An annuity is similar to a whole life insurance policy. It earns interest based on the company's investments and pays the owner a guaranteed monthly payment at retirement. When you open an annuity, you name beneficiaries to the money. Beneficiaries are those who will receive your money in the event of your death. Beneficiaries usually receive a set payment at the death of the annuity holder, so there is nothing to cash out.
While an annuity is an investment vehicle used to provide income through retirement, it is basically an insurance product with death benefits, unless you choose a product that cannot be part of your estate. Unless you set up an annuity that would continue to pay your heirs after your death, there is no product to cash out. An heir receives the death payment as determined in the original contract. If there are multiple beneficiaries, the money is divided and paid out after the death of the annuitant. Unlike an insurance payment however, since the money was invested before taxes were paid, your heir must report the inheritance on her current taxes.
The amount you leave to your beneficiaries from an annuity depends on the type of product you purchased. For example, you can own a life-only annuity that pays you a guaranteed monthly income for the rest of your life, but at your death, the account is closed with nothing left for your heirs. A life-only annuity pays the highest monthly stipend because of the lack of a pay-off at your death. A life-plus-10 annuity on the other hand, continues to pay your beneficiaries the monthly payment for 10 years following your death. Your heirs cannot cash out that type of annuity.
Variable annuities carry a death benefit with a guaranteed payout. At the time of your death, your beneficiaries receive the amount you agreed on when you purchased the investment. Typically the death benefit is guaranteed to be at least equal to the amount you originally invested. For example, if you invested $25,000 in a variable annuity and drew monthly payments for five years, your death benefit would still be $25,000 or higher, depending on how the investments in the market performed. Your monthly payments do not lower the final cash benefit paid to your estate.
The money you place in an annuity is yours and you can take part of the initial investment out without incurring a penalty after the age of 591/2. If you withdraw part of your original investment, that will reduce the death benefit of your policy. So if you had the $25,000 annuity and took out $10,000 one year from the principal, your heirs would receive at least $15,000. If your investment grew over time, your heirs would receive the interest earned on the account as well.
Linda Ray is an award-winning journalist with more than 20 years reporting experience. She's covered business for newspapers and magazines, including the "Greenville News," "Success Magazine" and "American City Business Journals." Ray holds a journalism degree and teaches writing, career development and an FDIC course called "Money Smart."