Inherited an Annuity? Your Options, Deadlines, and Taxes

Our death benefit guide covers what the contract promises from the owner's side. This page is the other side of that event: you are the beneficiary, the paperwork has arrived, and the boxes you check in the next weeks determine how much of the money survives the tax bill. Here is the map.

Inheriting an annuity starts a clock most beneficiaries do not know is running. The elections below have deadlines, and the default that applies if you do nothing is usually the most expensive one.

The two questions that determine everything

Are you the surviving spouse? Spouses get an option nobody else gets: continuing the contract as their own. Is the annuity qualified or nonqualified? Qualified means it held retirement-account money — an IRA annuity — and retirement-plan rules govern it. Nonqualified means after-tax money, governed by the annuity's own contract and the tax code's annuity provisions. Every option below sorts by those two answers, so establish them before reading further; the carrier can confirm both in one phone call.

If you are the surviving spouse

Spousal continuation lets you step into the owner's place: the contract continues, deferral continues, your own beneficiaries go on the policy, and no tax event occurs at all. For most spouses who do not need the money immediately, it is the strongest option on the table — which is why it is worth confirming the paperwork actually elects it, rather than a distribution the default form quietly assumes.

A spouse can also take any of the non-spouse options below, and occasionally should — for instance, when the contract's terms are poor and a taxable exit into something better beats continuing a bad contract. Continuation preserves the wrapper; it does not improve it.

Nonqualified annuities: the non-spouse menu

Lump sum. Everything at once, all gain taxable as ordinary income in one year. Simple, fast, and frequently the worst tax outcome — a large gain stacked on your salary can climb brackets. Right mainly when the gain is small or the need is immediate.

The five-year rule. Distribute the entire contract within five years of death, on any schedule you choose within them. The flexibility is genuinely useful: gain can be taken in your low-income years, deferred growth continues meanwhile, and the tax spreads across up to five returns instead of one.

The nonqualified stretch. Elect within the window — commonly one year of the owner's death — and take payments over your own life expectancy, spreading the taxable gain across decades while the balance keeps compounding. For a younger beneficiary of a large-gain contract, this is usually the most valuable option in the menu, and it is the one that dies quietly when paperwork sits on a counter.

Qualified annuities: the SECURE Act changed the answer

For deaths after 2019, most non-spouse beneficiaries of qualified annuities fall under the ten-year rule: the entire account must be distributed by the end of the tenth year after death. The old any-beneficiary stretch is gone; what remains is timing flexibility inside the decade — and for accounts where the original owner had begun required distributions, annual distribution requirements can apply within it, a detail worth confirming with a tax professional because the IRS guidance evolved after the law passed.

Eligible designated beneficiaries keep longer schedules: surviving spouses, the owner's minor children until majority, disabled and chronically ill individuals, and beneficiaries less than ten years younger than the owner. If you might be in one of those categories, establish it before electing anything — it is the difference between ten years and a lifetime of deferral.

The tax fact that surprises everyone

Inherited stock gets a step-up in basis — the gain vanishes at death. Inherited annuities get no step-up. Every dollar of untaxed gain passes to you as future ordinary income, at your rates, not capital-gains rates. On a nonqualified contract you do inherit the owner's basis, so the original premium returns tax-free; on a qualified contract there is typically no basis at all.

This is not a reason to refuse an inheritance; it is the reason the option you elect matters so much. The same $150,000 of gain taxed in one year, five years, or thirty produces three very different totals — and it is also, as our pros and cons guide argues, the strongest reason annuities fit estate plans badly in the first place.

Deadlines and defaults

The stretch election commonly closes one year after death. Five-year computations run from the date of death, not from when you got around to the forms. Carriers' default elections — what happens if you sign nothing — tend toward lump sums and forced distributions at deadlines. Inaction is itself an election, and it is usually the most expensive one available. Open the paperwork, establish the two facts at the top of this page, and get the election right once; there is no amending it later.

A worked example, briefly

A 45-year-old inherits a nonqualified annuity: $250,000 value, $100,000 original premium, $150,000 gain. Lump sum: $150,000 of ordinary income lands in one year on top of her salary. Five-year rule: roughly $30,000 of gain per year, if taken evenly, each slice taxed at whatever her bracket is that year. Stretch: payments over her multi-decade life expectancy, each containing a small taxable slice while the balance compounds. Same inheritance, three tax bills that differ by tens of thousands of dollars — decided by a checkbox with a deadline. That asymmetry, not the arithmetic, is this page's whole argument.

About the Author

Connor Cedro

Connor is the founder of Palm Wealth Capital, an independent retirement and annuity research firm based in Tampa, Florida. He holds a Finance degree (SMU '21) and an MBA ('25), and writes about annuities and retirement income planning with a focus on independent, jargon-free analysis.