Inherited Annuity and Beneficiary Payout Options

Some annuities can be passed on to a beneficiary after you die. This death benefit allows the person you select to inherit remaining payouts from the insurance company.

However, not all types of annuities include a death benefit, or it may be limited. This provision must be written into the contract you signed with the insurance company.

Different annuities have different payout options.

To receive an inherited annuity, your contract must include a death benefit provision and name a beneficiary.

Otherwise, payments will stop when you die, or the insurance company will keep any future payments.

If your contract includes a death benefit, remaining annuity payments are paid out to your beneficiary in either a lump sum or a series of payments.

You can choose one person to receive all the available funds or several people to receive a percentage of remaining funds.

You can also select a nonprofit organization as your beneficiary, or a trust established as part of your estate plan.

If you have inherited your spouse’s annuity, you can choose to transfer the annuity contract into your name.

Doing so allows you to keep the same options as the original owner, including the annuity’s tax-deferred status.

You will also be able to receive remaining funds as a stream of payments instead of a lump sum.

Non-spouses can also inherit annuity payments. However, they cannot change the terms of the contract and will only have access to the designated funds outlined in the original annuity agreement.

There are three main ways beneficiaries can receive inherited annuity payments.

Different tax consequences exist for spouse versus non-spouse beneficiaries.

Surviving spouses can change the original contract into their own name. This allows partners to enjoy the same tax-deferred benefits as the original annuity owner.

According to the Internal Revenue Service, spouses calculate the tax-free part of received annuity payments the same way the primary annuitant did.

Any beneficiary — including spouses — can choose to take a one-time lump sum payout. In this case, taxes are owed on the entire difference between what the original owner paid for the annuity and the death benefit. The lump sum is taxed at ordinary income tax rates.

Lump sum payouts carry the highest tax burden. The sudden influx of money may also push you into a higher tax bracket and further increase how much money you owe in taxes.

Spreading payments out over a longer time period is one way to avoid a big tax bite.

For example, if you make withdrawals over a five-year period, you will owe taxes only on the increased value of the portion that is withdrawn in that year. It is also less likely to push you into a much higher tax bracket.

A final option is spreading payments out over the beneficiary’s lifetime. This offers the least tax exposure but also takes the longest time to receive all the money.

If you’ve inherited an annuity, you often must make a decision about your death benefit quickly. Decisions about how you want to receive the money are often final and can’t be changed later.

Understanding your options is essential in order to make the best choice for your situation.