What Are Inherited Nonqualified Annuities?

Shawn Plummer

CEO, The Annuity Expert

In the landscape of financial planning, nothing seems quite as perplexing as the realm of annuities – and when it comes to the inherited nonqualified annuity, the waters become even murkier. The labyrinth of rules and regulations governing this financial tool can often seem overwhelming. Fortunately, we’re here to make it a breeze for you. With this comprehensive guide’s insights, you’ll soon navigate the inherited annuity territory confidently and clearly.

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Understanding Nonqualified Annuities

1.1 What is a Nonqualified Annuity?

A nonqualified annuity is a contract between you and an insurance company, primarily used as a long-term investment tool for retirement savings. It differs from a qualified annuity because its contributions are made with after-tax dollars. Hence the term “non-qualified.”

 Non Qualified Annuity Inheritance

Inheriting a Nonqualified Annuity

When you inherit a nonqualified annuity, you essentially step into the shoes of the original annuitant. The rules and options you’ll need to understand as a beneficiary depend primarily on your relationship with the deceased and the decedent’s age at the time of death.

Inherited Nonqualified Annuity Distribution Options

Inheriting a nonqualified annuity involves understanding various rules and options that can significantly impact the inheritance’s taxation and financial planning aspects.

  • Spousal Continuance Provision: If the annuity beneficiary is the deceased’s spouse, they can opt for a spousal continuance. This means they effectively step into the original owner’s shoes, continuing the contract as if they were the original owner. This option allows the deferral of taxes until withdrawal and extends the period of tax-deferred growth.
  • Lump Sum Payout: A beneficiary can receive the annuity’s value as a lump sum. This requires the total value of the annuity to be paid out at once, and any gains above the original investment amount will be subject to income tax in the year the lump sum is received.
  • 5-Year Rule: In the absence of a spousal continuance, non-spouse beneficiaries must adhere to the 5-year rule, requiring the total value of the annuity to be distributed within five years of the original owner’s death. Taxes on the gains are paid as the distributions are taken over this period.
  • Life Expectancy Rule: Non-spouse beneficiaries can take distributions over their life expectancy. This method, also known as “stretching,” allows the beneficiary to spread out the tax liability over many years while continuing the tax-deferred growth of the annuity’s balance. The first distribution must be taken no later than one year following the death of the original owner.
Inheriting A Non Qualified Annuity

The Inherited Annuity 5-Year Rule

The inherited annuity 5-year rule is a fundamental element to understand when dealing with an inherited nonqualified annuity. It mandates that the beneficiary withdraws the annuity’s funds within five years of the original owner’s death. This rule applies unless the decedent received payments based on their life expectancy.

Example: If Susan’s mother had not yet begun receiving payments from the annuity, Susan must comply with the inherited annuity 5-year rule. She will need to entirely withdraw the $200,000 from the annuity within five years of her mother’s death, with any growth on the original investment being subject to tax.

Nonqualified Annuity Beneficiary Options

Your options as a beneficiary differ depending on whether you’re a spouse or a non-spouse inheritor. Non-spousal inherited annuity spousal continuance isn’t an option. However, non-spouse inheritors can take immediate lump-sum distributions or opt for the aforementioned 5-year rule.

 Inherited Nonqualified Annuity

Managing a Nonqualified Inherited Annuity

Inheriting nonqualified annuities can be a double-edged sword, bringing about potential tax implications. Your choices in managing these can have significant financial consequences, making it crucial to seek competent financial advice.

Next Steps

Inheriting a nonqualified annuity has various options, each bearing its financial implications. Understanding these intricacies can guide you in making sound decisions that align with your financial goals. Remember, knowledge isn’t just power but peace of mind regarding inherited annuities.

Inherited Non Qualified Annuity

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If I have an inherited nonqualified annuity, do I have to pay taxes on it?

Yes, you must pay taxes on an inherited, nonqualified annuity. The IRS considers any distributions from a nonqualified annuity taxable income and requires taxes be withheld from the payments made to beneficiaries. Depending on your tax bracket, withholding and taxes due could range from 10% to 39.6%.

Can the inherited nonqualified annuity income move me into a new tax bracket?

Yes, it is possible that the income you receive from an inherited, nonqualified annuity could move you into a new tax bracket. The IRS considers any distributions from a nonqualified annuity to be taxable income. If the distribution amount puts you in a higher tax bracket than your current one, you must pay taxes at that rate.

Is it better to take the income from an inherited nonqualified annuity in a lump sum or use the five-year rule?

The answer to this question depends on various factors, including your income, applicable tax brackets, and financial goals. Generally speaking, taking the income in smaller increments would result in lower overall taxes due than if you took the money in one lump sum payment. That said, consulting with a qualified tax professional is essential to determine the best course of action for your particular situation. Additionally, the 5-year rule allows for spreading the taxes due across five consecutive years, which can provide more tax savings than a lump sum payment.

Can I transfer an inherited nonqualified annuity to another person?

It is possible to assign or transfer an inherited nonqualified annuity to another person. However, this process is subject to the rules and regulations of the insurance company that issued the annuity, so it’s essential to review your policy documentation and speak with a qualified financial professional before taking action. Additionally, certain taxes may be due if you assign or transfer an inherited nonqualified annuity, so it’s essential to consult with a tax advisor before making any decisions.

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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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