What Is a Stretch Annuity and How Does It Work?

A stretch annuity is a payout election that lets someone who inherits an annuity take the money out gradually instead of cashing the whole contract at once, so the untouched balance keeps compounding tax-deferred and each year’s taxable income stays smaller. It isn’t a separate product you buy. It’s a choice the beneficiary makes on an existing contract after the original owner dies, and how long you can stretch depends on two things: whether the annuity is qualified or non-qualified, and your relationship to the person who died.

What Actually Happens When You Elect the Stretch

An annuity is a contract with an insurance company. The owner pays premiums, the carrier invests the money, and gains inside the contract grow without being taxed each year. When the owner dies, the beneficiary has a decision to make. Take the death benefit as a lump sum and owe income tax on all the accumulated earnings in a single year, or elect a stretch and pull the money out over a longer schedule.

If you choose the stretch, the carrier opens a new inherited annuity account in your name. The investments stay where they were, in whatever fixed, variable, or indexed sub-accounts the contract offers. Distributions come out on a schedule set by federal tax rules and your beneficiary category. Everything still inside the contract keeps growing tax-deferred until you withdraw it.

Qualified vs. Non-Qualified Annuities

The single biggest factor in how long you can stretch is which type of annuity you inherited. The two live under different sections of the tax code and follow entirely different rules.

A qualified annuity sits inside a tax-advantaged retirement account, such as a traditional IRA, 401(k), or 403(b). Its distribution rules come from 26 U.S.C. § 401(a)(9), as modified by the SECURE Act of 2019.¹ Those rules include the ten-year cap that now applies to most non-spouse heirs.

A non-qualified annuity was bought with after-tax money outside any retirement plan. It follows 26 U.S.C. § 72(s), a section the SECURE Act didn’t touch. The default rule under § 72(s) is that the remaining interest must be distributed within five years of the owner’s death, but if any portion goes to a designated beneficiary (any named individual), that person can stretch distributions over their own life expectancy as long as payments start within one year of death.² The SECURE Act’s ten-year ceiling does not apply here.

That difference can be enormous in practice. A 40-year-old inheriting a qualified annuity from a parent has ten years to empty it. The same person inheriting a non-qualified contract from the same parent can spread payments across roughly four decades. If you’re not sure which type you inherited, look at whether the original owner ever deducted the premiums or held the contract inside an IRA or employer plan. If either is true, it’s qualified.

Who Can Still Take a Full Life-Expectancy Stretch on Qualified Annuities

The SECURE Act sorted beneficiaries of qualified accounts into three groups. Your group decides your timeline.

Eligible Designated Beneficiaries

This is the only category that still gets a true life-expectancy stretch on a qualified contract. It covers:

Surviving spouses
Minor children of the deceased owner (not grandchildren)
Disabled individuals as defined under IRC § 72(m)(7)
Chronically ill individuals as defined under IRC § 7702B(c)(2)
Any beneficiary no more than ten years younger than the deceased owner

These beneficiaries take annual distributions based on their own single life expectancy. Minor children lose eligible status once they reach the age of majority in their state and then switch to the ten-year rule for whatever remains.¹

Designated Beneficiaries Subject to the Ten-Year Rule

Adult children, grandchildren, siblings, friends, and any other named individual who doesn’t qualify above lands here. The entire account has to be emptied by December 31 of the tenth year after the owner’s death.¹ Whether the IRS also requires distributions along the way depends on the owner’s age at death, covered below.

No Designated Beneficiary

When the beneficiary is an estate, a charity, or a trust that doesn’t meet the see-through requirements, the account generally has to be distributed within five years of the owner’s death.¹

Did the Owner Die Before or After Age 73?

If you’re subject to the ten-year rule on a qualified annuity, one detail catches people off guard: whether the original owner had reached their required beginning date for distributions. Under SECURE Act 2.0, the RBD age is 73.³

If the owner died before turning 73, you only have to empty the account by the end of year ten. There are no required minimum distributions in the meantime, so you can time withdrawals around lower-income years.

If the owner died at 73 or later, you must take annual RMDs during each of the ten years, calculated on your own life expectancy, and still empty the account by the end of year ten.⁴ Skipping a year triggers an excise tax.

How the Distributions Are Taxed

Every dollar you pull out of a qualified inherited annuity is ordinary income in the year you receive it. Federal rates for 2026 range from 10 percent to 37 percent depending on your total taxable income.⁵ The full distribution is taxable because the original premiums were either deductible or made with pre-tax dollars.

Non-qualified annuities get better treatment because the owner already paid tax on the premiums. How that treatment plays out depends on how you take the money:

Lump sum or partial withdrawals follow last-in, first-out order. Earnings come out first and are fully taxable; you don’t reach the tax-free return of premium until all the gains have been distributed.⁶
Annuitized payments under a stretch election use the IRS’s exclusion ratio. Divide the original investment by the total expected return, and that percentage of each payment is a tax-free return of premium until the whole cost basis has been recovered. After that, every remaining payment is fully taxable.⁷

The exclusion ratio is one of the main reasons the stretch beats a lump sum on a non-qualified contract: it spreads tax-free basis recovery across every payment instead of pushing all the taxable earnings into year one.

No Step-Up in Basis

Most inherited assets get their cost basis reset to fair market value on the date of death. Annuities don’t. Section 1014(b)(9)(A) of the Internal Revenue Code specifically excludes annuities described in § 72, and § 1014(c) excludes property that represents income in respect of a decedent.⁸ You inherit the original owner’s basis, and every dollar of accumulated gain remains taxable.

Spouses Have the Most Flexibility

Surviving spouses get the widest set of choices on both types of contracts.

On a qualified annuity, a spouse can stretch over their own life expectancy as an eligible designated beneficiary or, in many cases, treat the inherited annuity as their own. Treating it as their own resets the clock: no distributions are required until the spouse reaches their own RBD age of 73, and they can name new beneficiaries.¹

On a non-qualified annuity, § 72(s)(3) simply treats the surviving spouse as the holder of the contract.² No five-year clock, no immediate distributions. The spouse steps into the owner’s shoes and can continue the contract as if it had always been theirs.

How to Actually Elect the Stretch

The stretch doesn’t happen on its own. If you don’t affirmatively elect it, many carriers default to a lump-sum payout, and once that check is written the tax-deferral opportunity is gone for good. Non-spouse beneficiaries of qualified annuities cannot roll the money into their own IRA or use a 60-day rollover. The only safe path is a direct trustee-to-trustee transfer into an inherited annuity or inherited IRA. A check made payable to you triggers immediate taxation with no way to undo it.

What Carriers Typically Require

The original annuity contract number
A certified copy of the owner’s death certificate
Social Security numbers and dates of birth for each named beneficiary
A completed Election of Payout Option form from the carrier’s beneficiary services portal or claims department

On the election form, find the section labeled “Life Expectancy” or “Stretch” and select it explicitly. Missing or incomplete paperwork can delay processing and, at worst, trigger a default lump-sum distribution.

First-Distribution Deadlines

For qualified annuities, the first distribution generally has to occur by December 31 of the year following the owner’s death.¹ For non-qualified contracts, payments must begin within one year of the owner’s death.² Start the paperwork as soon as you have the death certificate. Carriers can take weeks to process a claim, and administrative delays don’t excuse a missed deadline.

The Penalty for Missing a Required Distribution

If you were required to take a distribution and didn’t take enough, the IRS imposes an excise tax equal to 25 percent of the shortfall. If you fix the mistake and withdraw the correct amount before the end of the second calendar year after the missed distribution, the penalty drops to 10 percent.⁹

The penalty applies both to the annual RMDs required when the owner died after their RBD and to the final deadline for emptying the account. Blowing past the ten-year or five-year finish line could expose the whole remaining balance to the excise tax.

Trusts as Beneficiaries

Naming a trust as beneficiary is common in estate plans, but it complicates the stretch. A trust isn’t an individual and has no life expectancy of its own, so by default it lands in the five-year distribution bucket for both qualified and non-qualified contracts.

A qualified annuity’s trust beneficiary can still qualify if the trust meets IRS “see-through” requirements. When it does, the IRS looks past the trust and treats the underlying individual beneficiaries as the designated beneficiaries; whether they get life-expectancy treatment or the ten-year rule then depends on their own status. One non-individual beneficiary in the trust, such as a charity, can pull the whole arrangement into the shorter timeline. For employer-sponsored plans, the trust documentation has to reach the plan administrator by October 31 of the year following the owner’s death.

Fees and Surrender Charges Can Eat Into the Benefit

An inherited variable annuity typically keeps charging mortality and expense fees, administrative fees, and investment management fees on the sub-accounts after it transfers to you. Those costs continue during the stretch.

Surrender charges are separate. Many contracts impose declining surrender charges during the first several years for withdrawals above a free-withdrawal allowance. Some carriers waive them at the owner’s death, but that waiver is a contract feature, not a legal requirement. Before you commit to a distribution schedule, request the current surrender schedule and confirm whether the death benefit triggers a waiver. A few states also charge premium taxes on annuity distributions, up to roughly 1.75 percent, deducted by the carrier before payment and separate from federal and state income taxes.

1
Office of the Law Revision Counsel. 26 USC 401 Qualified Pension, Profit-Sharing, and Stock Bonus Plans
2
Office of the Law Revision Counsel. 26 US Code 72 – Annuities, Certain Proceeds of Endowment and Life Insurance Contracts
3
Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
4
eCFR. 26 CFR 1.401(a)(9)-3 Death Before Required Beginning Date
5
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
6
Internal Revenue Service. Publication 575 Pension and Annuity Income
7
Internal Revenue Service. Publication 939 General Rule for Pensions and Annuities
8
Office of the Law Revision Counsel. 26 US Code 1014 – Basis of Property Acquired From a Decedent
9
Internal Revenue Service. Notice 2024-35 Certain Required Minimum Distributions for 2024