Growing a Legacy: A Death Benefit Audit on an Inherited VA (Ethel, 64)
Ethel came to us at 64 with a different problem than most people who request an audit. She didn’t need income. Between her teacher’s pension and Social Security, her monthly cash flow was solid. What she had was $180,000 sitting in a Variable Annuity she had inherited from her late husband six years ago, and a clear goal: get as much of that money as possible into her two adult daughters’ hands when she passed.
The audit found that her existing VA’s “enhanced death benefit” rider had become a fee she was paying for almost no benefit. By exchanging into a current-generation Fixed Indexed Annuity with a true stepped death benefit guarantee, Ethel could project a death benefit growing to $245,000 in 10 years versus the existing contract’s projected $185,000 – roughly $60,000 more passing to her daughters at the same point in time.
- Client
- Ethel, age 64
- Contract Type
- Nonqualified Variable Annuity (inherited, stretched)
- Account Value
- $180,300
- Years Held (since inheritance)
- 6 years (original contract 14 years old)
- Annual Fees
- 3.40% (M&E + admin + subaccount + death benefit rider)
- Goal
- Maximize legacy to two adult daughters
The “Death Benefit Rider That Doesn’t Step Up” Problem
When Ethel’s late husband bought the contract in 2012, he paid 0.55%/yr for an “Enhanced Death Benefit” rider. The brochure language promised that the death benefit would step up to the highest account value on each contract anniversary, locking in market gains for heirs.
It sounded great. In practice, the subaccounts the rider was layered over had been volatile, and the actual step-ups happened far less often than expected. The death benefit on the contract today sits at roughly $182,000 – barely above the account value. Ethel has been paying about $1,000 a year for a feature that has functionally added almost nothing.
What Her Contract Actually Looks Like
| Annuity Type | Inherited Nonqualified Variable Annuity |
|---|---|
| Original Issue Date | 14 years ago (inherited 6 years ago) |
| Surrender Period | Completed |
| Current Account Value | $180,300 |
| Current Death Benefit | $182,100 |
| Annual M&E + Admin Fees | 1.45% |
| Subaccount Fees (avg) | 0.95% |
| Death Benefit Rider Fee | 0.55% |
| 10-Year Projected Death Benefit (no rider step-ups) | ~$185,000 |
At 3.40% in total annual fees, Ethel’s account was struggling to outgrow its drag. The death benefit rider was technically still in force, but for the past several years the subaccount net performance hadn’t been strong enough to trigger fresh step-ups. She was paying for a guarantee that wasn’t actually guaranteeing anything new.
Three Paths Forward
Projected death benefit at 10 years
Why the FIA Won This Audit
Option 3 produced the highest projected number. We recommended Option 2 anyway, and the reasoning matters.
The MYGA-plus-life-insurance combo only works if the client qualifies for life insurance at acceptable rates. Ethel is in good health for 64, but underwriting is never guaranteed – and the moment any of her lab work or family history surfaced an issue, the projected $255K would shrink fast. The audit recommendation has to survive contact with reality.
The FIA option, by contrast, is contractual. The carrier guarantees the annual death benefit step-up regardless of Ethel’s health, the market, or anything else. The 0.85% rider fee is fixed. The principal is protected. The growth comes from index crediting (typically 3-6% per year over a long horizon for a conservative FIA strategy). And the same step-up mechanism that didn’t fire on her variable subaccounts does fire on an FIA, because FIAs never have a negative crediting year. Every locked-in gain becomes a new death benefit floor.
The Beneficiary Story
Ethel’s death benefit will pass to her two daughters non-probate, directly via beneficiary designation. There is no will contest, no court process, no waiting. (Our full breakdown of how this works is here: What Happens to Your Annuity When You Die.)
For inherited nonqualified annuities, the beneficiaries will owe ordinary income tax on the gain portion only – the cost basis carries through. In Ethel’s case, the original cost basis on her late husband’s contract was about $95,000, so roughly $90,000 of the projected $245,000 death benefit will be taxable as ordinary income to her daughters, split between them. That tax bill is unavoidable regardless of which option she chose, but the FIA option produced the largest dollar amount net of tax.
What the audit revealed
Ethel was paying for a death benefit rider that wasn’t doing what the brochure suggested it would. A current-generation FIA with a contractual stepped death benefit projected roughly $60,000 more to her daughters at the same 10-year horizon, with no health underwriting required, on the same $180,300 of money.
The right answer was not “annuities are bad for legacy.” It was “your inherited contract was built for accumulation. Move the money into one built for transfer.”
What This Means If You Have a Similar Contract
Anyone holding an inherited annuity – or any annuity bought primarily for legacy reasons – should audit the death benefit rider performance. Three things tend to be true:
- The rider you’re paying for may not be stepping up. Variable annuity subaccount volatility means promised “anniversary step-ups” trigger far less often than illustrated.
- FIA death benefit riders fire more reliably because FIAs never credit a negative year – every positive crediting period creates a new floor.
- A 1035 exchange preserves cost basis, so the tax treatment to your heirs doesn’t change. Only the projected dollar amount they receive does.
The audit models projected death benefit at 5-year, 10-year, and 15-year horizons across all options so you can see the legacy math directly. Request your free audit here.
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Request my free auditAbout this case study. The client featured here is anonymized — name changed and some details adjusted for privacy. Account values, fee percentages, and income figures reflect actual audit outcomes for clients with similar contracts. Individual results will vary depending on contract specifics, carrier, current market rates, and client goals.
Before considering exchanging one annuity contract for another, all aspects of the exchange should be considered, including but not limited to cost, guaranteed interest rates, surrender charges, rider costs, possible rating changes, and different features and benefits of the two contracts. A 1035 exchange must be carefully evaluated for tax and contractual implications. Annuities are long-term investments designed for retirement planning. Withdrawals prior to age 59½ may result in a 10 percent federal tax penalty, in addition to any ordinary income tax. The guarantee of the annuity is backed by the claims-paying ability of the issuing insurance company.
Variable annuities are securities under federal law and may be considered securities under state law. If a variable or registered annuity is part of an audit, securities-related services are provided through First Palladium, LLC, Member FINRA. Past audit outcomes are not a guarantee of future results.
