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Options When Inheriting An Annuity Account

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Annuity InheritanceDepending on your situation, usually you’ll have several options when inheriting an annuity. Your decisions can have significant effects on withdrawals, taxes, and future investment options.

That’s why it’s important to find the right help when deciding how to proceed. A good accountant, annuity broker and/or financial advisor can help you maximize your inheritance.

Different Options For Different Relations

Your options with an inherited annuity will depend on who you are. Spouses typically have the most flexibility. In most cases, a spouse can either continue the annuity, end the contract and take a full withdrawal, or take systematic withdrawals over time. If it’s a well-performing annuity, it can make sense to keep the policy as is. Other times, it’s a good idea to end the contract or start withdrawals in order to fund a more competitive product.

Children of the annuity owner usually cannot continue the contract as a spouse might. This means the child (or children) must begin taking withdrawals. This can happen all at once or over time. If there are significant tax-deferred gains in the annuity, then systematic withdrawals may be wise in order to reduce income taxes.

Extended family and non-relatives will have similar options as would a child. These beneficiaries are usually required to take a full withdrawal or systematic payments. Non-children may have to withdraw all funds over a shorter time period, however.

The reason is that most annuities grow tax-deferred, but not tax-free. IRS rules require distributions on a taxable basis. You do not get a stepped-up basis when inheriting an annuity.

Qualified vs Non-Qualified Funds

There is some confusion with these two terms, but they simply refer to the contract’s tax status. Qualified annuities are those where the original deposit was not taxed. In other words, they are retirement accounts. Most commonly they are IRA accounts, but can also be 401(k) or 403(b) accounts as well.

Non-qualified funds are those where the original deposit was already taxed. Non-qualified annuities are funded with post-tax money from the bank or another non-qualified annuity… perhaps one that was transferred using a 1035 tax-free exchange. That’s not to say there can’t be tax-deferred gains in a non-qualified annuity. There usually are, but the deposit will always have been made with post-tax dollars.

The important thing to know is that the IRS treats these two types of money differently. Your options when inheriting a qualified annuity are much different than those with a non-qualified policy.

Inheriting A Non-Qualified Annuity Policy

Again, the rules vary depending on who you are, but non-qualified annuities allow for more flexibility when the owner/annuitant has passed away. The insurance company will send you paperwork detailing your options. Spouses of the deceased have the most as mentioned above.

Sometimes it makes sense to keep the policy going, other times it’s wise to take it out all at once – or systematically over time. In other cases, a 1035 tax-free exchange into a new policy is a wise thing to do. It depends on your financial needs and how much tax-deferred growth exists in the contract.

If you’re a sole inheritor and there are significant deferred taxes, then stretching the payments is wise… especially if you don’t want to jump into a higher tax bracket.

Non-Qualified Stretch Annuity Options

One option for the children and/or spouse of the deceased is to stretch the policy proceeds over their lifetime. This way small incremental payments can be withdrawn based on the beneficiary’s life expectancy.

This is a very smart way to reduce taxable income while generating a pension-like income stream for life. Not all annuity companies offer this option, however.

In many cases, you have to transfer the old annuity you’re inheriting (using a 1035 exchange) to a new one that allows for the non-qualified stretch option. There are a handful of large, well-rated insurance companies specializing in non-qualified stretch annuity conversions.

Choosing the right one is important. Since this is typically a long-term decision, you want a policy offering competitive rates and diverse investment options. Our independent brokerage can help. We’ll illustrate the top options available in the fixed MYGA markets and highest indexed annuity accounts for your review.

Qualified Annuity Inheritances

Congress recently changed the rules when it comes to inheriting qualified funds. This is true whether it’s an annuity or any other investment. The line in the sand is the year 2020.

If you inherited your qualified funds before 2020, typically you can stretch payments out over a lifetime. However, funds inherited after 2020 must now be distributed in their entirety over ten years. After ten years, there can no longer be any funds left in the policy.

In other words, the funds must be completely withdrawn and taxes paid on the principal and interest. This is frustrating for consumers as this was not how IRA rules were originally established. Now it’s much harder to defer taxes on most accounts.

The rules still are evolving, but options are limited. There are some annuities designed for ten-year drawdowns if you inherited your annuity after 2020. We will illustrate the top indexed and the best fixed-rate annuity options for you in this category as well.

Choosing The Best Path Forward

The information above is a general explanation that applies to most annuity beneficiaries. It is not tax advice. When inheriting an annuity, you’ll want to consult your accountant and talk with a knowledgeable annuity broker.

This way, you’ll be informed as to all of your choices. There isn’t always a right or wrong way to withdraw your portion. Siblings may choose different options altogether for example.

What’s important is examining all options carefully. Especially when it comes to non-qualified stretch accounts. This is the option we see that’s most frequently overlooked as most insurance companies do not adequately explain it.

Contact us for a free annuity consultation today.

Category: Annuities

Last updated on August 15th, 2023