Yes, an inherited annuity is generally taxable, but only the growth is taxed if the original owner funded it with after-tax dollars, while the entire payout is taxed if the annuity sat inside a retirement account like an IRA or 401(k). The taxable portion counts as ordinary income in the year you receive it, at rates from 10% to 37% for 2026 depending on your total income.1Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Unlike a house or stock inherited through an estate, annuity earnings do not get a step-up in basis, so every dollar of gain the original owner accumulated eventually reaches the IRS.2Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
Qualified or Non-Qualified: What Actually Gets Taxed
The first question to answer is where the annuity was held. That single fact controls how much of the payout is taxable.
A qualified annuity lives inside a tax-advantaged retirement plan such as a traditional IRA or 401(k). No income tax has ever been paid on any part of the balance, so every dollar you withdraw is taxable as ordinary income.3Internal Revenue Service. Publication 575 – Pension and Annuity Income Inherit a $500,000 qualified annuity, and $500,000 gets added to your income across the years you draw it down.
A non-qualified annuity was bought with after-tax money outside any retirement plan. The original owner already paid income tax on the money they put in, so only the earnings are taxable when you inherit.4Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts If a $500,000 non-qualified contract was funded with $300,000 of contributions, only the $200,000 of growth is taxed. The insurance company splits each payment into a tax-free return of principal and a taxable earnings piece using an exclusion ratio.
The insurer and the decedent’s tax records can confirm which type of contract you have inherited. If nobody can document the original after-tax investment, the insurance company may treat the full payout as taxable, so hold onto the original contract, contribution statements, and any 1099-R forms the owner received during life.
Roth Accounts Are the Friendly Exception
Annuities inside a Roth IRA or designated Roth 401(k) come out tax-free — both principal and earnings — as long as the Roth account was open for at least five years before the owner died.5Internal Revenue Service. Retirement Topics – Beneficiary Miss the five-year window and the earnings can become taxable, though the contributions still are not. The withdrawal deadlines below still apply; you simply owe little or no income tax on what you take out.
Your Relationship to the Owner Changes Everything
A surviving spouse can step into the contract as the new owner. No tax is triggered at that moment, the account keeps growing tax-deferred, and the spouse only pays income tax as they later take withdrawals.6Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts – Section (s)(3) Spouses can instead take a lump sum or annuitize like any other beneficiary if they want the money sooner.
Any other beneficiary — a child, sibling, friend, trust — cannot continue the contract. You have to take the money out on a schedule the IRS sets, and each withdrawal generates the tax described above.
The Deadlines That Force the Tax Bill
How fast you have to withdraw depends on the type of annuity. These deadlines matter because each withdrawal is a taxable event.
Qualified Annuities: 10 Years
For qualified annuities inherited after 2019, most non-spouse beneficiaries must empty the account by December 31 of the tenth year after the year the owner died.5Internal Revenue Service. Retirement Topics – Beneficiary Within that window you can withdraw as much or as little as you like, as long as the balance hits zero by the deadline. If the owner had already begun required minimum distributions, you generally have to keep taking at least annual withdrawals during the 10-year window as well.7Internal Revenue Service. Notice 2022-53 – Certain Required Minimum Distributions for 2021 and 2022
A narrow group of “eligible designated beneficiaries” can still stretch withdrawals over their own life expectancy instead of following the 10-year rule: minor children of the deceased, disabled or chronically ill people, and beneficiaries who are not more than 10 years younger than the owner.5Internal Revenue Service. Retirement Topics – Beneficiary Adult children of the deceased fall under the 10-year rule.
Non-Qualified Annuities: 5 Years or Life Expectancy
If the owner died before annuity payments started, the entire non-qualified contract must generally be distributed within five years of death.8Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts – Section (s)(1) There is no required annual amount inside those five years.
You can bypass the five-year clock by starting payments over your own life expectancy within one year of the owner’s death.9Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts – Section (s)(2) That stretches the taxable income across many years and keeps each year’s amount small. If the owner had already begun annuity payments, the remaining interest has to be paid out at least as quickly as the owner was receiving it.
How the Speed of Withdrawal Shapes What You Owe
Federal tax brackets are progressive, so pulling everything in one year almost always costs more than spreading it out.
A lump sum drops the entire taxable amount into a single year’s income. A large enough distribution can reach the top 37% bracket, which for single filers starts at $640,600 of taxable income in 2026.1Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
Spreading withdrawals across the five-year or 10-year window keeps each year’s income in a lower bracket, often saving thousands. Even distribution across the available years is a common approach.
Life expectancy annuitization, where available, produces the smallest annual tax hit because the insurance company calculates payments over your projected lifespan using actuarial tables.
The 10% Early Withdrawal Penalty Does Not Apply
Withdrawals from retirement accounts before age 59½ normally carry a 10% additional tax. Distributions paid to a beneficiary after the account owner’s death are exempt from that penalty.10Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions A 35-year-old inheriting a qualified annuity from a parent owes ordinary income tax on the taxable portion but not the extra 10%.
The Penalty for Missing a Required Distribution
If you miss a required withdrawal deadline for a qualified annuity — an annual RMD or the final 10-year cutoff — the IRS imposes an excise tax of 25% on the amount you should have taken. The penalty drops to 10% if you correct the shortfall within two years by withdrawing what you missed.11Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs For a non-qualified annuity, missing the five-year deadline can cause the contract to lose its tax-deferred status entirely.
Estate Tax and the IRD Deduction
The full value of an inherited annuity is included in the deceased owner’s gross estate for federal estate tax purposes.12Office of the Law Revision Counsel. 26 USC 2039 – Annuities For deaths in 2026, estates worth less than $15,000,000 owe no federal estate tax at all.13Internal Revenue Service. Estate Tax Estates above that threshold face a top marginal rate of 40%.14Office of the Law Revision Counsel. 26 USC 2001 – Imposition and Rate of Tax
When an estate is large enough that both estate tax and income tax hit the same dollars, federal law offers partial relief called the IRD deduction. You can deduct the portion of federal estate tax attributable to the annuity earnings when calculating your income tax.15Office of the Law Revision Counsel. 26 USC 691 – Recipients of Income in Respect of Decedents Claiming it means working with the estate executor to pin down the exact estate tax allocable to the annuity. For most inherited annuities the $15,000,000 threshold means estate tax is not in play at all.
State Taxes
Federal income tax is only one layer. Most states with an income tax treat inherited annuity distributions as ordinary income the same way the IRS does, at rates that run from zero in no-income-tax states to over 13% in the highest-tax jurisdictions. A handful of states also charge a separate inheritance tax based on your relationship to the deceased, reaching as high as 16% for unrelated beneficiaries; spouses and close family are often exempt. Check your own state’s rules before estimating a total bill.
How the Distributions Get Reported
The insurance company or plan administrator will send a Form 1099-R for each year you receive money. Death benefits carry distribution code 4, which tells the IRS the payment went to a beneficiary of a deceased owner.16Internal Revenue Service. Instructions for Forms 1099-R and 5498 Box 1 shows the gross distribution and Box 2a shows the taxable amount — the earnings piece for a non-qualified contract or the full amount for a qualified one.
On your Form 1040, the total goes on line 5a and the taxable portion on line 5b.3Internal Revenue Service. Publication 575 – Pension and Annuity Income If you are also claiming the IRD deduction for estate tax paid on the same funds, that goes on Schedule A as an itemized deduction. Keep every 1099-R, the original annuity contract, and any estate tax paperwork together; you may need them across the years your distributions run.