If you have inherited an annuity, you might be wondering how to reduce or avoid paying inheritance tax on the amount. You might be wondering: Can an inherited annuity be rolled over to an IRA to avoid tax liability? The answer to this is complicated and many factors must be considered.
Taxes and Inherited Annuities
Do I pay taxes on an inherited annuity? The first thing you need to know is that the rules on taxation are different for the spouse of the deceased person than for other relatives. Annuities have several different payout options, including regular payments, a lump sum payment and five-year plan payments.
Typically, a spouse inherits an annuity “as-is,” which means the payments remain the same as they were for the deceased person. All you have to do is to change the name of the annuity to your own name. Your tax liability would be the same as for the deceased spouse.
When you buy an annuity, you are exchanging funds you have now to have a source of income in the future. Many will use annuities to supplement their retirement plans or to protect a windfall from something like a lawsuit. Many people purchase a death benefit rider that allows you to name one or more people as the recipients of any funds remaining to be distributed upon death. If you are the spouse of the deceased, you might be allowed to start the inherited annuity rollover to IRA process, but certain rules apply.
If you are not the spouse of the deceased, an inherited annuity is taxable just like any other source of income. The schedule of when the taxes are due depends on the structure and schedule of the payments. It also depends on whether the annuity was opened as a tax-deferred annuity.
Another factor is whether the annuity is qualified or non-qualified. A qualified annuity is funded with pre-tax dollars like a traditional IRA. A non-qualified annuity is funded with after-tax dollars like a Roth IRA. Also, certain income limits apply to IRA contributions.
Options for Inherited Annuities
What is the best thing to do with an inherited annuity? One thing to consider is whether the annuity payment will bump you into a higher tax bracket. If you are not the spouse of the deceased, moving an inherited annuity might not get you out of tax liability.
You can fund your personal IRA with any source of funding, but an inherited annuity rollover to an IRA will not prevent you from paying taxes. The question is whether you will pay taxes now or when you begin receiving payment distributions.
If the annuity was qualified and you have a traditional IRA, you could be in for double tax jeopardy. You would have to pay tax on the annuity when you receive the income, and you have to pay taxes when you receive distributions from the IRA. If you move a qualified annuity to a traditional IRA or you move a non-qualified annuity to a Roth IRA, taxation issues become quite complex.
Moving an Inherited Annuity
Can I move an inherited annuity to another company? The answer to this depends on whether the new annuity has a structure that is similar to the old one. In some cases, the IRS will not allow the conversion without stiff penalties.
The bottom line is that inheriting an annuity – and the rules that apply to them – is complex, and if you are in this situation, it might be best to consult a tax professional or attorney about your specific situation.
Adam Luehrs is a writer during the day and a voracious reader at night. He focuses mostly on finance writing and has a passion for real estate, credit card deals, and investing.