What Are Reversionary Annuities?
The term reversionary annuity refers to a retirement income strategy that combines an insurance policy with an immediate annuity to provide for a surviving spouse. Similar to a permanent life insurance policy, the policy owner of a reversionary annuity pays a premium to guarantee a benefit to the survivor. Upon the insured's death, the beneficiary receives a guaranteed lifetime income instead of a lump sum payment with a reversionary annuity.
- A reversionary annuity is a retirement income strategy that combines an insurance policy with an immediate annuity for a surviving spouse.
- The beneficiary receives a guaranteed lifetime income instead of a lump sum payment after the insured party dies.
- Policies are often terminated if the beneficiary dies before the insured individual.
- Beneficiaries do not owe income tax when the insured dies, and once payments begin, the tax is pro-rated based on how long the payments are expected to last.
How Reversionary Annuities Work
Annuities are designed by financial institutions to pay out a fixed amount of money at regular intervals to an individual—usually to retirees. The terms of these financial products depend on several different factors, including the type of annuity, when the payout begins, and the length of time for the payout. But annuities are not for everybody, and reversionary annuities are for fewer people still.
Reversionary annuities are a type of life insurance policy. Once the insured dies, the policy pays an annuity to the beneficiary. But payments only start if the beneficiary is still alive when the insured party dies. Unless specified otherwise, the policy is often terminated if the beneficiary dies before the insured individual. That's why this kind of annuity is also known as an insurance survivorship annuity.
Reversionary annuity policies are often terminated if the beneficiary dies before the insured individual.
Since the age and gender of the beneficiary can impact the premium, this allows people with serious medical conditions to become insured at a rate they can afford. With this type of annuity, the older the beneficiary, the lower the premium.
By paying the benefit out over many years, insurers aren't exposed to large lump-sum payouts. The policies typically lack a cash surrender option, which also helps keep costs down. Most policies dictate that once a beneficiary has been selected, it cannot be changed.
Because the income payments cease upon the death of the beneficiary, and if the beneficiary dies before the insured, the policy is terminated, premiums are more consistent with those of term insurance policies than permanent policies. This makes the reversionary annuity more affordable for older individuals.
A reversionary annuity's beneficiary will not owe income tax at the time of the insured's death. Once payments to the beneficiary begin, the tax is pro-rated based on how long the payments are expected to last. This means that part of the income is taxable, while another part is a tax-free return of the annuity's value at the time of the insured's death.
Annuities are tax-deferred investments, so any earnings accrued in the contract are not recognized as net investment income until they are distributed. Rather than choosing an investment that results in capital gains tax, which is considered net investment income, clients may prefer to use an annuity, which remains tax-deferred until distributions are taken. This may allow for more control of when net investment income would be assessed.
Distributions from a deferred annuity will still be included in the modified adjusted gross income (MAGI), and require clients to manage the distributions carefully to ensure the MAGI thresholds are not exceeded.
With that, they might be able to preserve the tax-deferral of their individual retirement accounts (IRAs) longer and not begin taking taxable distributions until required by law. Not all reversionary annuities are alike. Some offer inflation protection. Some have a return of premium benefit in case the insured outlives the beneficiary, while others allow the beneficiary to bypass medical exams.
Keep in mind that annuities are complex investments subject to fees and commissions and little or no access to the money you paid in, so be prepared to do substantial research before investing.