Inherited Annuity

An annuity is a type of investment that provides income on a regular basis. A life annuity, for example, starts paying income after the initial purchase and typically ends when the purchaser dies.  Inheriting an annuity can provide you with some options that are not available to recipients of other forms of inheritances.

How Inherited Annuities Work

An annuity is a contract that can contain many investments. You purchase an annuity for money or other assets, and the purchaser promises to pay you back income over time.  The term of the annuity can be anywhere from five years to 30 years or longer. Recipients of inheritances don’t have many options. Inheritances are usually either cash or property, and the estate gets to decide what you received.  If you inherit an annuity, you can take ownership of it after the original owner dies (the “annuitant”). An annuity is not like other investments that typically only pay income to the original owner. 

Benefits of Inherited Annuity

The benefits of inheriting an annuity depend on a few factors, including the age of the annuitant, the type of annuity, and the state where it is purchased. These are some of the benefits of the inherited annuity:

  • The payments may be larger than those you would receive from other inheritances.
  • The annuity might have life insurance protection that can pay out a death benefit to your beneficiaries. 
  • The annuity payments are typically tax-free, which is not the case with other types of inheritances. 
  • The income from an annuity can be used to supplement Social Security or other retirement income. 
  • You can continue to receive payments from the annuity for your lifetime, even if you are not the original owner of the policy. 
  • The payments from an annuity can be used to pay for health care expenses

How to Inherit an Annuity

If you are the beneficiary of an annuity, you will need to take a few steps to inherit it. 

Accomplishing Forms

You should contact the company that holds the annuity and ask for a copy of the beneficiary designation form. This is the form that lists who should receive the payments from the annuity when the annuitant dies.  You will need this document to start the process of transferring ownership.  Typically, you must complete a form with your contact information and send it back to the company that holds the annuity.  Then, the company will send another form to be signed by all living beneficiaries who are listed on the beneficiary designation form. Unless an immediate family member is listed on the form, it will be necessary for you to go through probate court.

Tax Rules

When you inherit an annuity, there are certain tax rules that may apply. Look into these rules before transferring ownership of the annuity.  For example, if the original owner purchased the annuity with pre-tax dollars, then your beneficiary cost basis is adjusted accordingly.  Inheriting an annuity can be a complex process, but taking the necessary steps could help you continue to receive payments for a long time.  It can provide you with many benefits, but it is important to understand the process and the tax rules before making any decisions.

Distribution Options for an Inherited Annuity

When you inherit an annuity, you will have three distribution options: You can take the payments over your lifetime, you can take a lump-sum of the cash value, or you can continue to receive payments as before. 

Lifetime Payment

If you choose to receive lifetime payments, it is important to understand that the timing of those payments will depend on several factors.  For instance, if your annuity was established with a specific number of years remaining, then you may have to take distributions over that same period of time. Otherwise, your account balance could diminish significantly. This payment method can be helpful if you want to ensure a steady stream of income. 

Lump-Sum Payment

If you take the lump-sum payment, you will receive the cash value of the annuity. This amount may be less than the total payments that would have been made over your lifetime.  When you receive a lump-sum from your annuity, it will be taxed as ordinary income. It can also have adverse effects on your tax bracket and capital gains rates if the annuity was established with non-qualified money.  This option may be best if you need the money sooner than the lifetime payments would provide. 

Continued Lifetime Payments

The third option is to continue receiving the payments as before. This may be helpful if you are comfortable with the payment amounts or you prefer stable, regular income over time. This route also ensures that your inherited annuity will not disappear after several years due to market fluctuations.  When you continue receiving payments, it is important to understand that the payments may be smaller than if you took the lump sum.

Key Takeaways

Inheriting an annuity can be a complex process, but taking the necessary steps could help you continue to receive payments for a long time. It can provide you with many benefits, but it is important to understand the process and the tax rules before making any decisions.  When you inherit an annuity, you will have three distribution options: You can take the payments over your lifetime, you can take a lump-sum of the cash value, or you can continue to receive payments as before.  It is important to understand the implications of each option before making a decision. Remember, inheritance isn’t just life insurance policies and annuities. Be sure to check your accounts, investments, and other assets to see who your beneficiaries are. This can be an important step in ensuring that your loved ones will receive what you want them to when you die.

An annuity is a financial product that provides payments to the owner over a set period of time or for the lifetime of the owner. Annuities can be either immediate or deferred.
An inherited annuity is an annuity that is transferred to a beneficiary after the owner's death.
The three distribution options for an inherited annuity are: taking payments over your lifetime, taking a lump-sum of the cash value, or continuing to receive payments as before.
The payout may depend on when the annuity was established. Inherited annuities can be immediate or deferred, which means that they usually start immediately or after a set amount of time from when they were established.
An inherited annuity is taxed as ordinary income.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.