Should Annuities Be Put in a Trust? Tax Rules and Tradeoffs

Putting an annuity in a trust works cleanly in exactly one situation: a revocable living trust used to avoid probate. Every other structure carries a real tax cost. An irrevocable trust that owns an annuity loses the contract’s tax deferral entirely, and a trust named as an annuity’s beneficiary is forced to empty the account within five years of the owner’s death. Those trade-offs are only worth accepting when a specific non-tax problem, like a special needs beneficiary or a blended family, requires the control a trust provides.

Why the Tax Code Penalizes Trust Ownership

The rule that drives everything else is short. If an annuity contract is owned by anyone other than a natural person, it loses its status as an annuity for tax purposes, and each year’s investment gains become ordinary income to the owner whether or not any money is withdrawn.¹ A trust is not a natural person, so an annuity sitting in a trust starts throwing off taxable income immediately, destroying the deferral that was the whole reason to buy the contract.

The statute gives one way out. If the trust holds the annuity “as an agent for a natural person,” the non-natural person rule doesn’t apply.¹ Which trusts qualify is the question the rest of this article turns on.

The Revocable Living Trust Exception

A revocable living trust is the one structure that reliably preserves deferral. Because it is a grantor trust under federal tax law, the IRS looks through the trust and treats you as the owner of everything inside it. The trust is effectively invisible for income tax purposes while you are alive, so it qualifies as an agent for a natural person and the annuity keeps its tax-deferred status.

Nothing about the annuity’s taxation changes during your lifetime. You keep full control, since you can amend or revoke the trust at any time. At your death, the annuity passes through the trust without going through probate, which avoids court costs, delay, and the public disclosure of your estate.

The trade-off is what a revocable trust does not do. It offers no creditor protection while you are alive and limited protection after your death. The assets still count as yours for lawsuits, Medicaid eligibility, and estate tax purposes. If probate avoidance is your goal, a revocable living trust is the clean answer. If you need protection beyond that, you are looking at irrevocable structures, and the tax picture changes sharply.

Irrevocable Trusts Destroy the Tax Deferral

An irrevocable trust that is not a grantor trust fails the agent-for-a-natural-person exception. The moment it takes ownership of an annuity, every dollar of annual gain becomes taxable ordinary income on the trust’s own return.¹ The contract still exists. The tax advantage does not.

Trust tax brackets make the damage worse. For 2026, a non-grantor trust hits the top 37% federal rate once its income exceeds just $16,000.² The full 2026 trust schedule looks like this:

10% on the first $3,300 of taxable income
24% from $3,301 to $11,700
35% from $11,701 to $16,000
37% on everything above $16,000

An individual doesn’t reach 37% until income tops $640,600. So an annuity generating $50,000 of annual gains inside a non-grantor irrevocable trust would owe roughly $16,400 in federal income tax on those gains, while the same $50,000 taxed to an individual beneficiary in the 22% bracket would produce roughly $11,000. That gap compounds every year the annuity sits inside the trust.

There is one nuance. Some irrevocable trusts are drafted as grantor trusts on purpose, treating the grantor as owner for income tax purposes even though they cannot revoke. These intentionally defective grantor trusts can preserve annuity deferral while the grantor is alive. Once the grantor dies, the trust becomes a non-grantor trust and the deferral advantage disappears. This is advanced drafting territory and not a do-it-yourself move.

Naming a Trust as the Annuity’s Beneficiary

The more common approach is to keep the annuity in your own name and name a trust as its beneficiary. That sidesteps the non-natural person problem while you are alive, because you remain the owner and the deferral continues. The complications arrive when the trust actually inherits the money.

The Five-Year Rule

Inherited non-qualified annuities run on their own distribution rules, separate from IRAs. If the owner dies before the annuity starting date, the entire balance must be distributed within five years.³ If the owner had already begun annuitizing, the remaining payments must continue at least as quickly as before.

The statute allows a life-expectancy payout for a “designated beneficiary,” but defines that term as “any individual designated a beneficiary by the holder.”³ A trust is not an individual. The see-through trust rules that exist for IRAs have no counterpart for non-qualified annuities. A trust named as beneficiary is stuck with the five-year rule, and there is no stretch option available.

This is where a lot of general planning advice goes wrong. The 10-year rule from the SECURE Act, the see-through trust concept, and the eligible designated beneficiary category all belong to the qualified retirement plan world. They do not apply to non-qualified annuities.

What the Five Years Cost

Compressing an annuity into five years of taxable distributions creates a concentrated tax hit. Taxed inside the trust, nearly all of that income lands in the 37% bracket. A trustee can distribute income out to individual beneficiaries to shift the tax to their personal returns, but the five-year window still forces far more income per year into their brackets than a life-expectancy payout would. Naming an individual directly avoids this: a person qualifies as a designated beneficiary and can generally elect life-expectancy payments if they begin within one year of the owner’s death, and a surviving spouse can step into the contract and continue it as their own.³

No Stepped-Up Basis

Death does not reset the cost basis of an annuity. The tax code specifically excludes annuities from the stepped-up basis that applies to most inherited property.⁴ All deferred gain is treated as income in respect of a decedent, taxable to whoever receives it. No trust structure changes that. Planning is about spreading the tax over time and keeping it in lower brackets, not eliminating it.

When a Trust Is Worth the Tax Cost

Some situations justify the tax cost because they solve a problem the annuity contract alone cannot. The common thread is a beneficiary who needs protection from themselves, from others, or from circumstances that make direct access dangerous.

A special needs beneficiary who receives Supplemental Security Income or Medicaid could lose eligibility by inheriting an annuity outright. A properly drafted special needs trust receives the proceeds and pays for supplemental expenses without disqualifying the beneficiary. The five-year timeline is an inconvenience. Losing benefits would be worse.
Minor children cannot receive annuity death benefits directly. Without a trust, a court-appointed guardian manages the funds, with ongoing judicial oversight and expense. A trust names a trustee you choose and defines how the money is used.
Beneficiaries with addiction issues, active creditors, or pending judgments can be shielded by an irrevocable trust with a spendthrift provision. Protection varies by state, but in most jurisdictions a properly drafted spendthrift trust puts the assets out of reach of the beneficiary’s personal creditors and blocks the beneficiary from assigning their interest.
Blended families sometimes require a trust to give a surviving spouse income for life while ensuring the remainder passes to children from a prior marriage. A direct beneficiary designation cannot enforce that sequence.

Titling, Fees, and Medicaid Timing

If a trust owns the annuity, the contract must be titled in the trust’s full legal name, typically formatted as “The [Name] Trust, dated [Date],” not the trustee’s personal name. Carriers can be strict about the format, and a mismatch invites disputes after the owner dies. If a trust is named as beneficiary, the designation must reference the full legal name and date of the trust. Vague wording like “my family trust” invites litigation.

The administrative cost is real. A trustee has to track cost basis for future distributions, and a non-grantor trust that owns an annuity has to calculate and report annual income on its own return. Professional trustees typically charge 0.6% to 2.0% of trust assets annually and often impose minimums that hit small trusts hard. Those fees sit on top of the annuity’s own mortality and expense charges, investment fees, and rider costs.

Medicaid planning adds another layer. Transferring an annuity into an irrevocable trust triggers Medicaid’s 60-month look-back. A transfer inside that window is treated as a disqualifying gift, and Medicaid imposes a penalty period during which the applicant is ineligible for nursing home benefits. The penalty length equals the value transferred divided by the average monthly cost of care in your state. Any annuity income paid from the trust to or for a Medicaid applicant also counts against Medicaid’s income limits. The strategy only works when planning starts at least five years before care might be needed.

One piece of flexibility is worth knowing about. If a trust already owns an annuity and you want to swap it for a better contract, the tax code allows a tax-free exchange of one annuity for another as long as the owner stays the same.⁵ The trust that owned the original must own the replacement. You cannot use the exchange to move ownership between the trust and an individual without triggering tax.

A Note on Annuities Inside IRAs

Everything above applies to non-qualified annuities, bought with after-tax money outside a retirement account. An annuity held inside an IRA or an employer retirement plan follows the qualified plan rules instead. Those rules impose a 10-year distribution window for most non-spouse beneficiaries and do allow certain see-through trusts to look through to their underlying beneficiaries for distribution timing, with longer payouts available when the trust’s sole beneficiaries are eligible designated beneficiaries such as a surviving spouse, a minor child, or a disabled or chronically ill individual.⁶ If your annuity is held inside a retirement account, the analysis in this article does not govern; the qualified plan rules do.

1
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts – Section: Treatment of Annuity Contracts Not Held by Natural Persons
2
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026, Including Amendments from the One Big Beautiful Bill
3
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts – Section: Required Distributions Where Holder Dies Before Entire Interest Is Distributed
4
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
5
Internal Revenue Service. Part I Section 1035 – Certain Exchanges of Insurance Policies
6
Internal Revenue Service. Retirement Topics – Beneficiary