Annuities are common retirement investments most of which can designate a beneficiary. To be clear, annuities are contracts made for a promise of repayment in the future between an investor and an insurance company. Like other investments, the gains made on the annuity accounts over time, stay with the actual contract. However, the gains made when someone inherits the annuity, is treated as normal income and is taxed at the new owner’s tax bracket.
The inheritance of an annuity can be complicated when it comes to taxes. For example, if you were to inherit a fixed annuity which was purchased with after tax dollars you, and you took a lump-sum payment you would owe taxes on the funds you receive. Generally, however, the person inheriting the funds can take out the entire worth of the annuity all at once, a bit every month, periodically, or wait for up to five years, while the money in the account continues to accumulated with deferred taxes. This last option would allow for tax-deferred growth of the funds in the account. To increase your level of options to withdraw annuity funds inherited, one would need to take the money out of the annuity within five years of the inheritance. In any of the options, the funds withdrawn will be taxed in the individual’s tax bracket.
Depending on the annuity and depending on what option for withdrawing the funds are chosen and spelled out in the contract, the tax burdened may be calculated differently. Nevertheless, the insurance company would be able to assess the tax and any fee obligations for new owner in a clear manner. The new owner is ultimately responsible for paying taxes as it were income when it is withdrawn. The tax would include the obligation on the accumulated gains that the account has received or will continue to receive, if the account is not withdrawn immediately.
A spouse may choose to inherit the annuity altogether in a process known as “spousal continuation.” If this is the case the spouse may be able to make good on the tax deferred status. In either case, either the spouse or the beneficiary will have to supply a death certificate and fill out the necessary paperwork to prove the death of the annuity owner. The decision to withdraw funds can depend on a number of factors for the beneficiary and what he or she is willing to stomach when it comes to the taxman. A lump sum payment may spare the need for complicated taxes, as the person inheriting the annuity will be taxed immediately. The problem with that is that the lump sum amount my kick the beneficiary up into a new tax bracket, which will result in him more taxes overall. If this is the case, he could elect to withdraw the taxes in percentages that would allow him or her to stay within his tax bracket and allow him to gain further accumulation of funds from the money that is still in the annuity.
There may be restrictions on single premium indexed annuities on beneficiaries. Some contracts restrict the ability to inherit the funds altogether, so it would be strongly recommended to review the contract with your insurance agent to ensure the right kind of investment the investor needs for him and his family. With careful planning inheriting an annuity doesn’t have to be as difficult as it may seem. It is best to talk with an insurance agent to understand the obligations on the investor’s part and what the options are for those that inherit the funds are.