A typical feature of annuities is that they provide you with an income for the rest of your life. But one of the limitations is that if you die within a few years of taking an annuity, any funds remaining in the plan revert to the insurance company – not to your heirs.
Some annuities offer a basic death benefit. What they will do is to pay your heirs a certain amount of money, usually limited to your investment in the plan, less any withdrawals or income payments that you have received.
But if you want to provide your heirs with something more, you can add a death benefit rider to your annuity, which will provide an enhanced death benefit.
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How the Death Benefit Rider Works
A death benefit rider gets around the missing or limited death benefit feature that’s typical of annuities. By paying a relatively small annual fee, you can add the death benefit rider to your annuity, ensuring that you will have both lifetime income payments as well as an enhanced death benefit for your heirs upon your death.
The death benefit from an annuity has a major advantage over ordinary life insurance…
While you will have to qualify for a life insurance policy based on your health, no such qualification is required for an annuity death benefit rider. You can qualify for that death benefit, even if you would have been declined for ordinary life insurance.
Now there is one negative aspect to the death benefit rider. Unlike the death benefits paid by an ordinary life insurance policy, the death benefit from an annuity does not pass to your beneficiaries on a tax-free basis. Your heirs will have to pay tax on the income received from the annuity after your death.
Death Benefit Rider Features
A death benefit rider can provide a step up provision. With this provision, the insurance company will step up the value of your annuity on the anniversary date of when you took out the annuity. The step up will be based on the highest value that existed at any preceding anniversary date.
The step ups can be on an annual basis, but some also offer a monthly step up. In the case of a monthly step up provision, each month on the anniversary date of your annuity, the insurance company records the account value. When you die, and the death benefit is determined by the insurance company, it will be the highest monthly value that your annuity produced.
It will not matter if the value of the annuity has declined since that high-value date. Your heirs will be paid the highest monthly value instead.
It is important to understand that any death benefit determined will be reduced by the amount of withdrawals you’ve taken from the annuity. So even if the initial value of your annuity is $200,000 and the high value is $400,000, if you withdrew $100,000 prior to your death, your beneficiaries would receive $300,000.
Death Benefit Rider With a Step Up Provision
Let’s say that you take a deferred annuity for $200,000. After 10 years, the annuity value has grown to $500,000. But then the financial markets take a dive, and the value of the annuity drops to $250,000. At that point, you die suddenly – which value will be insurance company pay to your beneficiaries as a death benefit?
Your heirs would receive $500,000, because that is the highest value of the annuity since it began. That is of course significantly larger than your initial investment in the plan of $200,000.
But once again, it’s important to be reminded that whatever the death benefit balance is at the time of your death, it would be reduced by any withdrawals that you have taken from the annuity since it began. So, if the death benefit would be $500,000, but you received $150,000 in withdrawals during your lifetime, the net benefit to your heirs would be $350,000.
The insurance company may also offer a minimum compound interest rate, typically between 5% and 7%. If your annuity value has increased significantly due to a favorable financial market environment, the insurance company will give you the higher of the two values – either the value as a result of the increase in investment worth or the value that is the result of the minimum compound interest rate.
As an example, let’s say you took an annuity with an initial investment of $200,000. 10 years later, the value of the annuity is $300,000 based on the increase in the investment value of the account. But the annuity also had a minimum compound interest rate of 7%, which produced a value in excess of $393,000. Your death benefit would be $393,000 since it is higher than the investment value of the annuity.
Death Benefit Rider Costs
There’s a pretty wide range as to the cost of adding a death benefit rider to your annuity. The rate will vary based on the insurance company, the annuity, and the specific provisions of the rider itself. The cost of the rider can range from between 0.25% and 1.15% of the value of the annuity.
For example, a death benefit rider that includes a monthly step up provision will add between 0.25% and 0.50% to the cost of the fee. If the base cost of the rider is 0.25%, and the monthly step up provision is 0.35%, then the total cost of the rider will be 0.60%.
The rider fee is not something that is collected upfront nor as a separate fee. Instead, it is charged as a reduction in the income payment percentage that you will receive from your annuity. So if you set up your annuity to pay you an annual interest rate of 5.50%, and the cost of a death benefit rider is 0.75%, then you will receive a net annual income payment of 4.75% of your annuity value.
Final Thoughts – Why You Might Want to Add a Death Benefit Rider to Your Annuity
There are three main reasons why you would want to add a death benefit rider to your annuity.
Providing a Death Benefit to Your Heirs. By adding the death benefit rider to your annuity, you will have both the living benefits that an annuity provides, as well as a generous death benefit to pass on to your survivors.
Creating a Death Benefit When You Can’t Qualify for Ordinary Life Insurance. If age or certain chronic or serious health conditions make it impossible for you to qualify for an ordinary life insurance policy, adding a death benefit rider to your annuity is a way to provide a death benefit to your heirs. Since you don’t need to qualify for the death benefit, you will be able to provide for your beneficiaries what you could never do with life insurance itself.
Adding the Step up Provision to Your Annuity. There are other riders that offer a step up provision, but by adding the death benefit rider to your annuity, you can include the step up provision along with being able to provide a death benefit for your heirs. The step up provision enables you to pass on a death benefit to your beneficiaries that can be larger than the original amount of your annuity.
A death benefit rider is a way to overcome one of the primary drawbacks of an annuity, which is having the balance of your annuity revert to the insurance company if you die early in the income payment period. The death benefit rider will enable your annuity to provide you with both a lifetime income provision for yourself as well as an enhanced death benefit for your heirs.