Wills and annuities are popular tools for estate planning as both can be used to distribute property to beneficiaries after a person dies. Wills distribute probate property to identified beneficiaries. Annuities are contracts that allow a person to pay a third party, which then pays a series of annual payments to beneficiaries for a set period of time. Since both wills and annuities deal with property distributions after a person’s death, a common question is whether the lack of a will would affect the beneficiaries of an annuity set up by the decedent.
If there is no will, the estate is “intestate.” Since the will normally establishes who the executor will be, the probate court must appoint a personal representative to manage an intestate estate. The personal representative is required to inventory all of the decedent’s probate assets, determine what debts associated with the decedent and estate need to be paid, and pay those liabilities using the decedent’s probate assets. If any assets remain after this, the representative distributes those assets to the decedent’s heirs based on the state’s intestate succession rules. Generally, the closest living family members get the decedent’s assets, so the decedent’s living spouse and children would get the decedent’s assets before the decedent’s aunt and uncle.
There are three types of annuities. A fixed annuity pays a flat rate every pay period. A pay period can be monthly, quarterly or annual. These periodic payments can last for an established period of time, such as 10 years, or for the duration of a beneficiary’s life. An indexed annuity is similar to a fixed, except that the value of the payment fluctuates based on a market index such as the Dow Jones Stock Index. An indexed annuity will establish a minimum payment level that it will make regardless of how the index that the payment is attached to performs. A variable annuity is similar to an indexed annuity. The person who creates the annuity picks a mutual fund or something comparable to invest his contribution in, and the eventual annuity payments are based on how well the investment performs.
Read More: How Do Annuities Avoid Probate?
Annuities and Intestacy
Annuities are a popular estate planning device because these contacts are not considered probate property. Since wills only affect probate property, a will or the absence of one generally does not affect annuity beneficiaries. Since the annuity is not part of the probate estate, the decedent’s creditors may not be able to claim the annuity payments to settle the estate’s debts. There are two exceptions. First, if the beneficiary of the annuity is dead, the annuity is included in the probate estate. The second possibility is that the decedent named his estate as the annuity’s beneficiary. In both cases, the annuity is included in the estate and can be used to settle the estate’s debts. If any of the annuity value remains, it is distributed to the decedent’s heirs subject to the state’s intestate succession plan.
Taxation of Annuities
The annuity payments received by the beneficiary are taxed the same way they would have been taxed if the decedent received the payments, with some minor adjustments. The amount the beneficiary receives from the annuity, minus what the decedent paid to obtain the annuity, is included in the beneficiary’s gross income on his personal tax return. If the annuity was included in the decedent’s estate and it paid estate tax, you may deduct the portion of estate tax that was attributed to the annuity from any taxes you are required to pay on the annuity payments you received. Calculating this tax can be difficult, so consider obtaining the services of a tax professional if you are an annuity beneficiary.
- National Paralegal College: Historical Overview of Wills
- National Paralegal College: Intestate Succession Rules
- National Paralegal College: Personal Representative
- Carter, Dougherty & Keiley: Avoiding Probate
- U.S. Securities and Exchange Commission: Annuities
- Internal Revenue Service: Publication 575 – Pension and Annuity Income
John Cromwell specializes in financial, legal and small business issues. Cromwell holds a bachelor's and master's degree in accounting, as well as a Juris Doctor. He is currently a co-founder of two businesses.