Spousal Continuation of Annuity Contracts: Eligibility and Taxes

Spousal continuation of an annuity is a federal tax rule that lets a surviving spouse who is named as the sole beneficiary step into the deceased owner’s place and keep the contract going, instead of taking a lump-sum death benefit or being forced onto a five-year payout schedule. The contract number, the invested balance, and the tax-deferred status all carry over. No income tax is triggered at the moment of death, and the surviving spouse decides when and how to take money out.

The rule sits in Internal Revenue Code Section 72(s)(3), which says that when the designated beneficiary of an annuity is the surviving spouse, the spouse is treated as the holder of the contract. That single sentence is what makes continuation possible. Any other beneficiary — a child, sibling, or trust — has to empty the contract within five years of the owner’s death or start distributions over their own life expectancy within a year.¹

Who Can Elect Spousal Continuation

Three things have to be true.

First, you must have been legally married to the contract owner at the time of death. The IRS recognizes any marriage that was valid where it was performed, regardless of where the couple later lived, and same-sex marriages carry the same federal recognition. Common-law marriages count for federal tax purposes if they were valid under the law of the state where they were established.² Registered domestic partnerships and civil unions that are not classified as marriages under state law do not qualify. The IRS has said directly that individuals in those arrangements are not treated as married or as spouses for federal tax purposes.³

Second, you must be the designated beneficiary on file with the insurance company. In practice, carriers require the surviving spouse to be the sole primary beneficiary. If the owner split the beneficiary designation among multiple people, or named a trust, the continuation option typically disappears even for the spouse’s share. The beneficiary designation controls, not what a will says.

Third, the contract has to be a non-qualified annuity — one bought with after-tax dollars outside a retirement account. Section 72(s) explicitly carves out annuities held inside 401(a), 403(a), and 403(b) plans and individual retirement annuities.¹ If the annuity is inside an IRA or employer plan, you may still have favorable options, such as rolling it into your own IRA or treating the inherited IRA as your own, but those options come from the IRA rules rather than from the continuation provision.⁴

What You Keep, and What You Don’t

Continuation preserves the contract, not just the money in it. The tax deferral rides along. No Form 1099-R is issued for the full contract value at death, and no tax is owed until you take a withdrawal. The gains inside the annuity keep compounding on a deferred basis, which over a long horizon is the whole point of the election.

What does not transfer is a step-up in cost basis. Annuities are specifically excluded from the fair-market-value basis adjustment that most inherited property gets at death; Section 1014 carves out annuities described in Section 72.⁵ You inherit the original cost basis, meaning the after-tax dollars the deceased owner put into the contract. If the owner invested $200,000 and the contract is now worth $350,000, your basis is $200,000 and the $150,000 of gain is still taxable when it comes out. People who assume inherited annuities work like inherited real estate or stock get an unpleasant surprise.

The contract itself keeps running on its existing terms. Surrender charge schedules do not restart. If the owner bought the annuity six years into a ten-year surrender period, you have four years of charges left, not a fresh ten.⁶ Riders and optional benefits generally carry over, but the details vary by carrier and by rider. Death benefit guarantees, income riders, and anniversary value protections may continue on different terms once ownership transfers, and some carriers require you to affirmatively elect which riders to keep. Read the original contract and call the insurance company. Do not assume every feature transfers just because the base contract does.

How Withdrawals Are Taxed Once You Continue

When you eventually take money out of a continued non-qualified annuity, the IRS applies a last-in, first-out rule. Earnings come out before principal, so every dollar you withdraw is taxed as ordinary income at your current rate until all the gain has been distributed. Only after the gain is exhausted do withdrawals become a tax-free return of the original investment.⁷

There is a trap here for younger spouses. Section 72(q) imposes a 10% additional tax on annuity distributions taken before age 59½, with an exception for distributions made after the death of the holder. Once you elect continuation, though, you are the holder. The death exception applied to the original owner’s death, but the contract now treats you as if you had owned it all along. If you are under 59½ and take withdrawals from the continued contract, you owe the 10% penalty on the taxable portion.¹⁸

By contrast, taking a death benefit distribution instead of continuing avoids the 10% penalty, because that payout is made on or after the death of the original holder. The tradeoff is losing tax deferral on whatever is not immediately needed.

When Continuation May Not Be the Right Choice

Continuation is the default recommendation for most surviving spouses, but a few situations call for a hard look at the alternatives.

You need the money now and you are under 59½. Continuing exposes withdrawals to the 10% early distribution penalty. A lump-sum death benefit avoids that penalty, though the gain portion is taxed as ordinary income in the year you receive it.
The contract has high fees or poor investment options. Preserving deferral in a costly variable annuity may drain more in ongoing fees than the tax deferral saves. Taking the death benefit, paying the tax, and reinvesting the rest in a lower-cost account can come out ahead.
The annuity sits inside an IRA. Rolling the funds into your own IRA, with or without an annuity wrapper, often offers more flexibility than keeping the inherited account intact.⁴
The contract’s guaranteed death benefit is higher than its account value. Some annuities guarantee a death benefit larger than the current cash value. Electing continuation typically makes you the new owner at the account value and gives up the enhanced death benefit. Claiming the guaranteed payout could put more money in your hands.

There is no universal right answer. The decision depends on your age, your income needs, the specific contract terms, and how the annuity fits with the rest of the estate. A tax professional who can model the numbers on both paths is worth the consultation fee.

How to Elect Continuation With the Insurance Company

Each carrier has its own paperwork, but the core package is similar across the industry:

A certified death certificate. Most carriers want an original certified copy rather than a photocopy. Order several from the vital records office; other financial accounts will ask for one too.
The original annuity contract. If it has gone missing, expect to sign a notarized affidavit of lost contract before the company will proceed.
The carrier’s spousal continuation election form. It asks for the deceased owner’s name and Social Security number, the contract number, and your taxpayer identification information.
Proof of marriage, typically a government-issued marriage certificate. Some carriers accept a copy; others require a certified original.
A new beneficiary designation. The original owner’s designation no longer applies once you become the owner, so name your own beneficiaries as part of the paperwork.

Processing usually takes one to three weeks after the carrier has a complete file. Any discrepancy, such as a name mismatch between the beneficiary designation and the marriage certificate or a missing signature, extends the timeline. Once the transfer is complete, the carrier sends a written confirmation listing you as the new owner. Keep it with your financial records as proof of ownership and continued tax-deferred status.

Most carriers do not impose a hard deadline for electing continuation. The contract stays in force and keeps growing on a tax-deferred basis while you decide, which is one of the practical advantages of this option. There is no 60- or 90-day window forcing an immediate decision during a difficult period. Do not let the absence of a deadline become indefinite delay, though. Until the paperwork is complete, you have no legal control over the contract and cannot make withdrawals, change investment allocations, or update beneficiaries.

What You Can Do After Continuation Takes Effect

Once you are the recognized owner, you have the same rights any annuity owner has. You can make additional premium payments if the contract allows them, change investment allocations inside a variable annuity, or begin taking withdrawals on your own schedule. Because the annuity is now yours under Section 72(s), there is no forced distribution deadline hanging over it. You can leave the money in the contract indefinitely.

You can also execute a 1035 exchange, a tax-free transfer of the annuity’s value into a new annuity contract with a different insurance company. This is useful if the current contract has high fees or limited investment options, or if you want features it does not offer. A 1035 exchange preserves tax-deferred status and carries the original cost basis into the new contract, so no taxable event occurs. Moving to a new contract usually starts a fresh surrender charge period with the new carrier.

One longer-term consideration: if you later need long-term care and apply for Medicaid, a continued annuity is generally treated as a countable asset. In 2026, the community spouse resource allowance ranges from $32,532 to $162,660 depending on the state, and an annuity that pushes assets above the applicable threshold can affect eligibility. Converting the annuity to an irrevocable income stream is one strategy used in Medicaid planning, but doing it incorrectly can trigger transfer penalties, so this is an area where specialized elder law advice matters.

1
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
2
Internal Revenue Service. Internal Revenue Bulletin 2016-38
3
Internal Revenue Service. Answers to Frequently Asked Questions for Registered Domestic Partners and Individuals in Civil Unions
4
Internal Revenue Service. Retirement Topics – Beneficiary
5
Office of the Law Revision Counsel. 26 US Code 1014 – Basis of Property Acquired From a Decedent
6
Equitable. Spousal Continuation of Annuity Contracts
7
Internal Revenue Service. Publication 939 – General Rule for Pensions and Annuities
8
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions