Key Takeaways
- Annuities with a survivor benefit or period-certain payout continue paying your beneficiaries after your death; annuities without these options stop paying when you die.
- The amount your beneficiaries receive depends on which payout option you selected at purchase — a choice that affects how much you receive while living.
- Your beneficiary designation on the annuity contract controls who receives the money, regardless of what your will says.
- Inherited annuities are subject to income tax on the earnings portion, though the timing and amount of tax varies by beneficiary type and contract terms.
- Some annuities allow beneficiaries to take a lump sum; others require them to continue receiving payments over a set period or their lifetime.
How Payout Options Determine What Gets Inherited
When you purchase an annuity, you choose a payout option — the method the insurance company uses to send you money. This choice is permanent and directly determines whether anything passes to your beneficiaries.
A life-only annuity pays you a monthly or annual amount for as long as you live. When you die, payments stop completely. Nothing goes to your beneficiaries. This option provides the highest monthly payment because the insurance company keeps any remaining balance.
A life with period-certain annuity guarantees payments for a minimum number of years — typically 10, 15, or 20 years — even if you die early. If you die in year three of a 10-year period-certain option, your beneficiary receives the remaining seven years of payments. If you live past the may provide period, payments continue for your lifetime, but nothing additional goes to beneficiaries after you die.
A joint and survivor annuity continues paying your surviving spouse (or sometimes another beneficiary) at a reduced rate after your death. The reduction is typically 50%, 75%, or 100% of your original payment, depending on what you selected. This option pays you less while living because the insurance company expects to pay longer.
Lump-Sum Payouts and Cashing Out an Inherited Annuity
Not all annuities allow beneficiaries to take a lump sum. Whether your beneficiary can cash out the remaining balance depends on the contract terms and the type of annuity.
when ready annuities — the most common type — rarely allow lump-sum withdrawals. If you chose a life-only or period-certain option, your beneficiary typically cannot cash out; they either receive the remaining may provide payments or nothing.
Deferred annuities — annuities you haven't started taking money from yet — often allow beneficiaries to withdraw the full remaining balance as a lump sum. This is called the death benefit. The amount equals either the remaining contract value or the amount you paid in, whichever is greater. Some contracts specify a different amount.
Check your annuity contract or call the insurance company to learn whether your specific annuity allows a lump-sum death benefit. This is one of the most important questions to answer before you die, because your beneficiary's options depend on it.
Tax Treatment of Inherited Annuities
Inherited annuities are not tax-free. Your beneficiary will owe income tax on the earnings portion — the difference between what you paid in and what the annuity is now worth.
If you inherited a deferred annuity and take a lump sum, you pay income tax on all the earnings in that single year. This can push you into a higher tax bracket. Some beneficiaries spread the tax burden by taking payments over time instead.
If you inherited an when ready annuity that continues paying you, each payment includes a portion of earnings and a portion of your original contribution (called the exclusion ratio). You pay income tax only on the earnings portion of each payment. The insurance company calculates this ratio and reports it to you.
Spouses have a special option: they can treat the inherited annuity as their own, which delays taxes until they begin withdrawals. Non-spouse beneficiaries cannot do this and must begin taking distributions within one year of the owner's death.
Naming Beneficiaries and Overriding Your Will
The person or people listed on your annuity contract as beneficiaries receive the death benefit or continuing payments — not whoever your will names. Annuities pass outside of probate, directly from the insurance company to the beneficiary you designated.
This means if your will says your estate receives your annuity, but your contract names your ex-spouse, your ex-spouse gets the money. Updating your beneficiary designation is one of the most important steps after a major life change: marriage, divorce, birth of a child, or the death of a named beneficiary.
You can name multiple beneficiaries and specify how the death benefit is split among them. You can also name a contingent beneficiary who receives the benefit if your primary beneficiary dies before you do. Review your beneficiary designation every few years to make sure it still reflects your wishes.
What Happens if You Die Before Annuity Payments Begin
If you bought a deferred annuity and died before you started taking withdrawals, your beneficiary receives the death benefit — typically the full contract value or what you paid in, whichever is greater. Your beneficiary can usually take this as a lump sum or spread it over several years, depending on the contract.
If you bought an when ready annuity but died before the first payment was sent, your beneficiary receives the remaining balance according to your payout option. If you chose life-only, there is no remaining balance and nothing goes to your beneficiary. If you chose period-certain or joint and survivor, your beneficiary receives the may provide payments or the survivor's portion.
This is why the payout option you choose at purchase matters so much. A life-only when ready annuity provides the highest monthly income but leaves nothing for your family. A period-certain option provides lower monthly income but guarantees your beneficiary receives something if you die early.
Inherited Annuity Withdrawal Rules and important date
Non-spouse beneficiaries must begin taking distributions from an inherited annuity within one year of the owner's death. You cannot straightforward leave the money sitting in the annuity indefinitely.
The amount you must withdraw each year depends on the contract and your relationship to the deceased. Some contracts allow you to stretch withdrawals over your lifetime, taking small amounts each year and deferring taxes. Others require you to empty the annuity within five or ten years. A few allow you to take the full balance when ready.
Spouse beneficiaries have more flexibility. You can treat the inherited annuity as your own, which means you can delay withdrawals until you reach age 73 (the current required minimum distribution age). You can also elect to receive payments over your lifetime or take a lump sum.
Read the contract carefully or contact the insurance company to learn the withdrawal rules for your specific inherited annuity. Missing the one-year important date to begin distributions can result in penalties and accelerated taxation.
Frequently Asked Questions
What if the annuity owner had no beneficiary named?
The death benefit becomes part of the owner's estate and goes through probate. This is slower and more expensive than a direct beneficiary payout. To avoid this, name a beneficiary on your annuity contract and update it after major life changes.
Can I refuse to inherit an annuity?
Yes. You can disclaim the inheritance, which means the death benefit passes to the next beneficiary named on the contract or to the owner's estate. You must disclaim within a specific timeframe — usually nine months — so contact the insurance company when ready if you want to refuse.
Do I have to pay estate tax on an inherited annuity?
Inherited annuities are included in the deceased's taxable estate for federal estate tax purposes if the estate is large enough to owe estate tax. Most estates do not owe federal estate tax because the threshold is high, but some states have lower thresholds. Consult a tax professional if the estate is substantial.
Can I move an inherited annuity to a different insurance company?
You can exchange an inherited deferred annuity to another company using a tax-free 1035 exchange, but rules are strict and timing matters. An inherited when ready annuity cannot be exchanged. Contact a tax professional before attempting any transfer.
What happens if my beneficiary is a minor?
A minor cannot receive annuity payments directly. You can name a custodian or a trust as beneficiary to manage the money until the child reaches adulthood. Discuss this with an estate planning attorney when you set up your beneficiary designation.