an annuity because someone is contesting the beneficiary designation, it is crucial that you get in touch with a probate lawyer as soon as possible to enforce your rights.
Who Can Contest an Annuity Beneficiary?
Only certain persons have standing to contest an annuity beneficiary. Determining whether you have standing is simple. To do so, ask yourself whether you would stand to inherit proceeds from the annuity if the current annuity beneficiary designation were invalidated. If the answer is yes, you have standing.
Persons with standing to contest an annuity beneficiary generally include:
- Primary designated beneficiaries
- Contingent designated beneficiaries
- Former designated beneficiaries (i.e., beneficiaries who were inheriting under a previous version of the annuity contract)
- Heirs of the annuitant who would stand to inherit annuity proceeds under intestate succession if the beneficiary designation were overturned
It’s worth noting that there are some circumstances under which the personal representative of an annuitant’s estate or the trustee of their trust may also be authorized to contest an annuity beneficiary, particularly if the annuity is a part of the annuitant’s estate or trust.
If you have questions surrounding your standing to contest an annuity beneficiary, speak with a probate lawyer about your rights.
Looking to contest an annuity beneficiary? Keystone can help.
It is not easy to contest the designated beneficiary on an annuity because you will have to prove why the designated beneficiary is invalid, as well as present your arguments to the court.
If this process seems overwhelming to you, our team of probate attorneys can navigate the process on your behalf. Learn how we can help by calling us today to request a free consultation.
