Most variable annuity (VA) contracts include a portion of insurance coverage that gives a benefit in the event of loss of life. The loss of life gain is normally triggered by the death of the annuitant, although there are contracts where the loss of life of the contract holder triggers the gain. This is because annuities allow the owner and the annuitant to be completely different individuals.
Key points to remember
- Death benefits in a variable annuity (VA) can also be triggered by the death of the annuitant or contract holder.
- The charge for a VA Life Loss Gain is part of the Mortality Cost and Expenses (M&E), included in the VA prospectus, and can be up to 2% of the contract value.
- The usual life loss gain is initially set to the amount invested and then reset in response to the contract. Once fixed, it only decreases if the contract holder takes a distribution.
- Enhanced death benefit riders, which guarantee an annual increase in the monetary value of the PV, can be used to extend the value of the benefit in the event of the beneficiary’s death.
- Before investing in a variable annuity with M&E fees, consider the additional prices and whether or not the benefits are important in your situation.
The value of a death benefit
The payment for the usual lost profit in a VA is part of the mortality and expense (M&E) cost, which varies by contract and share class in addition to the insurer.VA share prices – which encompass B, C and L – are normally tied to the size of the contract abandonment schedule. The M&E fees for each share class can be found in the VA prospectus.
Many AVs that only invest in the investment do not include a typical loss of life profit and have no M&E payments. However, for a VA that has an M&E cost, the price can be as excessive as 2% of the contract value. The payment is billed annually and insurers use various strategies to calculate when the payment is automatically removed from the VA cash value. When you have a VA price of $250,000 and an M&E cost of 1.25%, for example, you’re essentially paying $3,125 a year for insurance coverage. For many people, this is usually a very expensive way to buy a limited amount of life loss (with a price that continues to increase if VA stability increases).
How vanishing perks work
The usual life loss gain in a VA is available from the start, regardless of the amount invested. Depending on the VA, the loss of life gain is then reset, on the contract anniversary date if the contract price has increased or whenever the contract price reaches a new high. Other investments in the annuity can also help increase the loss of life profit. Once established, the loss of life gain does not decrease if the value of the contract decreases, but it certainly decreases if the contract holder takes a distribution. The adjustment could also be dollar for dollar or less.
Many contracts additionally offer an enhanced loss of life rider that can be purchased for an additional payment of approximately 0.5% to 1.0% of the contract value. The additional payment is billed annually. Benefits for enhanced loss of life differ, but many contracts provide an assured annual increase. The contract could, for example, guarantee that the gain in the event of loss of life will increase by a maximum of 5% per year or be reset at the best price of the contract. Over time, it is not uncommon for a VA to end up with a life loss gain greater than the exact value of dropping the contract.
Annuity recipients may pay income or capital tax on the death benefits they obtain, but these benefits do not need to be subject to probate.
Maximization methods
If you already own or are considering buying a VA with M&E fees, here are some methods to consider.
For a conservative investor or someone with a short life expectancy who wants to return the VA money to their partner (or someone else) but is worried about an investment that may lose value, the increase in loss of life offers a solution. Since the value of the enhanced loss of life benefit increases each year, the beneficiary is guaranteed to get the higher of the loss of life benefit or the market value of the VA. There is no risk of loss. This technique also allows the investor to allocate funds more aggressively, ensuring that a safeguard is in place in case they were to ride out a market downturn.
In a current VA, where the loss of gain in life is greater than the monetary value, the contract can be partially surrendered. In a partial waiver, you allow some of the money into the contract, which helps protect some of the profit from loss of life. For this technique to work, make sure you leave enough money in the VA to cover all future M&E and contract costs.
Also, be sure to test any remaining surrender fees before making a distribution, and if the VA is an IRA, be sure to make a change from trustee to trustee.
Special problems
In 2019, the US Congress passed the SECURE Act, which made changes to pension plans containing annuities. The new ruling makes annuities more portable. In other words, if you quit your job, your 401 (ok) pension can be transferred to another plan at your new job. Additionally, the new pension legislation removes some of the legal risks for annuity providers by limiting whether an account holder can sue them if the provider goes bankrupt and cannot honor annuity funds.
For many who have named beneficiaries in their retirement accounts, the new ruling removed the “stretch provision.” Prior to the decision, a beneficiary of an IRA can extend required minimum IRA distributions over time, which further lengthened the taxes owed on inherited funds.
Beginning in 2020, non-spouse beneficiaries are expected to distribute all funds from the inherited retirement account within 10 years of the death of the owner. Nevertheless, there are exceptions to the brand new legislation. Therefore, it is essential for purchasers to seek the advice of a tax and monetary expert to assess the new changes to retirement accounts and their named beneficiaries.
The back line
Variable annuities with M&E fees can be an expensive technique to make investments in case you don’t want the added benefits. Before making a financing decision, it’s essential to fully understand what you’re paying and assess whether or not the extra price is smart in your specific situation.
