Provide for Your Beneficiary Survivor with a Reversionary Annuity

12 Jan

When couples are in their retirement, circumstance may arise where a wife is in jeopardy of losing a living income when her husband dies. Perhaps the husband – before a late marriage – had opted for a ‘single life’ payout for his pension or annuity. Or, perhaps a 50% reduction of his pension payout for his wife just won’t be enough. How can one spouse assure an adequate income for his surviving spouse when a pension or Social Security benefit is involved?

Normally, you might say, ‘just go out and buy life insurance on the husband’s life so the wife can live off the death benefit’. But buying permanent life insurance may be too expensive for a retiree. And then there’s the issue about whether or not the wife can manage it to maintain an income for her life.

A reversionary annuity as an alternative
A reversionary annuity would supply an immediate annuity payout for the life of the wife at the death of the husband.  The funding for the ‘immediate annuity’ comes from the life insurance death benefit associated with the husband’s reversionary annuity premium payments.

The reversionary annuity is similar to a combination of term life insurance policy, a permanent life insurance policy, and an immediate annuity. The premiums that the husband would pay for the reversionary annuity may be less than those of a permanent policy and possibly competitive with a those of a term life policy. Yet the policy doesn’t stop at a given date like a term life policy does.

Most reversionary annuities dictate that once you chose the beneficiary, you can’t change it.   Thus, the premiums are typically less than typical life insurance because the issuing company can better estimate their total payout based on the known beneficiaries age.  Clearly, insurance companies can play the life expectancy statistics game for both the husband and beneficiary wife for such contracts to produce attractive policy premiums compared to the original permanent life insurance option.

Taxation of reversionary annuity payout
When the payout begins for the beneficiary, she’ll be taxed on only a portion of each payout in a fashion similar to most annuity payouts. The untaxed portion of each payment arises from the tax-free return of the reversionary annuity’s value at the time of the husband’s death. This is pro-rated by dividing that value by the remaining life expectancy of the beneficiary in months – for a monthly payment scheme.

An additional advantage is that annuity income attributed to principal is not included when calculating the taxability of Social Security benefits.

Although a reversionary annuity may offer an affordable way to provide a guaranteed income to protect your beneficiaries’ standard of living, not all of them are alike. Some have a return of premium benefit in case the insured outlives the beneficiary; some have inflation protection for payouts, and some don’t require the beneficiary to bypass a medical exam. But watch out, since premiums can increase over time. Read the fine print.

Note: that annuities once annuitized cannot be surrendered for value.  Income from deferred annuities is taxed as ordinary income and withdrawals prior to age 59 ½ are subject to a 10% penalty.  Income from annuitization is taxed part as ordinary income and part as return of capital. Any guarantees are based on the claims paying ability of the insurance company. Annuities should be considered long term investments. Annuities are insurance products and subject to insurance related fees and expenses. The purchase of life insurance involves costs, fees, expenses and potential surrender charges and depends on the health of the applicant.  Not all applicants are insurable. If a policy is structured as a modified endowment contract, withdrawals will be subject to tax as ordinary income and withdrawals prior to age 59 ½ are subject to a 10% penalty.

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