Inherited Annuity: What Are My Options?

Shawn Plummer

CEO, The Annuity Expert

Understanding the Basics Of An Inherited Annuity

  • Inherited Annuity: This is an annuity that a beneficiary receives upon the death of the original annuity owner.
  • Inheriting an Annuity: When you become the recipient of an annuity due to the demise of the original holder, you are inheriting it. There is a spousal beneficiary and a non-spousal beneficiary, both comes with various tax implications and distribution rules.
  • Non-Qualified vs. Qualified Annuities: Annuities can either be non-qualified or qualified. The primary difference lies in their tax treatment. Non-qualified annuities are funded with after-tax dollars, while qualified annuities are typically part of a retirement plan like an IRA and are funded with dollars that have not been taxed.
Inherited Annuities

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Inherited Annuities: Qualified vs. Nonqualified

Inherited Qualified Annuities

Qualified annuities are funded with pre-tax dollars, often as part of an individual retirement account (IRA). Here are the options if you inherit a qualified annuity:

  • Lump Sum Payout: You can withdraw all the funds at once. However, this could push you into a higher tax bracket and result in a hefty tax bill since the entire amount is taxable as ordinary income.
  • 10-Year Rule: Introduced by the Secure Act of 2019, this rule requires most non-spouse beneficiaries to withdraw all funds within ten years of the original owner’s death. You can take distributions at any time during this period as long as the account is emptied by the end of the tenth year.
  • Spousal Continuance: This option is exclusively for surviving spouses. The spouse can assume ownership of the annuity, allowing them to defer distributions until the annuity’s original payout schedule begins. This effectively avoids the 10-year payout rule.

Inherited Nonqualified Annuities

Nonqualified annuities are funded with after-tax dollars. When you inherit a nonqualified annuity, the options are slightly different:

  • Lump Sum Payout: You can take all the funds simultaneously with a qualified annuity. However, only the earnings portion of the annuity will be subject to taxes.
  • 5-Year Rule: Some nonqualified annuities may still be subject to this rule, depending on the annuity contract’s stipulations. It requires all funds to be withdrawn within five years of the original owner’s death.
  • Life Expectancy Option: For nonqualified annuities, some non-spousal beneficiaries may have the option to stretch distributions over their lifetime, depending on the specific contract terms. The earnings portion of each payout will be taxable.
  • Spousal Continuance: As with qualified annuities, the surviving spouse can continue the annuity contract as the original owner, deferring distributions and potentially allowing for more tax-efficient payouts.
What Are Inherited Annuities

Inheriting Annuities: Tax Implications and Exceptions

Taxation isn’t always cut and dried when it comes to inherited annuities. A few exceptions and unique circumstances might change how your inherited annuity is taxed.

Spousal Continuance

Spouses who inherit an annuity have a unique option called ‘spousal continuance.’ This allows the surviving spouse to continue the annuity contract as the original owner, avoiding any payout rule and potential immediate tax implications.

The 5-Year Rule and Lump Sum Payouts

While the Secure Act enforces a 10-year payout period for most inherited nonqualified annuities, some older contracts still follow the ‘5-Year Rule,’ which means all funds must be withdrawn within five years. Moreover, opting for a lump-sum payout might seem attractive but could catapult you into a higher tax bracket, resulting in more taxes owed.

What Is An Inherited Annuitiy?

Making the Best of Your Inherited Annuity

  • What is the Best Thing to Do with an Inherited Annuity?: This largely depends on your financial goals. Some might opt for immediate cashing out, while others might choose a rollover to another retirement account.
  • How Do I Avoid Paying Taxes on an Inherited Annuity?: While you can’t entirely avoid taxes, strategies like rolling it into a new deferred annuity or considering a 1035 exchange can offer tax benefits.
  • Inherited Annuity Options: Beneficiaries have several options, from taking a lump-sum payment, stretching the payments over their life expectancy, or abiding by the 5 or 10-year rules.

Helpful Tip: If you’re a living annuity owner reading this guide, consider purchasing a new or replacing an old annuity with a new deferred annuity that offers an enhanced death benefit to help offer most, if not all, taxes your beneficiaries will have to pay at the time of your death.

How To Avoid Paying Taxes On An Inherited Annuity

While taxes on inherited annuities are unavoidable, certain strategies can reduce the tax burden. A surviving spouse can use ‘spousal continuance’ to maintain the annuity and defer taxes. Beneficiaries can reinvest in bonus annuities to counterbalance taxes with premium bonuses. Living annuity owners can secure enhanced death benefits or opt for joint payouts, potentially providing tax-free income to surviving spouses, especially with Roth IRA Annuities.

Things To Consider

When dealing with inherited annuities, several key points matter:

  • Tax Issues: If the annuity’s owner and the person receiving the annuity payments are different, it can lead to tax problems, especially if the beneficiary is under 59 ½.
  • Annuity Loans: If you take a loan on an annuity, any unpaid amount will lower the eventual death benefits.
  • Minor Beneficiaries: Money for minors is placed in a custodial account until they’re older, with rules varying by state.
  • Controlled Payouts: Annuity owners can set specific payout terms for beneficiaries, affecting how and when they receive the money.

Next Steps

Inheriting an annuity can be a financial boon, but navigating the rules and tax implications is essential. Whether you’ve just inherited an annuity or are planning for the future, understanding your options and obligations can make a world of difference. Remember, while this guide provides a comprehensive overview, consulting with a financial advisor can offer personalized advice tailored to your situation. Stay informed, make wise choices, and let your inherited annuity serve you well. If you’re interested in rolling the inherited into a new annuity, contact us below for a quote.

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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.

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.

How do you handle an inherited annuity?

If you find yourself in possession of an inherited annuity, your choices are plentiful. First, you can keep it as is and let the payments continue over time. You could also take a one-time lump sum payout or spread the money over multiple years. Finally, for more flexibility when dealing with taxes, consider performing a 1035 exchange and rolling the funds into an inherited IRA instead; this will give you access to various investment options for greater returns on your investment.

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. It’s important to check the specific annuity contract or consult Nationwide directly.

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 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.

*Disclosure: Some of the links in this guide may be affiliate links. I may receive a commission at no cost if you purchase a policy. It helps us keep the lights on!

Shawn Plummer

CEO, The Annuity Expert

Shawn Plummer is a licensed financial professional, 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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