What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


Tax Rules for an Inherited Non-Qualified Annuity

Original post by Susan Reynolds of Demand Media

Inherited annuity accounts are subject to taxation.

Insurance companies commonly offer non-qualified annuities as retirement products, which can be funded with post-tax money. Non-qualified accounts are those offered through independent companies not affiliated with your employer. Unlike qualified annuities, however, you cannot get tax deductions for deposits into non-qualified accounts. Taxes are due when the money is withdrawn from the account, but there are some ways to put off paying taxes on an account when the owner dies.

Death Before Annuitization

If the owner of the non-qualified annuity account dies before the account is annuitized, then the beneficiary receives the total value. He can choose to take a lump sum payment, but it will be taxed according to the exclusion ratio. For example, a contract that started before August of 1982 is called a "Pre-TEFRA contract." If the principal is out first or last, it is not taxed. If the earnings are taken out first or last, this money is taxable, but may be subject to IRS penalty taxes.

Death Benefit Distribution

The beneficiary of the non-qualified annuity must receive the money from the account within five years of the account holder's death. There are some exceptions to this rule. For example, the beneficiary may choose to receive the death benefit over the course of his own lifetime, but the payments need to start within a year of the original owner's death. If multiple people hold the same annuity contract, it starts distributing the funds upon the first death of any of the account holders.

Surviving Spouses

There is a spousal rule that allows the surviving spouse of the account holder to continue the annuity contract. The living spouse will continue the contract as the new owner of the account. If no money is taken out, no tax penalties will emerge. This is one way to delay any IRS taxes on the retirement funds. The rule only applies to spouses, not to other relatives or business partners.

Distribution Options

Upon the death of the account holder, the beneficiary must immediately choose one of several options. He can choose to receive a lump sum or to completely withdraw all the money within a span of five years. If he is the surviving spouse, he may choose to start annuitization over the course of his lifetime. The spouse may elect to continue the contract and avoid IRS taxes.

                   

References

About the Author

Since completing her English degree in 2006 from the University of South Florida, Susan Reynolds has worked in real estate and higher education. She published her first article online in 2008. She now writes articles for many different websites and also writes marketing articles for various businesses in her hometown.

Photo Credits

  • Comstock/Comstock/Getty Images

Advertisement