Annuity beneficiaries and inherited annuity options

When an annuity owner dies before the annuity pays out, the money goes to the named beneficiary, outside the will and probate. What the beneficiary can do with it, and how it is taxed, depends on two things: whether the annuity is non-qualified (bought with after-tax money) or qualified (held in an IRA or other retirement plan), and whether the beneficiary is the spouse. A surviving spouse usually has the most flexibility; other beneficiaries face a deadline for emptying the contract.

Before the owner dies: three setups to know

• Deferred annuity in the accumulation phase. The beneficiary typically receives the contract's death benefit, often the greater of the account value or the premiums paid minus withdrawals, depending on the contract. See what happens to an annuity when you die.
• Annuity in payout. What happens depends on the payout option chosen at annuitization. A life-only payout stops at death with nothing left, while a period-certain, refund or joint-and-survivor option continues payments to a beneficiary or survivor. See what is an annuity and how does it work?.
• Owner and annuitant different. In a non-qualified contract the owner and the annuitant (the person whose life measures the payments) can be different people, and which one dies determines what is triggered. Check the contract.

Beneficiary options: non-qualified annuity

Federal tax law sets required distribution rules for non-qualified annuities. Under 26 U.S.C. 72(s), if the holder dies before the annuity starting date, the entire interest in the contract must generally be distributed within five years after death. Two exceptions matter:

1. Life or life-expectancy payments. If a portion is payable to a designated beneficiary (an individual) and is paid over that person's life or over a period not longer than life expectancy, with payments beginning within one year of the death, the five-year limit does not apply to that portion.
2. Spousal continuation. If the designated beneficiary is the surviving spouse, the spouse is treated as the holder of the contract. The spouse can keep the annuity going, continue the deferral and take their own withdrawals later, which is why most insurers offer "spousal continuation."

If the owner dies after annuitization, the remaining payments must go out at least as fast as under the method already in use.

Other points for a non-qualified annuity:

• Taxes: the part of the payout that is gain is ordinary income to the beneficiary; the original premium (cost basis) comes back tax-free. Annuities do not receive the stepped-up basis that stocks or real estate get at death, so the deferred gain is taxable when received. See how annuities are taxed.
• A beneficiary who takes a lump sum owes tax on all the gain in that year, which can push them into a higher bracket.
• The insurer has its own forms and deadlines. Check them, because the insurer may default to a lump sum if you do not elect another option in time.

Beneficiary options: qualified annuity (IRA or plan)

A qualified annuity inside an IRA or a retirement plan follows the retirement account rules rather than the five-year rule. Since the SECURE Act applies to deaths after 2019, most non-spouse beneficiaries must empty the account by the end of the 10th year following the year of the owner's death, according to the IRS. The rule has exceptions for "eligible designated beneficiaries": a surviving spouse, a minor child of the account owner, a disabled or chronically ill person, and someone not more than 10 years younger than the owner. Those people can generally take distributions over their life expectancy instead.

Under the IRS's beneficiary guidance:

• A spouse who is the sole beneficiary can keep the account as an inherited account, take distributions over their own life expectancy, or roll it into their own IRA. The sole-beneficiary determination is made by September 30 of the year after death.
• A non-spouse who is not an eligible designated beneficiary generally follows the 10-year rule. If the owner died on or after their required beginning date for required minimum distributions, the beneficiary also generally has to take annual distributions in the years before year 10 under final regulations that took effect in 2025. Confirm which applies with the plan or a tax professional.
• Missed required withdrawals can bring an excise tax of 25% (10% if timely corrected within two years), according to the IRS.
• Every dollar withdrawn from a traditional (pre-tax) IRA annuity is generally taxable income, so the pace of withdrawals within the 10 years is a tax-planning choice. A Roth IRA annuity is generally tax-free to the beneficiary if the account was open long enough, but the 10-year clock still applies to non-eligible beneficiaries.

Comparing the options

Steps for a beneficiary

1. Get certified death certificates and contact the insurer's claims department. The insurer will mail claim forms and election options.
2. Find out whether the annuity is qualified or non-qualified. The insurer's statement should say so.
3. Ask for the death benefit value and whether surrender charges, market value adjustments or interest credits apply. Many contracts waive surrender charges at death.
4. Compare payout options against your tax situation, not only the headline amount. Spreading a taxable payout across years may save tax.
5. Elect in writing before the insurer's deadline and before any distribution deadline in the tax rules.
6. Do not cash out by mistake. A lump sum from a qualified annuity cannot be rolled back into the account if you are not the spouse.
7. Speak with a tax professional before choosing, especially for large balances.

For annuity owners: naming beneficiaries well

• Name primary and contingent beneficiaries on every annuity and keep them current. The designation controls, not your will.
• Avoid naming the estate. It can force a faster payout and exposes the money to probate and creditors.
• Name individuals (or a carefully drafted trust) rather than a minor outright; see naming a minor child as life insurance beneficiary.
• Coordinate your annuity designations with your IRAs and life insurance. See how to choose a life insurance beneficiary.
• Compare an annuity's death benefit with life insurance if leaving money to heirs is your main goal. See life insurance vs annuities: opposite tools for opposite risks.
• Annuity benefits are protected by state guaranty associations up to limits that vary by state if an insurer fails. See state guaranty association coverage lookup.

Key takeaways

• Annuity death benefits go to the named beneficiary outside probate; the beneficiary designation controls over the will.
• For non-qualified annuities, 26 U.S.C. 72(s) requires payout within five years unless the beneficiary takes life-expectancy payments starting within a year, and a spouse can continue the contract.
• For qualified annuities, most non-spouse beneficiaries must empty the account within 10 years, with exceptions for spouses, minor children, disabled or chronically ill people and those close in age to the owner.
• Gain in an inherited annuity is taxed as ordinary income and gets no step-up in basis.
• Check the insurer's election deadlines and talk to a tax professional before taking a lump sum.