Inherited Annuity: What Are My Options?

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Understanding Your Choices

When you inherit an annuity, you are presented with several options that significantly impact your financial future. It’s crucial to understand these options to make the best decision for your situation.

Lump-Sum Distribution

A lump-sum distribution allows you to receive the entire annuity amount at once. This option is straightforward but comes with immediate tax implications. The inherited amount is considered taxable income for the year you receive it, which could push you into a higher tax bracket.

10-Year Rule

The 10-year rule requires you to withdraw the entire amount of the inherited annuity within ten years. You can take distributions at any time during this period, but the remaining balance must be fully distributed by the end of the tenth year. This option provides some flexibility and can help spread out the tax burden over multiple years.

Non-Spousal Beneficiaries

Non-spousal beneficiaries often have the option to take distributions over their life expectancy, commonly referred to as the “stretch” option. This method can minimize annual tax liabilities and allow the remaining balance to continue growing tax-deferred. However, it’s essential to start taking required minimum distributions (RMDs) by December 31st of the year following the annuitant’s death.

Spousal Beneficiaries

If you’re a spousal beneficiary, you have the unique option to assume the annuity contract as your own. This spousal continuance allows you to defer taxes and continue receiving payments based on the original terms of the annuity, providing a seamless transition and continued financial security.

Inherited Annuity Tax Calculator

Use this calculator to determine your Required Minimum Distributions (RMD) as a beneficiary of a retirement account.

How To Avoid Paying Taxes On An Inherited Annuity

  • Spousal Beneficiary Option: If you are the spouse of the deceased, you can roll over the annuity into your own name, deferring taxes until you withdraw the money.
  • Stretch the Payments: Opt for annuitization or periodic payments to spread out the tax liability over several years.
  • Inherited IRA Transfer: If the annuity is within an IRA, consider transferring it to an inherited IRA. This can allow for continued tax deferral based on required minimum distributions (RMDs).
  • Tax-Free Exchanges (1035 Exchange): Under certain conditions, you can exchange the annuity for another without immediate tax consequences. This can provide more favorable payout options and continued tax deferral.
  • Pay Taxes Now and Purchase a Bonus Annuity:
    • Strategy: Pay the taxes on the inherited annuity now and use the remaining funds to purchase a bonus annuity. A bonus annuity offers an upfront bonus on the initial premium, which can help offset the taxes paid on the inherited annuity.
    • Example: If you inherit an annuity worth $100,000 and the tax liability is $25,000, you can use the remaining $75,000 to purchase a bonus annuity. If the bonus annuity offers a 10% bonus, it adds an extra $7,500 to your contract value, potentially compensating for the taxes paid.
What Is An Inherited Annuitiy?

Qualified vs. Non-Qualified Inherited Annuities

When you inherit an annuity, understanding whether it’s qualified or non-qualified is crucial. Each type has distinct tax implications and distribution rules. Here’s a breakdown of the key differences:

Qualified Inherited Annuities

Qualified annuities are funded with pre-tax dollars, typically within retirement accounts like IRAs or 401(k)s. These annuities follow specific tax and distribution rules:

  • Tax Treatment: Distributions are fully taxable as ordinary income because the funds were initially contributed on a pre-tax basis.
  • Required Minimum Distributions (RMDs): The Secure Act 2.0 maintains the rule that most beneficiaries must deplete the inherited qualified annuity within 10 years of the original owner’s death. However, there are some exceptions for eligible designated beneficiaries.
  • Beneficiary Types:
    • Spouse: Can roll the annuity into their own IRA, treat it as their own, or continue it as a beneficiary.
    • Eligible Designated Beneficiary (EDB): Includes the spouse, minor children, disabled or chronically ill individuals, or individuals not more than 10 years younger than the deceased. They may be allowed to stretch distributions over their life expectancy.
    • Non-Eligible Designated Beneficiary: Must follow the 10-year rule, with the entire balance distributed by the end of the tenth year after the original owner’s death.

Non-Qualified Inherited Annuities

Non-qualified annuities are funded with after-tax dollars. They have different tax and distribution rules compared to qualified annuities:

  • Tax Treatment: Only the earnings portion of distributions is taxable. The principal, being after-tax contributions, is not taxed.
  • Distribution Options: Beneficiaries have more flexibility, such as:
    • Lump Sum Distribution: The entire value of the annuity is distributed in a single payment, with taxes owed on the earnings.
    • Five-Year Rule: The beneficiary can withdraw the entire amount within five years of the original owner’s death, paying taxes on the earnings portion.
    • Annuitization: The beneficiary can receive payments over their lifetime or a set period, with each payment containing a taxable earnings portion and a non-taxable return of principal.
  • Beneficiary Types:
    • Spouse: Can continue the annuity contract in their own name, deferring taxes until withdrawals are made.
    • Non-Spouse: Must choose one of the available distribution options within a year of the original owner’s death.

How We Can Help

At The Annuity Expert, we understand the complexities and emotional weight of managing inherited annuities. Our team has over 15 years of experience as an insurance agency, annuity broker, and retirement planner. We stand for finding the best solutions at the lowest costs, ensuring you make informed decisions that align with your financial goals.

The main problem our services solve is the confusion and potential financial missteps associated with inherited annuities. Symptoms of this problem include uncertainty about tax implications, overwhelming choices, and the fear of making costly mistakes. These issues can lead to stress, anxiety, and financial loss, impacting your peace of mind and future security.

By working with us, you’ll gain clarity and confidence. We provide personalized guidance, helping you navigate your options and implement strategies that maximize your benefits and minimize your tax liabilities. Our expertise and dedication to your financial well-being ensure you’re making the best decisions for your unique situation.

Inherited Annuity

What We Recommend

  • First Step: Initial Consultation
    • Schedule an initial consultation with our team.
    • Review your inherited annuity details and discuss your financial goals.
    • Benefit For You: Gain a clear understanding of your options and the potential impact on your finances.
  • Second Step: Personalized Strategy Development
    • Develop a personalized strategy tailored to your needs.
    • Outline the best options, considering factors like tax implications and long-term growth potential.
    • Benefit For You: Have a well-structured plan that aligns with your financial objectives and provides peace of mind.
  • Final Step: Implementation and Ongoing Support
    • Assist in implementing the chosen strategy.
    • Provide ongoing support to ensure everything progresses smoothly.
    • Benefit For You: Enjoy continued financial stability, minimized tax liabilities, maximized annuity benefits, and expert guidance whenever needed.

Features And Benefits Of Working With The Annuity Expert

We offer a range of features to support our clients, including:

  • Comprehensive Annuity Reviews: Ensure you understand all your options and implications.
  • Tax-Efficient Strategies: Optimize your financial decisions to minimize tax burdens.
  • Personalized Financial Plans: Tailor strategies to your unique goals and needs.
  • Ongoing Support: Provide continuous guidance and adjustments as needed.

These features mean you’ll make informed decisions, avoid costly mistakes, and achieve long-term financial security.

Addressing Common Objections

You might worry about the complexity of the process or fear hidden costs. We provide clear, straightforward advice with no hidden fees, ensuring transparency and trust.

Not working with us could result in missed opportunities and higher taxes, but partnering with The Annuity Expert guarantees expert guidance and optimal outcomes.

Experience the peace of mind and financial security that comes from making well-informed decisions about your inherited annuity. Contact us today for free advice or a free quote, and take the first step towards a secure financial future.

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Questions From Our Readers

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.

What happens if you inherit an annuity?

Inheriting annuity proceeds is not tax-free; all profits are subject to taxation as ordinary income. If the beneficiary opts for one lump sum payment, they must pay taxes immediately – this is the only circumstance in which paying at once applies.

Does an annuity end when a person dies?

If the plan were set up on a joint life basis, your beneficiary would continue receiving an allotment of the income you were already getting. However, payments would cease upon death if it’s a single-life annuity. So consider which option is best for you and those who depend on your financial stability.

Does an inherited annuity count as income?

Absolutely! Although your tax-deferred annuity income is subject to taxation, plenty of payout options may reduce the amount you owe in taxes. So maximize these opportunities and map out a plan for successful financial management!

How long does a beneficiary have to claim an annuity?

The claim period varies, but typically it’s within 1-5 years.

How long does it take for a beneficiary to receive an annuity payout?

It varies, but once a claim is filed and approved, it can take a few weeks to a few months for a beneficiary to receive the payout.

How long should an annuity process be without a beneficiary upon death?

If there is no beneficiary, the annuity proceeds go to the estate, and the timing depends on the probate process, which can take several months to over a year.

How do I report the annuity death benefit total distribution to the children of the parent?

Death benefits distributed to children should be reported on their individual tax returns, and IRS Form 1099-R is used to report distributions from annuities.

I inherited a non-qualified deferred annuity from my parents. Should I take a lump sum or a series of payments?

A series of payments because it avoids putting the beneficiary into a higher tax bracket.

Should you assume that annual service fees are applicable for a non-qualified inherited annuity?

Yes, it’s likely that annual service fees will apply. If a financial advisor is involved in managing the annuity, there are probably management fees. Additionally, if you are a surviving spouse who opted for spousal continuance of the annuity, and if the original contract included such fees, it’s quite probable that you will continue to pay these annuity fees. The terms of the annuity and its fee structure typically remain consistent even after the annuity is inherited.

What is the cost basis of an inherited annuity?

The cost basis of an inherited annuity is the original amount invested in the annuity by the deceased owner. Any growth or earnings on the annuity are subject to taxes when distributed to the beneficiary.

What is the 5-year rule?

The 5-year rule for inherited non-qualified annuities mandates that beneficiaries must withdraw the entire annuity balance within five years of the original owner’s death. Taxes are owed on the earnings portion of these withdrawals, but the principal amount is not taxed.

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Shawn Plummer is a Chartered Retirement Planning Counselor, insurance agent, and annuity broker with over 14 years of first-hand experience with annuities and insurance. Since beginning his journey in 2009, he has been pivotal in selling and educating about annuities and insurance products. Still, he has also played an instrumental role in training financial advisors for a prestigious Fortune Global 500 insurance company, Allianz. His insights and expertise have made him a sought-after voice in the industry, leading to features in renowned publications such as Time Magazine, Bloomberg, Entrepreneur, Yahoo! Finance, MSN, SmartAsset, The Simple Dollar, U.S. News and World Report, Women’s Health Magazine, and many more. Shawn’s driving ambition? To simplify retirement planning, he ensures his clients understand their choices and secure the best insurance coverage at unbeatable rates.

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

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