Estate Planning Tool: Reversionary annuities; A guaranteed lifetime income to beneficiaries

A growing concern amongst retirees and those close to retirement is the ability to care for their survivors. When it comes to providing benefits for survivors, life insurance and annuities are great estate- planning tools. Upon the death of the insured, beneficiaries avoid probate, receive immediate payment and the proceeds can be protected from creditors. However, most life insurance and annuities policies are expensive. Fortunately, the reversionary annuity is gaining popularity as an estate- planning tool because it combines the features of a term life insurance policy, a permanent life insurance policy and an immediate annuity in order to provide survivors a guaranteed lifetime income, without the high costs.

Some of the advantages it offers are premiums competitive with term life insurance, without the coverage being stopped at a predetermined date. Additionally, it guarantees benefit to survivors, similar to permanent life insurance, but instead of a lump sum benefit, it pays the beneficiaries a guaranteed lifetime income. This protects against the possibility that the beneficiary will make poor financial decisions and end up with insufficient income later in life. Furthermore, its annuity feature means that each dollar is leveraged to maximize the amount for a beneficiary.

Reversionary annuities are typically much less expensive because a reversionary annuities’ value is derived from the beneficiary outliving the policy owner. Moreover, the cost of the policy is based upon the life expectancies and medical history of the policy owner and beneficiaries. Additionally, because the policy is paid for over time, a reversionary annuity provides a more affordable option. The beneficiary of a reversionary annuity will not owe income tax at the time of death of the policy owner. This results in the beneficiary receiving the value of the premium payments tax-free. Once the beneficiary starts receiving payments, the tax will be pro-rated based on how long the payments are expected to last.

What about the disadvantages? A reversionary annuity is irrevocable once it is established. Most policies state that once a beneficiary has been selected, it cannot be changed. Furthermore, unless otherwise specified, the policy often is terminated if the beneficiary dies before the insured individual. If the beneficiary predeceases the policy owner, the policy is terminated and no death benefit is paid out. Thus the lifetime income benefit may not be transferred to another individual. Also, this type of annuity does not provide the investment type qualities of many life insurance policies. However, because annuity income is not included when calculating the taxability of Social Security benefits, this could result in higher net income for a beneficiary than they would receive from their other investments.

For a client seeking to provide a viable financial security plan for survivors, the reversionary annuity can serve as a prudent estate-planning tool.