Are Annuity Death Benefits Worth It?
Passing assets to beneficiaries is a key concern for many retirees and there are plenty of ways to do it. Annuities have a big advantage because they require probate for those who haven’t done detailed estate plans. Income annuities might leave a stream of payments to the next generation and deferred annuities for the most part will leave the full account value without penalty. Death benefit enhancements come as an additional rider to many contracts and I’m going to cover those fixed indexed annuities because that’s where you’ll find some pretty enticing stuff. If you want to look at death benefit options for variable annuities then check out my report, A Simple Guide to Variable Annuities.
Yes, it is easy to pass annuity payments or account values to beneficiaries but it’s not the best asset to use for this purpose alone. It can be a good alternative for anyone who is uninsurable or if old enough that life insurance is too expensive. We’ll focus on that because of a recent request I received. The guy I was working with has experience using these contracts and wants to add a couple before he’s too old to buy one. Most of these aren’t available past the age of 80 and he’s close. Two types of contracts exist for this purpose. One is a guaranteed annual increase for a fee and the other comes with a bonus and performance-based payout.
Guaranteed Death Benefit Enhancement
This one is fairly straightforward with the enhanced death benefit being a guaranteed annual increase. Fixed indexed annuities are guaranteed to not lose money but they are not guaranteed to grow. With a death benefit addition you will get an annual increase to the death benefit regardless of account performance. There is a fee for this and most of these contracts are not built to grow a whole lot so you need to have a singular focus on legacy. Let’s assume a fee of 1%, initial purchase of $100,000 and 7% annual growth on the death benefit. If the index annuity doesn’t grow in the first year, the fee comes out of the contract value to leave you with $99,000 in cash and a death benefit of $107,000.
This is just one product I looked at and the 7% is simple interest compounding for a maximum term of 15 years. Therefore the initial purchase is capped at 205% for the death benefit. It would be most beneficial in terms of money for the contract owner to die before the end of the term. But, doubling your money over a 15 year period creates an actual yield of less than 5% so it may not be as good as it seems. In this case you may be better off by just using a MYGA with no fees and letting that run for 15 years. Now there are 125 products on the market with an enhanced death benefit so I am by no means quoting the best deal.
Bonus With Performance-Based Death Benefit
This is a big selling point for many of the big bonus products. Free income riders and huge bonuses sell a lot of annuities with misleading claims made by novice agents. This guy knows the game so he’s not in danger of being scammed. The catch is that you can take the cash value of the contract as a lump sum or you can take the enhanced death benefit in equal annual payments over five years. If the contract owner dies when the contract is worth $120,000 and the death benefit base is $150,000, the beneficiary can take $120K right away or $30K annually for five years. A lot of people buy these contracts for this purpose but that doesn’t mean the beneficiary will elect the larger payout. If there are two or more beneficiaries then each can elect a different option.
Long-term projections are difficult because a lot of things can change with an indexed annuity. Any death benefit is most valuable immediately after it is purchased and becomes less valuable as every year passes. And paying out over five years reduces the current value of the death benefit. In the example above, $30K per year for five years is only worth $135K today, using a 5% discount rate so it’s not as valuable as it seems. Indexed annuities may also have growth rates reduced, making the initial illustration worth less than the paper it’s printed on.
By all means, go for the enhanced death benefit if that’s what you want but realize it’s a much smaller benefit than it looks without digging into the numbers. A true legacy is always better with life insurance but annuities can be used for some enhancements as a last resort. Just make sure you are dealing with an honest advisor who has the capability to run the numbers. It seems like there are fewer of those people available than you’d think.
Call or email if you’d like me to go into some numbers with you.
Bryan
Podcast Episode: Are Annuity Death Benefits Worth It?
Last Updated on March 1, 2024 by Bryan Anderson
