Inheriting An Annuity

Inheriting an Annuity From a Parent

What happens to an annuity after the annuity owner passes away depends on the terms of the annuity contract. Some annuities simply stop distributing income payments when the owner passes away.

In many cases, however, the annuity has a death benefit. This provision allows the annuity owner to select a beneficiary, such as a spouse or a child. The beneficiary might receive all the remaining money in the annuity or a guaranteed minimum payout, usually whichever is greater.

If your parent had an annuity, their contract will specify who the beneficiary is and may also have information about what payout options are available for the death benefit.

What Are the Tax Implications of Inheriting an Annuity?

Almost all inherited annuities are subject to taxation, but how an annuity is taxed depends on its type, beneficiary status, and payment structure. The beneficiary does not owe any taxes until they withdraw money from the annuity.

Generally, you’ll owe taxes on the difference between the initial premium used to purchase the annuity and the annuity’s value at the time the annuitant died. So, whatever portion of the annuity’s principal was not already taxed and any earnings the annuity accumulated are taxable as income for the beneficiary.

Usually, you can choose a lump sum or set up a stream of income payments. With a lump sum payout, you’ll owe taxes on the entire annuity value at once. A stream of payments, sometimes called a “stretch provision,” allows you to stretch out the tax burden of the annuity over time.

The tax implications of inheriting an annuity can also change depending on if the annuity you inherit is qualified or non-qualified. A qualified annuity is funded with pre-taxed money through a retirement account like an IRA or 401(k). Non-qualified annuities are purchased with after-tax dollars.

Income payments from a qualified annuity are treated as taxable income in the year they’re received and must follow required minimum distribution rules. If you inherit a non-qualified annuity, you will only owe taxes on the earnings of the annuity, not the principal used to purchase it.

What Are My Options for Handling an Inherited Annuity?

When you inherit an annuity from a parent, you have a few options for what to do with the money. You might choose a lump sum payout or stretch the payments out over your lifetime. You can also roll over the annuity into an inherited IRA or disclaim the annuity.

Taking a Lump Sum

Many people who inherit annuities opt to receive the value of the annuity contract in one payment, known as a lump sum distribution. This might be a good option if you need the money to pay off debts quickly or make a large purchase such as a house.

On the other hand, a lump sum payout can have severe tax consequences. Because you’re receiving the entire annuity at once, you must pay taxes on the entire annuity in that tax year.

Rolling It Over

Under certain circumstances, you may be able to roll over an inherited annuity into a retirement account. Beneficiaries who are not the deceased person’s spouse can only roll over an inherited annuity into an inherited IRA.

An inherited IRA is a special retirement account used to distribute the assets of a deceased person to their beneficiaries. The account is registered in the deceased person’s name, and as a beneficiary, you are unable to make additional contributions or roll the inherited IRA over to another account.

Only qualified annuities can be rolled over into an inherited IRA. Non-qualified inherited annuities can be exchanged for a different annuity contract instead of a rollover. This is called a Section 1035 exchange.

Stretching the Payments

When you inherit an annuity, you’ll usually have the option of a “stretch provision.” When you choose to stretch the annuity payout, you’ll receive regular payments throughout your life, similar to how an annuity normally works.

Stretching the payments of an inherited annuity can be beneficial, as it sets up a reliable stream of income. This payout option also spreads out the tax burden of the annuity, so you won’t owe taxes on the entire value of the annuity at once.

Disclaiming the Annuity

As with any inheritance, you do have the option to disclaim an inherited annuity. Disclaiming means you refuse to accept property or assets left to you by the deceased.

If you choose to disclaim the inherited annuity, the annuity’s value or death benefit is paid to any other surviving beneficiaries. The annuity will go into the deceased person’s estate if there are no other beneficiaries to give it to.

What To Consider When Handling an Inherited Annuity?

When thinking about how to deal with an inherited annuity, it’s important to understand how the inheritance will impact your own financial plan. An inherited annuity can be an unexpected windfall or a complicated financial burden, depending on how you choose to handle it.

If you decide to accept the inherited annuity, you must then choose how to receive the annuity’s payments. As discussed, each payout option has benefits and drawbacks. Your personal financial circumstances will dictate what’s best for you.

For example, if you also inherit an IRA from your parent, rolling over the annuity might be a simple and tax-efficient way to deal with those funds. You might choose a stretch provision if you want to safeguard your own retirement with guaranteed income. Or you could elect to receive the lump sum payout if you want to pay off a large debt quickly and aren’t worried about the increased tax liability.

Finally, you must determine what you’ll do with the money you receive from the annuity. Ryze recommended working with a financial consultant to make the most of the annuity funds.

What Role Can a Financial Advisor Play in Helping Me With an Inherited Annuity?

Consulting a financial advisor can be extremely helpful when dealing with a financial event as big as inheriting an annuity. Financial advisors help their clients manage their assets wisely, and they can help you figure out the best use of the annuity money for your financial needs.

Many financial advisors have knowledge of a wide scope of financial topics. They can not only advise you about investing the annuity money once you withdraw it, but also inform you about the tax implications and other concerns. A financial advisor can help you create a holistic financial plan and work with you to determine how your inherited annuity fits into that plan.

How Do I Find a Missing Policy or Annuity Contract of Someone Who Has Passed?

If you believe that your parent had an annuity contract but are unable to find a record of it, you may be able to recover it.

To find missing or lost annuity contracts, you can reach out to the National Association of Insurance Commissioners. The NAIC’s Policy Locator Service helps consumers locate life insurance policies and annuity contracts of deceased family members free of charge.

State insurance departments in Illinois, Louisiana, Michigan, New York, North Carolina and Oregon also provide free missing policy search services, according to the American Council of Life Insurers (ACLI). The ACLI also advises contacting your loved ones’ previous places of employment in case the policy was part of their employee benefits package.

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