Inherited Annuity: What Are My Options?

Shawn Plummer

CEO, The Annuity Expert

Are inherited annuities taxable? I will be receiving an inherited annuity. What’s the best way to handle this large sum of money? This guide will provide you with a few options for both qualified and nonqualified annuity beneficiaries on how you can efficiently inherit the death benefit.

What happens when I inherit an annuity?

If you inherit an annuity, you may have to pay taxes on your money. You may also have to pay fees to cash out the annuity. If you keep the annuity, you will usually have to start taking withdrawals from it.

What is the best thing to do with an inherited annuity?

The best thing for a surviving spouse is to keep the annuity intact through spousal continuance and name new beneficiaries. The annuity won’t be taxed immediately, placing the widow in a higher tax bracket. For non-spousal beneficiaries, consider rolling the inheritance into another deferred annuity with a premium bonus to offset any taxes owed.

If these options don’t work, it may make sense to cash out the annuity and invest the proceeds in a way that makes more sense for their financial needs and goals.

Some factors to consider when deciding what to do with an inherited annuity are:

  • The size of the inheritance
  • The age of the beneficiary
  • The tax implications of cashing out or keeping the annuity
  • The fees associated with cashing out or keeping the annuity
  • The financial needs and goals of the beneficiary

How much tax do you pay on an inherited annuity?

The tax rate on an inherited annuity depends on the type of annuity and the beneficiary’s relationship to the person who purchased the annuity.

If the annuity is an immediate annuity, the entire payout is taxed as ordinary income in the year it is received.

If the annuity is a deferred annuity, the taxable portion is the difference between the purchase price of the annuity and the total amount of payments received. This portion is taxed as ordinary income in the year it is received.

The beneficiary’s tax rate also depends on their relationship with the person who purchased the annuity.

What are the fees associated with cashing out an inherited annuity?

If you cash out an inherited annuity, you may have to pay taxes on the money you receive. You may also have to pay fees to cash out the annuity. If you keep the annuity, you will usually have to start taking withdrawals from it.

Qualified Vs. Nonqualified Death Benefits

  • Qualified Inherited Annuities = All death benefits will be subject to taxes.
  • Nonqualified Inherited Annuities = Only the interest earned will be subject to taxes.

Nonspousal Inherited Annuity

If you’re a non-spousal beneficiary, you may have the option to transfer the death benefit amount into a new inherited annuity. This method will provide a way to spread your tax liability while allowing the inheritance to continue growing.

The Benefits

Continuing the annuity’s growth

Transferring the death benefit into an inherited annuity, your assets may continue to grow, which can significantly boost your inheritance over time.

Spread income tax impact over time

Collecting the death benefit as a lump sum payment could leave you with a significant tax burden. However, utilizing an inherited annuity, your money will not be taxed until you make a withdrawal.

Designating your beneficiaries

With a new inherited annuity contract, you will be able to name a new beneficiary in case of your premature death.

Spousal Inherited Annuities

The same options apply to spousal inherited annuities, but with one additional option, spousal continuance. Spousal continuance will allow the surviving spouse to continue the deceased’s annuity and avoid paying taxes at death. Any withdrawals from now on will be subject to ordinary income taxes.

Things To Know

  • In many cases, the IRS requires the first payment from an inherited IRA to be made by December 31 of the calendar year following the owner’s death. Likewise, the first payment from an inherited non-qualified annuity must be made by the first anniversary of the owner’s death.
  • If the death benefit is paid directly to you, a new inherited annuity will no longer be an option. If you decide to open an inherited annuity, the death benefit will need to be transferred to another insurance company that will accept inherited annuity funds.
  • The IRS requires you to withdraw a minimum amount each year in many cases. Required Minimum Distributions (RMD) for an inherited IRA or a 72(s) payment for an inherited non-qualified contract. In some cases, a final distribution must be made from an inherited IRA annuity after ten years.

Can I roll over an inherited annuity?

In general, you cannot roll over an inherited annuity. However, there are a few exceptions.

If the deceased were your spouse, you might be able to roll over the annuity into your account. This is called a spousal rollover.

If the deceased was younger than age 59½ at the time of death, you might be able to postpone withdrawals from the annuity for up to five years. This is called a 5-year rule rollover.

In both cases, you will have to pay taxes on the money you receive from the annuity.

What are the penalties for cashing out an inherited annuity?

If you cash out an inherited annuity, you may have to pay taxes on the money you receive. You may also have to pay fees to cash out the annuity. If you keep the annuity, you will usually have to start taking withdrawals from it.

Penalties for cashing out an inherited annuity depend on the type of annuity and the beneficiary’s age.

Immediate annuities typically have a 10% early withdrawal penalty if you are younger than 59½.

Deferred annuities may have a surrender charge if you cash out the annuity within a certain number of years. This charge is usually 5-10% of the

Who pays taxes on annuity at death?

The beneficiary of an annuity pays taxes on money received from the annuity. The tax rate depends on the type of annuity and the beneficiary’s relationship to the person who purchased the annuity.

If the annuity is an immediate annuity, the entire payout is taxed as ordinary income in the year it is received.

If the annuity is a deferred annuity, the taxable portion is the difference between the purchase price of the annuity and the total amount of payments received. This portion is taxed as ordinary income in the year it is received.

The beneficiary’s tax rate also depends on their relationship with the person who purchased the annuity. For example, if the beneficiary is a close relative, such as a spouse or child, they may be eligible for a lower tax rate.

Consider Life Insurance

If you want to leave money to your beneficiaries, life insurance might be better. In some cases, you don’t need to take a medical examination. Instead, compare instant life insurance quotes to determine if affordable coverage is available. Coverage starts at $9.37 per month.

Bottom Line

An annuity is a financial product that can be passed down from one generation to another. If you inherit an annuity, you may have to pay taxes on your money. You may also have to pay fees to cash out the annuity. If you keep the annuity, you will usually have to start taking withdrawals from it. An inherited annuity can be a great way to receive income, but it is essential to understand the associated costs before making any decisions.

Inherited Annuity

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Frequently asked Questions

Can an annuity be inherited?

An annuity can be inherited by the beneficiary of the annuity owner’s choosing. The beneficiary can be anyone, including a family member, friend, or charity.

Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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