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Taxes and Your Inherited Annuity


One of the perks of purchasing an annuity is the ability to pass it down to heirs when the time comes. But with this feature comes significant tax implications that your beneficiary must deal with. The potential tax liability could climb as high as hundreds of thousands of dollars, according to a recent article from Financial Planning magazine. If a beneficiary elects for a lump-sum distribution when inheriting a non-qualified deferred annuity, they could pay full income taxes on any earnings without knowing their other options.

The issue “creates a challenge as people are trying to sort out the affairs of a deceased parent or grandparent,” said Laird Johnson, the senior director of advanced markets for AXA Distributors. “They have to move it over within 12 months. It’s really that beneficiary taking that first distribution which really cements what kind they’re taking.”

One alternative option is the so-called stretch option, spreading out the distribution over their life expectancy and allows the beneficiary to be in control of when the funds are subject to taxes. Funds that are left in the annuity keep growing on a tax-deferred basis under the control of the beneficiary. When a beneficiary is in their 50s and 60s, it’s important that they understand that they will likely end up in a lower tax bracket if they wait until they are older to receive the distributions.

Another option is a 1035 exchange if the inherited annuity doesn’t look like a good fit. Inherited contracts aren’t eligible for transfer to a long-term care insurance policy, but their are other choices. For example, AXA’s Investment Edge variable annuity carries daily fees of up to 75 basis points for operations, 30 basis points for administration and 20 basis points for distributions. The product also includes more than 120 investment options for the beneficiary, Johnson pointed out.

“They still control how the assets are invested,” he said. “But they get the tax benefits of annuitization. We like to say it’s kind of like having your cake and eating it too.”

It is always recommended to discuss any financial decisions with a trusted financial advisor. When it comes to annuity products, understanding your options is crucial in finding the right choice for your unique circumstances.

Written by Rachel Summit

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