What covers the cost of a variable annuity death benefit?

What is a variable annuity death benefit?

A variable annuity death benefit is a guarantee built into the contract: if you die while the contract is still in the accumulation phase (before you've converted it to income payments), the insurer pays a specified amount to whoever you named as beneficiary, usually the greater of the account's current value or total premiums paid in, minus withdrawals¹. Many contracts let you pay extra for an enhanced or "stepped-up" version that locks in a higher value along the way, such as the highest value the account reached on a contract anniversary⁸. If you die after you've already started taking guaranteed income payments, beneficiaries may not receive anything further unless the annuity guarantees a minimum total payout or you chose a continuing payout option¹. A variable annuity is an investment and insurance product, not a life insurance policy, and this death benefit is one feature built into its fee structure⁴.

What actually covers the cost of the death benefit?

The guarantee is funded by charges the insurer deducts from your account value, whether or not a death ever triggers a payout.

The mortality and expense (M&E) risk charge funds the basic guarantee

The main charge that covers the cost of the basic death benefit is the M&E risk charge, which the NAIC describes as "a fee charged on variable annuities... a percentage of the account value invested in subaccounts"¹. The SEC illustrates it with a worked example: at an annual rate of 1.25%, an average account value of $100,000 generates about $1,250 in M&E charges for the year³. It compensates the insurer for the risk it may pay out more than the account is worth.

An enhanced or stepped-up death benefit costs extra

Adding a richer death benefit means paying an additional rider charge on top of the M&E charge. The NAIC notes that "you can add features (called riders) to many annuities, usually at an extra cost," and lists enhanced death benefits among them¹. FINRA similarly lists charges "for special features and riders, such as stepped-up death benefits," as a layer separate from the base M&E charge⁴.

The death benefit is not reduced by a surrender charge

Variable annuities carry a surrender charge on early withdrawals, but it does not apply to a death payout. New York's Department of Financial Services states that "death benefits are not treated as surrenders and, as such, are not subject to surrender charges"⁸, and the NAIC tells buyers to look for "waivers for events (such as a death)" in the surrender-charge terms¹.

Fund, administrative and state premium-tax charges add cost without funding the guarantee

Underlying fund charges on the subaccounts you invest in, which can include "an investment management fee, distribution and service (12b-1) fees, and other fees," plus a separate administrative fee, affect how fast your account grows, without funding the guarantee itself¹. Some states also charge a premium tax; the NAIC notes the insurer "may subtract the amount of the tax when you pay your premium... or when it pays a death benefit to your beneficiary"¹. Ask the company directly whether it applies to your contract.

How much does each layer typically cost?

What happens if the insurance company fails?

None of these charges protect a beneficiary if the insurer becomes insolvent; that separate risk is covered by state guaranty associations, which step in when an insurer fails by moving policies to a solvent insurer or paying claims directly⁹. Most states protect at least $250,000 in annuity contract value per owner, per company, and several, including Connecticut, Minnesota, New York, Utah and Washington, protect up to $500,000⁹. This is a backstop of last resort, not a normal death claim.

How fast is the death benefit paid to a beneficiary?

Federal tax law, not the contract, sets the outer deadline for a nonqualified annuity: "the entire interest in such contract will be distributed within 5 years after the death of such holder" (26 U.S.C. § 72(s), checked 2026-09-23). A beneficiary can avoid that lump-sum deadline by electing, within 1 year of the death, to stretch payments "over the life of such designated beneficiary" instead (26 U.S.C. § 72(s), checked 2026-09-23). A surviving spouse can instead have the relevant provisions "applied by treating such spouse as the holder of such contract" and continue it (26 U.S.C. § 72(s), checked 2026-09-23).

Is the death benefit taxable to the beneficiary?

Yes. The NAIC states that "when you die, your survivors will typically owe income taxes on any death benefit they receive from an annuity"¹; the IRS directs beneficiaries to Publication 575 for the income-inclusion rules⁶. A nonqualified annuity's beneficiary owes tax only on the gain above what the owner paid in; a qualified annuity's beneficiary owes tax on the entire payout. Unlike many other inherited assets, an annuity's gain does not get a step-up in basis; see our step-up in basis guide.

How does this vary by state?

The "free look" period, how long you have to cancel a newly purchased annuity, is set by state law rather than the insurance contract. It varies, so confirm the current rule with your state insurance department before relying on a number below.

Steps for a beneficiary claiming a variable annuity death benefit

• Get several certified copies of the death certificate.

• Find the annuity contract or latest statement; note the insurer's name and the policy number.

• Contact the insurer's claims department directly, not just the original selling agent, and ask what forms are required.

• Confirm the death benefit amount and valuation date used, usually the greater of account value or premiums paid in.

• Choose a payout option: lump sum, the 5-year rule, a life-expectancy stretch elected within 1 year, or spousal continuation (26 U.S.C. § 72(s), checked 2026-09-23).

• Confirm the Form 1099-R tax reporting with the insurer and a tax professional before filing.

• Keep every form, letter and confirmation until the claim is closed.

What should go in your family guide?

This is the kind of detail that gets lost between the day someone buys a contract and the day their family needs it. For each annuity you own, record:

• The insurance company's name and claims-department phone number
• The contract or policy number
• Whether it is qualified (held inside an IRA) or nonqualified, since that changes the tax treatment
• The named beneficiary or beneficiaries, and whether a rider adds an enhanced death benefit
• Where the original contract and most recent statement are kept

This is the kind of information a family guide, such as the one Omliva helps families build, keeps in one place, so a beneficiary is not starting a claim from a name on an old statement. See our beneficiary designations checklist for how to keep every named-beneficiary account current.

What mistakes do people commonly make?

• Assuming the death benefit is paid on top of the account value, when in most contracts it is a floor under it.
• Not checking whether a rider was ever added; a contract without one only pays the basic amount.
• Missing the 1-year window to elect life-expectancy payments, after which the default 5-year rule applies (26 U.S.C. § 72(s), checked 2026-09-23).
• Assuming the payout is tax-free; it is generally taxable as ordinary income¹.
• Forgetting that annuities do not receive a step-up in basis, unlike many other inherited assets.
• Waiting to notify the insurer, since deadlines run from the date of death.

When to get professional help

Start with the insurer's claims department for the claim itself. Bring in a tax professional before choosing between a lump sum, the 5-year rule or a life-expectancy stretch, since the choice affects how much tax is owed and when. If the annuity is held inside an IRA, coordinate with whoever handles inherited IRA distributions. Bring in an estate attorney if the beneficiary designation is unclear, out of date or contested.