Can an Annuity Be Inherited? Payouts, Taxes & Beneficiary Rules

Yes, an annuity can be inherited. Whoever the contract owner named as beneficiary receives the remaining value directly from the insurance company, outside of probate. What you can do with the money, and how much of it you keep after taxes, depends on three things: whether the annuity is qualified or non-qualified, whether you are the surviving spouse, and which payout option you choose.

The Beneficiary Form Controls Everything

An annuity passes through the beneficiary designation on the contract, not through the deceased owner’s will. The insurance company pays whoever is named on the form, and a will saying something different does not override it. That is why annuities skip probate and typically reach beneficiaries faster than other inherited assets.

Contracts usually list a primary beneficiary and one or more contingent beneficiaries. The primary has first claim. Contingents receive the death benefit only if the primary has died or cannot be located. If the designation looks outdated, the insurer will still follow it unless a court order says otherwise.

Qualified vs. Non-Qualified Annuities

Before anything else, find out which kind you have inherited. It changes every rule below.

A qualified annuity was funded with pre-tax dollars inside a retirement account such as an IRA or 401(k). No tax was paid going in, so every dollar coming out is taxable income. Qualified annuities follow the same distribution rules as other inherited retirement accounts, including the SECURE Act’s 10-year rule.

A non-qualified annuity was purchased with after-tax money outside any retirement plan. Only the earnings are taxable when distributed; the original contributions come back to you tax-free because the owner already paid income tax on that money. Non-qualified annuities follow their own rules under Section 72 of the tax code, with a five-year default and a life-expectancy option.

Payout Options for an Inherited Non-Qualified Annuity

Federal tax law requires the entire remaining interest in a non-qualified annuity to be distributed within five years of the owner’s death.¹ Within that window you can take a lump sum, periodic withdrawals, or any combination, as long as the account is emptied by December 31 of the fifth year after death.

A named individual beneficiary has a second option. You can take distributions spread over your own life expectancy instead. Payments must begin within one year of the owner’s death to qualify.¹ The insurer uses IRS life expectancy tables to set your minimum annual payout. This spreads the tax hit over many years and lets the balance keep growing tax-deferred.

Miss the one-year deadline and you are locked into the five-year rule. There is no extension. Contact the insurer soon after the owner’s death if you want the stretch.

Payout Rules for an Inherited Qualified Annuity

Qualified annuities held inside retirement accounts follow the SECURE Act, which Congress passed in 2019. For most non-spouse beneficiaries who inherited after January 1, 2020, the entire balance must be withdrawn by December 31 of the year containing the tenth anniversary of the owner’s death.² The 10-year rule applies no matter how old you are.

A narrow group called eligible designated beneficiaries can still stretch distributions over their own life expectancy:

Surviving spouses of the account holder
Minor children of the account holder (not grandchildren), until they reach the age of majority
Disabled or chronically ill individuals
Beneficiaries not more than 10 years younger than the deceased owner

Once a minor child reaches adulthood, the 10-year clock starts for them.² Within your 10 years you can withdraw in any pattern, including waiting until the final year and taking everything at once. That approach usually produces a much larger tax bill than spreading withdrawals out.

What a Surviving Spouse Can Do

Surviving spouses have an option no other beneficiary gets. For a non-qualified annuity, federal tax law treats the surviving spouse as if they were the original contract holder.¹ Rather than taking a distribution and paying tax on the gains, the spouse continues the contract as their own. Tax-deferred growth continues, any living benefit riders stay in effect, and the five-year distribution clock never starts.

For a qualified annuity inside an IRA, a surviving spouse can roll the inherited annuity into their own IRA. Required minimum distributions then wait until the surviving spouse reaches their own RMD age. For a spouse who does not need the money right away, this is almost always the better tax outcome.

One trap for younger spouses: if you elect to treat an inherited IRA as your own and then take a distribution before age 59½, the 10% early withdrawal penalty applies. That penalty would not apply if you had kept the account as an inherited IRA and taken distributions as a beneficiary.³ If you may need access before 59½, think carefully before rolling over.

How Inherited Annuities Are Taxed

No Step-Up in Basis

This is what catches most beneficiaries off guard. Unlike stocks, real estate, or mutual funds, annuities do not get a step-up in cost basis at the owner’s death. Federal law explicitly excludes them from the step-up rule.⁴ You inherit the original owner’s basis, and every dollar of accumulated gain remains taxable to you as ordinary income. If the owner paid $100,000 and the contract grew to $200,000, you owe income tax on $100,000 in gains regardless of the value on the date of death.

Non-Qualified Annuity Distributions

Only the earnings portion of each payment is taxable. The original after-tax contributions come back tax-free. The IRS uses an exclusion ratio to split each payment into taxable and non-taxable pieces.¹⁵

Take a lump sum and the entire gain lands on one year’s tax return as ordinary income. Federal income tax rates for 2026 run from 10% to 37%. A large lump sum can push you into a higher bracket than you normally occupy, which is the practical reason many beneficiaries prefer the life-expectancy option.

Qualified Annuity Distributions

Simpler, but harsher. Every dollar you withdraw from an inherited qualified annuity is taxable as ordinary income because no after-tax money went in. There is no exclusion ratio and no tax-free portion.

No 10% Early Withdrawal Penalty

The 10% penalty that normally applies to retirement account withdrawals before age 59½ does not apply to distributions taken by a beneficiary after the account holder’s death.³ This applies whether you are 25 or 55. You still owe income tax on the distributions, but no penalty on top.

Estate Tax Is a Separate Question

The annuity’s value at the owner’s death is included in the owner’s gross estate for federal estate tax purposes. For 2026, the federal estate tax exemption is projected at roughly $15,000,000 per person.⁶ Most estates fall well below that. Some states impose their own estate or inheritance taxes at lower thresholds.

Estate tax and income tax are separate. Even if no estate tax is owed, you still owe income tax on the gains when you take distributions. In the rare case where both apply to the same annuity, a partial income tax deduction may be available under the income-in-respect-of-a-decedent rules. A tax professional is worth the fee at that point.

How to File a Death Benefit Claim

To collect an inherited annuity, file a claim with the insurance company. Gather these documents first:

A certified copy of the death certificate from the local vital records office
The original policy or contract, or a lost policy affidavit (often notarized) if the paper document is gone
The insurer’s claimant statement, which asks for the deceased owner’s Social Security number, your identification, and your chosen distribution method

If the beneficiary is a trust, expect to provide the trust document showing its title, information about the settlors and successor trustees, signature pages, and any amendments. All named trustees will need to sign.

Most carriers offer claim kits on their websites or by phone. Submit the packet however the insurer accepts it, typically certified mail or a secure online portal. Once the insurer verifies the policy and sees no competing claims, payment usually arrives within a few weeks.

One useful detail: surrender charges that would normally apply during the contract’s surrender period are almost always waived when a death benefit is paid to a beneficiary. You should receive the full contract value or the guaranteed death benefit without reduction.

If a Trust Is the Named Beneficiary

Trusts are commonly named as annuity beneficiaries in estate plans, but there is a real tax trade-off. Trusts hit the top 37% federal bracket at a very low income level compared to individuals, so any distributions the trust holds rather than passes through to individual beneficiaries can be taxed heavily.

A trust also cannot use spousal continuation, because the statute requires the designated beneficiary to be the surviving spouse as an individual.¹ The non-qualified life-expectancy stretch also requires an individual beneficiary. A trust generally gets locked into the five-year rule unless it qualifies as a “see-through” trust under IRS regulations, in which case the individual trust beneficiaries can be treated as the designated beneficiaries.

There are good reasons to name a trust anyway: protecting minor children, controlling how funds are spent, or shielding assets from a beneficiary’s divorce. The point is to make that choice knowing what it costs.

1
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
2
Internal Revenue Service. Retirement Topics – Beneficiary
3
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
4
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
5
Internal Revenue Service. General Rule for Pensions and Annuities
6
Internal Revenue Service. What’s New – Estate and Gift Tax