What Happens to an Annuity When You Die: Payouts and Taxes

When an annuity owner dies, whether anything passes to heirs depends on the payout option the owner selected and who is named as beneficiary on the contract, and any money that does pass through is generally taxable to the beneficiary as ordinary income to the extent it represents growth the owner never paid tax on. That is the short answer to what happens to an annuity when you die. The longer answer turns on four things: the payout structure, the beneficiary designation, whether the annuity is qualified or non-qualified, and how quickly the heir takes the money out.

Whether Heirs Get Anything Depends on the Payout Option

A straight life (or life-only) payout offers the largest monthly check because the insurance company keeps whatever remains if the annuitant dies early. Payments stop at death and the insurer retains the balance. Heirs receive nothing.

Period-certain options guarantee payments for a fixed window, commonly 10 or 20 years, regardless of when the annuitant dies. If the annuitant dies eight years into a 20-year period-certain contract, the beneficiary collects the remaining 12 years of scheduled payments. A life-with-period-certain variation pays for the annuitant’s whole lifetime but also guarantees that minimum number of years, protecting heirs against an early death.

Cash refund and installment refund annuities guarantee that the total paid out at least equals the premiums the owner originally deposited. A cash refund annuity pays the gap between premiums and benefits already received as a single check to the beneficiary. An installment refund spreads that same difference across ongoing periodic payments. Either way, the insurer cannot keep more than the owner collected during their lifetime.

If the annuity is still in the accumulation phase and has not yet been annuitized, the full account value passes to the named beneficiary. Some contracts include a death benefit rider that pays the greater of the account value and premiums paid.

The Named Beneficiary Controls Who Receives It

The beneficiary named on the annuity contract receives the death benefit directly and bypasses probate. That designation overrides the owner’s will, which catches families off guard more than almost any other estate-planning issue. A primary beneficiary is first in line; contingent beneficiaries step in only if the primary has already died.

When no beneficiary is named, the death benefit typically defaults to the owner’s estate. That sends the money through probate, which brings court fees, potential delays of months, and exposure to the estate’s creditors. Updating designations after marriages, divorces, and births prevents this outcome.

Annuity contracts are either owner-driven or annuitant-driven. In an owner-driven contract, the death of the person who purchased and controls the policy triggers the death benefit. In an annuitant-driven contract, the trigger is the death of the person whose life expectancy set the payment schedule. Those are often the same person; when they are not, misreading which death triggers the payout creates confusion at the worst possible time.

Leaving a death benefit to a child under 18 creates a practical problem: minors cannot legally control financial assets. Without additional planning, a court may need to appoint a guardian to manage the funds. Naming an adult custodian under the Uniform Transfers to Minors Act avoids that proceeding and keeps control with someone the owner trusts until the child reaches the age specified by state law, usually 18 or 21. A trust designated as beneficiary offers even more control over timing.

Qualified vs. Non-Qualified Changes Everything That Follows

The single most important factor in how the money gets distributed and taxed is whether the annuity is qualified or non-qualified.

A qualified annuity lives inside a tax-advantaged retirement account like an IRA, 401(k), or 403(b). Premiums went in pre-tax, so the owner never paid income tax on the contributions or the growth. When a beneficiary takes distributions, the entire amount is taxable as ordinary income.

A non-qualified annuity was purchased with after-tax money outside a retirement plan. The owner already paid income tax on the premiums, so only the growth portion of each distribution is taxable. The original investment, known as the cost basis, comes back to the beneficiary tax-free. The tax-free share of each payment is calculated using an exclusion ratio that divides the owner’s investment in the contract by the total expected return.¹

How Long Heirs Have to Take the Money Out

Non-Qualified Annuities

Non-qualified annuities follow IRC Section 72(s), a separate set of rules from those governing retirement accounts. The baseline: if the owner dies before the annuity start date, the entire interest must be distributed within five years.²

Two exceptions soften that deadline. Under the designated beneficiary exception, if a named individual elects to receive distributions over their own life expectancy and payments begin within one year of the owner’s death, the five-year rule does not apply. The beneficiary can stretch payments across decades, keeping the remaining balance growing tax-deferred. Under the surviving spouse exception, a spouse who is the designated beneficiary is treated as the new holder of the contract, meaning the spouse can continue the annuity as if they had always owned it, name new beneficiaries, and delay distributions indefinitely.²

If the owner dies after payments have already begun, the remaining interest must be distributed at least as fast as the method already in use at the time of death. The insurance company cannot slow the schedule down.

Qualified Annuities and the 10-Year Rule

For owners who died after 2019, the SECURE Act replaced the old stretch-over-life-expectancy option with a 10-year deadline for most non-spouse beneficiaries of qualified annuities. The beneficiary must empty the entire account by December 31 of the tenth year after the owner’s death.³

Within that window, the beneficiary can pace withdrawals however they choose. If the owner died after their required beginning date, annual minimums may still apply during the 10 years.

A narrow group still qualifies for life-expectancy distributions and is not locked into the 10-year rule. These “eligible designated beneficiaries” are:³

A surviving spouse, who can roll the annuity into their own IRA, keep it as an inherited account, or take life-expectancy distributions.
A minor child of the deceased, who can stretch distributions until reaching the age of majority, at which point the 10-year clock starts.
A disabled or chronically ill individual, for the duration of the disability or illness.
A beneficiary not more than 10 years younger than the deceased, often a sibling or close-in-age friend.

Everyone else, including adult children, grandchildren, and non-individual entities like trusts and charities, follows the 10-year rule.

How the Distributions Are Taxed

Inherited annuity payments are income in respect of a decedent, which means the beneficiary picks up the income tax obligation the original owner would have owed. The tax treatment flows through IRC Section 72.²

For a qualified annuity, every dollar distributed is ordinary income because the entire balance was funded with pre-tax money.⁴

For a non-qualified annuity, only the growth above the owner’s cost basis is taxable. The exclusion ratio determines the tax-free portion of each payment.¹ Once the entire cost basis has been recovered, every subsequent dollar becomes fully taxable.

One piece of good news: the 10% early withdrawal penalty that normally applies to annuity distributions before age 59½ does not apply to payments made after the holder’s death.² A 35-year-old who inherits an annuity owes income tax on the gains but no penalty.

The insurance company reports all taxable distributions on Form 1099-R, which the beneficiary uses to file their federal return.⁵

Tax Traps That Enlarge the Bill

Bracket Creep From a Lump Sum

Taking the entire death benefit in a single year is the fastest way to trigger a tax spike. The taxable portion stacks on top of the beneficiary’s regular income and can push them into a much higher bracket. A beneficiary earning $80,000 who collects a $200,000 lump-sum gain from an inherited annuity could pay marginal rates they have never seen before. Spreading distributions over several years, where the rules allow, keeps more money out of the top brackets.

Medicare Surcharges (IRMAA)

Beneficiaries enrolled in Medicare face an added cost most people don’t see coming. Medicare uses modified adjusted gross income from two years prior to set Part B and Part D premiums through income-related monthly adjustment amounts. A large annuity distribution in 2026 could increase monthly premiums in 2028. For single filers, the standard Part B premium of $202.90 per month starts climbing once income exceeds $109,000 and can reach $689.90 per month at incomes of $500,000 or more. Part D carries a separate surcharge on the same thresholds, adding up to another $91.00 per month.⁶ Spreading distributions across multiple tax years can keep income under the IRMAA thresholds in any single year.

The 3.8% Net Investment Income Tax

Distributions from an inherited non-qualified annuity count as net investment income for purposes of the 3.8% surtax that applies to higher-income taxpayers. The tax kicks in when modified adjusted gross income exceeds $200,000 for single filers or $250,000 for joint filers. Distributions from annuities held inside qualified retirement plans like IRAs and 401(k)s are exempt from this surtax.⁷ Ordinary income tax, NIIT, and IRMAA together can consume a surprising share of a single large non-qualified distribution.

Estate Tax and the 691(c) Offset

The remaining value of an annuity at the owner’s death is included in the gross estate for federal estate tax purposes to the extent it is attributable to contributions made by the decedent or their employer.⁸ For 2026 the federal estate tax exemption is $15,000,000 per individual, so most estates will not owe federal estate tax.⁹ For estates that do cross the threshold, the annuity’s value is taxed at the estate level and the distributions are taxed again as income to the beneficiary. IRC Section 691(c) provides a partial fix: a beneficiary who reports inherited annuity income can deduct the portion of federal estate tax attributable to that income. It does not eliminate the double tax, but it reduces it.¹⁰

Filing the Claim and Finding a Lost Contract

The practical process starts with contacting the insurance company’s claims department. The carrier will ask for a certified copy of the death certificate and its own claim form, which is where the beneficiary selects a distribution method.¹¹ Most companies process claims within a few weeks of receiving complete documentation, though complex estates or disputed designations take longer. Do not rush the distribution election. Once a lump sum is paid out, the tax consequences are locked in.

Families sometimes know a relative owned an annuity but cannot locate the contract or identify the insurer. The National Association of Insurance Commissioners runs a free Life Insurance Policy Locator that searches participating insurers for both life insurance policies and annuity contracts. Beneficiaries, executors, and legal representatives can submit a request with the deceased’s Social Security number, name, date of birth, and date of death. If a matching contract is found, the insurance company contacts the requester directly.¹²

1
Internal Revenue Service. Publication 939, General Rule for Pensions and Annuities
2
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
3
Internal Revenue Service. Retirement Topics – Beneficiary
4
Internal Revenue Service. Publication 575 (2025), Pension and Annuity Income
5
Internal Revenue Service. 2025 Instructions for Forms 1099-R and 5498
6
Centers for Medicare & Medicaid Services. 2026 Medicare Parts A and B Premiums and Deductibles
7
Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
8
eCFR. 26 CFR 20.2039-1 – Annuities
9
Internal Revenue Service. Whats New – Estate and Gift Tax
10
eCFR. 26 CFR 1.691(c)-1 – Deduction for Estate Tax Attributable to Income in Respect of a Decedent
11
Internal Revenue Service. Retirement Topics – Death
12
NAIC. NAIC Life Insurance Policy Locator Helps Consumers Find Lost Life Insurance Benefits