Decoding the Tax Implications on Annuity Death Benefits

Shawn Plummer

CEO, The Annuity Expert

Understanding the nuances of taxes, particularly about annuity death benefits, can often feel like navigating an intricate labyrinth. The questions increase—Are death benefits taxable from an annuity? How are annuities taxed at death? How does the tax treatment differ between qualified and nonqualified annuities? This guide seeks to shed light on these pivotal questions, offering clear, concise, and accurate information on the taxation of annuity death benefits.

Confused About Annuities?

Are you new to annuities and unsure where to begin? Visit our Annuity Learning Lab for expert guidance and insights.

Understanding Annuities and Their Death Benefits

Annuities, essentially contracts between an individual and an insurance company, can be a reliable source of income during retirement. However, when the annuitant dies, the contract doesn’t simply dissolve. Instead, a death benefit becomes payable to a designated beneficiary. The taxation on this annuity death benefit can significantly vary depending on several factors.

Taxes On An Annuity Death Benefits

The Taxation of Annuity Death Benefits

Contrary to popular belief, an annuity death benefit is not universally taxable or tax-free. Instead, its tax status depends on the annuity type and the beneficiary’s payout mode.

Qualified Annuities

Qualified annuities are those that are funded with pre-tax dollars. The death benefit from a qualified annuity is generally entirely taxable. This is because the entire amount, including the original investment and the earnings, has not been taxed.

Example: Let’s assume Tom invested $50,000 pre-tax dollars into a qualified annuity that grew to $100,000. When Tom dies, Jane must pay taxes on the entire $100,000 as income because none has been taxed yet.

Annuity Death Benefits Taxable

Nonqualified Annuities

On the other hand, nonqualified annuities are funded with after-tax dollars. Therefore, only the earnings portion of the annuity death benefit is taxable. The return of the principal (the original investment) is typically tax-free.

Example: Suppose Tom, instead, invested $50,000 of his already taxed income into a nonqualified annuity, which grew to $100,000. After Tom’s death, Jane must only pay income tax on the $50,000 earnings part of the annuity death benefit. The original $50,000 that Tom invested won’t be subject to further taxes.

Special Consideration: Spousal Continuance

Sometimes, the surviving spouse can continue the annuity contract in their name. This provision, known as spousal continuance, can offer significant tax advantages, including the deferral of taxes on the annuity’s growth.

Example: If Tom’s spouse, Mary, is his chosen beneficiary, she might have the option to continue the annuity contract in her name. This means she can continue to defer taxes on the annuity’s growth until she chooses to withdraw the funds.

How Is An Annuity Taxed At Death

The Implications of Taxation at the Death of an Annuity Holder

Understanding how an annuity is taxed at death is vital for annuity holders and their beneficiaries. This knowledge can help inform decisions about annuity investment, payout options, and estate planning.

Next Steps

In conclusion, the taxation of an annuity death benefit is influenced by the type of annuity—qualified or nonqualified—the payout mode, and the potential for spousal continuance. Furthermore, contrary to the general tax-free status of life insurance death benefits, an annuity death benefit often has tax implications. Armed with this knowledge, you can make informed decisions, ensuring that you or your loved ones are not caught unprepared when navigating the complexities of annuity taxation upon death.

The Death Benefit Taxable From An Annuity

Request A Quote

Get help from a licensed financial professional. This service is free of charge.

Contact Us

Is a qualified or nonqualified annuity a better choice?

Whether a qualified or non-qualified annuity is better depends on your financial goals. Qualified annuities provide tax-deferred growth, meaning you won’t have to pay taxes on any gains until you start taking distributions. Non-qualified annuities are not eligible for these tax advantages, so there may be more potential for growth with a qualified annuity.

If I die, will the annuity inheritance be taxable income?

It depends on the type of annuity you have. Qualified annuities, such as those held in an IRA or 401k, are subject to income taxes upon inheritance by your heirs. Non-qualified annuities do not incur this tax burden and instead may be passed on without any direct taxes due. Speaking with a financial advisor is essential to understand the best option for your situation.

What are the benefits of owning an annuity?

Annuities can provide various benefits depending on the type of annuity you choose. These include tax-deferred growth, guaranteed income, potential death benefit payments, and protection from market losses. Additionally, some annuities may offer bonus payments or other incentives that can help maximize your return. Understanding the details of each annuity option before investing is important, so speak with a financial advisor about what would best meet your needs.

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. 

Scroll to Top