A cash refund annuity addresses a major concern of many retirement investors: What happens to the money if the investor passes away earlier than anticipated?
This annuity option ensures that if you (the annuitant) die before payout of the entire premium you paid, your beneficiary gets the remaining amount as a lump sum payment. Put another way, a person of your choosing receives the undisbursed cash in your annuity up to the limit of your premium payment(s).
In this article, we explain how cash refund annuities work, the tax implications, and how they may differ from other refund annuities.
What is a refund annuity?
A refund annuity refers to a provisional payout option sometimes added to an income or life annuity. This provision entails that if the annuitant dies before receiving annuity payments equal to the premiums paid, the insurer pays the difference to a beneficiary (typically the spouse).
How cash refund annuities work: Mechanics
The primary purpose of annuities in retirement is typically twofold: to provide a guaranteed income stream while the annuitant is alive, and to take care of their loved ones after their passing. Often, investors add a death benefit when purchasing an annuity to address the second concern. A cash refund annuity is one type of death benefit.
In a cash refund annuity, the annuitant’s beneficiary receives a lump sum if the annuitant dies prematurely. For example, if a retiree purchased a $200,000 annuity and received $100,000 in annuity payouts before passing away, the insurance company would write a check for the difference ($100,000) to the named beneficiary. This ensures you break even on the contribution.
It removes a downside of many straight life annuities — that payments will stop and you’ll lose part of your premium when you die.
SPIA structure, premium
The cash refund option typically falls under the Single Premium Immediate Annuity (SPIA) structure. With an SPIA, you make a one-time contribution and the insurer immediately starts making regular annuity payments. When the annuitant dies, the beneficiary receives the difference between the original contribution and the total of the annuity payouts made till that point. Not all SPIAs include a cash refund option though; you have to check to see if it is a part of your annuity contract. Alternatively, you can look for a cash refund rider that is an optional addition (typically for fee) that performs similarly.
Actuarial break-even concept
The basics of the cash refund option are straightforward. If you outlive the point where you have received payments equal to your original contribution, you’ll ultimately receive more than the initial premium. If you die sooner, you’re guaranteed to break even because your beneficiary receives the remaining balance.
The significance of this is that the cumulative payment you receive while living directly impacts the size of the lump sum payment your beneficiary will receive if you die before recovering your full contribution.
Role of age/gender/interest rates
Your insurance company determines the periodic payouts you’ll receive while you’re alive based on life expectancy among other factors. Younger annuitants tend to receive smaller payments because the insurer anticipates making payments for a longer period of time. The opposite holds true for older annuitants.
Along similar lines, because life expectancy is longer for women, they tend to receive slightly smaller payouts. However, more annuity companies are using unisex tables to calculate life expectancy, potentially equalizing payments.
If you purchase your annuity during a period of elevated interest rates, you might receive larger periodic payouts because of the high interest rate environments.
Rider vs. built-in option
Typically, the cash refund is included as a rider added on to your annuity, meaning you have to pay extra for the benefit. Some annuity companies include the cash refund provision as a built-in feature when you purchase an annuity.
Tax considerations
It’s important to distinguish between the tax treatment of periodic annuity payments and a lump sum payout as well as how the tax implications differ for annuitants and beneficiaries.
A simple rule of thumb (but not a catch all) is this: If the annuitant already paid tax on their investments, any return of those payments is non-taxable. However, the portion of annuity payments that reflect earnings generated on the original investments is treated typically like ordinary income and taxed accordingly.
Taxation of cash refunds or death benefits depends on the type of annuity:
- Non-qualified annuity: An annuity that was purchased with after-tax money is considered non-qualified. Since you’ve already paid taxes on the contribution, only the earnings portion is taxable. Your original premium comes back tax-free.
- Qualified annuity: An annuity that was purchased through a tax-advantaged account, such as IRA, is taxed normally. Since pre-tax dollars fund the principal contribution, all distributions — including a lump sum cash refund — are taxed as ordinary income.
Cash refund payments typically avoid probate because the payout goes directly to the named beneficiary, as stipulated in the annuity contract.
Installment, joint, and straight refund annuities
It’s important to understand the different annuity payout options to ensure you don’t lose your principal contribution.
Straight refund annuity option
Straight refund is a term often used when referring to the cash refund option. Particularly in the U.S., they mean the same thing. The term refers to the insurer making up for any difference between annuity contributions and annuity payments received till the annuitant’s passing.
To determine if the straight refund option or a straight life annuity makes more sense for you, learn more about straight life annuities.
Installment refund annuity option
Instead of paying out a lump sum of the difference between what the annuitant contributed and what they received till they passed away, the insurer spreads the amount into payouts over time. So, they make period annuity payments to the beneficiary until the break-even point is hit.
Joint refund annuity option
The joint refund annuity option is structured to deliver annuity payments to two people for life, typically spouses. Here are the most common joint refund structures.
Joint-life with cash refund
Annuity payments stop when both annuitants die, with any remaining principal paid as a lump sum to the beneficiary in the annuity contract. For example, a couple might list a child as the beneficiary to receive the lump sum (or any other benefits) after they both die.
Survivor options: 100%, 75%, or 50%
In a joint and survivor annuity, the primary annuitant receives lifetime annuity payments. When this individual passes away, the surviving annuitant keeps getting payments, but the amount depends on the chosen option.
At 100%, the survivor keeps getting the same payments, but at 75% they get only three-quarters of the original payment, and so on. The higher the percentage of survivor benefit, the lower the monthly payments will likely be while both are alive.
The joint refund option is available in addition to the survivor benefit, meaning if both people pass away before recovering the entire contribution, the remaining balance goes to the beneficiaries.
A guaranteed retirement income stream with Gainbridge
A cash refund annuity option confronts a major fear of many retirement investors — that they’ll prematurely die and lose their contribution. Opting for a cash refund ensures your beneficiaries get your due after your passing.
With Gainbridge’s fixed annuities, your premium grows at a competitive interest rate and can convert into a guaranteed stream of income you can count on for life, helping to reduce concerns about outliving your money and leaving nothing behind for your loved ones.
See how Gainbridge can help you personalize your retirement plan. Explore digital-first annuities — with no hidden fees and commissions — designed to help you grow and protect your savings and have something left over for your beneficiaries.
This article is intended for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice. For advice concerning your own situation please contact the appropriate professional. The GainbridgeⓇ digital platform provides informational and educational resources intended only for self-directed purposes. Guarantees are backed by the financial strength and claims-paying ability of the issuer.
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