A child inherits an annuity: the payout windows non-spouse heirs face

An adult child who inherits an annuity does not get the open-ended choices a surviving spouse gets. Federal tax rules put a clock on the money, and the insurer adds its own forms and deadlines on top. The clock starts on the date of the owner's death, and a few of its dates pass quietly if nobody is watching. This post lays the dates out in order, using an invented family, so you can see what happens when and which decisions have a window.

The dates, amounts and people are hypothetical. The rules described are federal, they have exceptions, and they differ for annuities held in retirement accounts. The wider rules are in the guide on annuity beneficiaries and inherited annuity options, and a tax professional should confirm how they apply to a real contract.

The family and the contract

Say Helen, 78, owned a non-qualified deferred annuity, bought with $200,000 of after-tax money. When she died on September 10, 2026 (an invented date), the contract was worth $300,000, so $100,000 was gain. She named her daughter Priya, 45, as the sole primary beneficiary. Priya is not a spouse, not disabled and not a minor.

For this walk-through, assume the contract is non-qualified, meaning it is not in an IRA or employer plan, and that Helen had not yet started annuity payments. Later sections note what changes if the annuity was qualified or if payments had begun.

Day 0 to day 14: notice and records

The clock under the federal rules runs from the date of death, September 10, 2026. Two dates follow from it:

• September 10, 2027 is the end of the first year. To take lifetime or life-expectancy payments, the tax rules generally require that those payments begin within one year of death.
• September 10, 2031 is five years after death. If no lifetime-payment election is made, the rules generally require that the entire interest be paid out by then.

In the first two weeks Priya's tasks are practical:

1. Locate the contract, the latest statement and the insurer's contact information. The statement should show whether the annuity is qualified or non-qualified.
2. Order certified death certificates. The claim usually needs one, and the guide on what happens to an annuity when you die explains how the benefit is determined.
3. Notify the insurer. Many insurers assign a claim number and mail the forms; some accept a phone call or online notice.
4. Do not move the money out of the contract on her own initiative. Nothing in the contract needs to change in the first days, and the owner's accounts may be frozen in any case.

Weeks 2 to 8: the claim packet

The insurer's packet commonly includes a claim form for each beneficiary, a request for the certified death certificate, proof of identity, a tax form for reporting the payment and an election form for the payout choice. It may also include a statement of the death benefit value and a description of how that amount was calculated.

Priya should read the options page before signing anything. A claim form can include an election, and in some contracts a signed lump-sum request cannot be reversed. If the packet leaves a payout box blank, ask what the default is and by when the insurer expects a choice. Some contracts apply a default if the beneficiary does not elect, such as a lump sum or a payout over the five-year period, and the default may not be the one she would have chosen.

If there are several beneficiaries, each usually has a separate share and often a separate election. A sibling's decision does not have to match Priya's, though the insurer's rules govern whether shares can be treated differently.

Months 2 to 4: the insurer's figures and the options letter

Within a couple of months the insurer typically confirms the death benefit value and lists the options. This is the moment to ask for three numbers in writing: the value on the date of death, the cost basis and the amount of any charge or adjustment. Many contracts waive the surrender charge and any market value adjustment at death, but the contract wording controls, so confirm it.

The value on the date of death matters for tax. In this example, the gain is $100,000 ($300,000 minus the $200,000 basis). Between the date of death and the date of payment, the contract may earn interest or change in value if it holds variable subaccounts. Any growth after death is also taxable gain.

The payout choices and what each does to taxable income

A non-spouse beneficiary of a non-qualified annuity generally has these routes, though each insurer decides which ones it offers:

1. A lump sum. The whole value is paid at once.
2. Withdrawals over up to five years. The beneficiary takes money at times of her choosing, provided the contract is emptied within five years of death.
3. Waiting until the end of the five years. Taking nothing until the last permitted date, leaving the contract to grow tax-deferred meanwhile.
4. Payments over her life expectancy, if elected within the required window and begun within a year of death.

Here is what each does to Priya's taxable income, ignoring growth and fees for clarity. The gain is $100,000 and the basis is $200,000.

Look at the middle row. A five-year plan with equal withdrawals does not spread the taxable income evenly. Withdrawals from a deferred contract generally come out gains first, so Priya's first $60,000 is all gain, and the next $60,000 contains the last $40,000 of gain and $20,000 of basis. After that, the withdrawals are a tax-free return of basis. The taxable income is front-loaded. If her goal is to keep each year's taxable income as small as possible, the third row defers it but concentrates all of it in one year, and the unused money stays exposed to the contract's fees and investment risk.

The fourth route, lifetime or life-expectancy payments, works differently, and the details depend on how the insurer structures and reports the payments. Say Priya's life expectancy is roughly four decades, so the payment is about $300,000 ÷ 40 = $7,500 a year before growth. If the insurer treats the stream as annuity payments using an exclusion ratio, her basis share is $200,000 ÷ $300,000, or two-thirds, so about $2,500 of each year's $7,500 is taxable. If instead it reports the payments as withdrawals taxed gains-first, the full $7,500 is taxable each year until the $100,000 of gain is used up, which takes about 13 years. The first treatment spreads the tax over a very long period. The second does not. Ask the insurer how it will report the payments, in writing, before electing. The post the exclusion ratio: how annuitized payments split into basis and gain shows how the ratio works.

Month 12: the deadline for lifetime payments

The first-year window is the one most likely to be missed. If Priya wants payments over her life expectancy, the payments generally must start by September 10, 2027, and the insurer usually requires the election earlier than that so it can process the paperwork. If the window passes without an election, the five-year rule is generally what remains.

The same one-year rule is why insurers often send a reminder letter around the six-month mark. A reminder is not guaranteed, so she should put the date on her calendar.

Another point on timing: the tax rules also say that if the owner had already started annuity payments, the remaining payments must continue at least as fast as under the method already in use. A beneficiary of a payout annuity usually has no new election to make; the payments simply continue under the option Helen chose.

Year 1 and after: tax forms and estimated payments

In January after any payout, the insurer sends Priya a Form 1099-R showing the gross amount and the taxable amount. Check the taxable amount against the basis and value statement. If the insurer's records of the basis are wrong, correct them before filing.

Three points on the tax side:

• No 10% additional tax. Distributions after the owner's death are generally exempt from the additional tax for early withdrawals, so Priya's age of 45 does not trigger it.
• No step-up. The gain is ordinary income to her, whatever the date of the owner's death.
• Withholding. The default federal withholding on a lump sum may be well below the tax on a $100,000 gain. She may owe more at filing, and a tax professional can help estimate quarterly payments.

If the estate owed federal estate tax, a deduction for the part attributable to the annuity gain may be available to the beneficiary. Few estates owe it, and a tax preparer can say whether it applies.

Years 2 to 5: the five-year clock

If Priya chose a five-year plan, the work is a yearly check: has she taken what she meant to, and does the schedule still empty the contract by the deadline? She should note September 10, 2031, in a calendar and in her tax file. A contract that still holds money when the five years end may be subject to a forced payout, and the tax then falls on a single year.

During these years the contract is a beneficiary account, not an annuity she bought. She generally cannot add money, and the investment options or interest crediting may differ from Helen's. Fees continue. If the annuity holds subaccounts, market ups and downs affect the value, and the gain on the date she withdraws is what is taxed.

The final date, and what happens if the annuity was qualified

The final date for a non-qualified annuity under the five-year rule is September 10, 2031. For a qualified annuity inside an IRA or employer plan, the deadline follows different rules. Most non-spouse beneficiaries must empty the account by the end of the tenth year after the year of death, which would be December 31, 2036 here. If the owner died after the date required minimum distributions had begun, the beneficiary may also have to take annual distributions in the earlier years. Exceptions apply to certain beneficiaries, such as a minor child of the owner, a disabled person or a person not more than 10 years younger than the owner. A tax professional should confirm which rule applies. The guide on annuity beneficiaries and inherited annuity options lists them, and the glossary entry on required minimum distribution gives the definition.

Every dollar from a qualified account that held pre-tax money is generally taxable. The planning question becomes how to spread the withdrawals across the ten years, not whether to elect a payout.

If the beneficiary is a minor, a trust or the estate

A minor cannot sign a claim on her own, so a guardian or custodian has to act, and the guide on naming a minor child as life insurance beneficiary explains the problems. A trust may or may not be able to use the longer payout options, depending on its terms and the contract. When the estate is the beneficiary, the contract often defaults to the five-year rule and the money goes through probate first, as the guide on why naming your estate as beneficiary is usually a mistake describes. These cases are good reasons to involve an estate attorney early.

When several children share the contract

Say Helen had named Priya and two brothers in equal shares instead. The $300,000 value splits into three shares of $100,000, and each share carries a third of the basis ($200,000 ÷ 3, about $66,667) and a third of the gain (about $33,333). The deadlines are the same for each child, because they run from the date of death, but the choices can differ:

• One brother, who wants the money now, takes his $100,000 as a lump sum. His taxable gain is about $33,333 in the payout year.
• The other brother takes withdrawals over the five years. His first $33,333 withdrawn is all gain, and the remaining $66,667 is basis, so his tax falls in the early years.
• Priya elects lifetime payments, and the insurer tells her how they will be reported.

Insurers differ on whether each beneficiary can choose independently, and most divide the contract into separate shares once the claims are in. A brother who delays his claim paperwork does not stop the others, but a share nobody claims may be paid under the contract's default. If siblings disagree, the state insurance department's guidance on beneficiary disputes are the next places to look. It helps to tell each child the date of death and the two deadlines in writing, so that no one learns about the one-year window in month eleven.

What the insurer cannot tell you

Insurance company staff can explain the contract's options and the forms. They generally cannot tell you which option is best for your tax return, whether to hold the money or take it, or what you should do with the proceeds. Those decisions turn on your income, your other assets and your plans, and the people who can help are a tax professional for the return and a fee-only financial planner for the larger picture. A few questions are worth asking before the hour you spend with either one:

• What other income will I have in each of the next five years, and might it be lower in a particular year?
• Do I need any of the money soon, and if so, how much?
• Would I rather pay more tax in one year or spread the bill, and what does the spreading cost in fees and risk?
• Who will inherit the money I do not spend, and do those wishes change which route fits?

A checklist for the first year

1. Write down the date of death and the two dates that follow from it: one year and five years.
2. Get the insurer's confirmation of qualified or non-qualified status, the value, the basis and the options.
3. Ask which payout routes the insurer offers and by what date each must be elected.
4. Ask how each route will be reported on Form 1099-R.
5. Estimate the tax of each route with a tax professional before signing the election.
6. Keep copies of everything the insurer sends and everything you send back.

Key takeaways

• The federal clock for a non-spouse beneficiary of a non-qualified annuity starts at the date of death: lifetime payments generally have to begin within one year, and otherwise the contract must be emptied within five years.
• Equal withdrawals over five years do not spread the tax evenly, because gains come out first and the early withdrawals are mostly taxable.
• Lifetime payments can spread taxable income over many years, but how they are taxed depends on how the insurer structures and reports them, so ask before electing.
• A non-spouse beneficiary pays ordinary income tax on the gain with no step-up in basis, but the 10% additional tax for early withdrawals generally does not apply after the owner's death.
• A qualified annuity follows different rules, usually a ten-year limit for non-spouse heirs, so confirm the type of annuity first.