An annuity is a type of savings plan that works much like a retirement account, though numerous differences do exist between the two plans. If you inherit an annuity, you become entitled to the funds inside the account, but it cannot be rolled over directly into an IRA.
How Annuities Work
An annuity differs slightly from other types of savings accounts, because a payment plan for the account is set up when the account is originally opened. This payment plan may be based on the lifespan of the original owner or on the life span of a dependent of an owner, called the annuitant. The account pays out, according to the schedule, to first the account owner, then to the annuitant, and then to a beneficiary listed on the account if both the owner and annuitant are deceased.
More than one type of annuity exists, and either of these types may be inherited. The first type of annuity is a non-qualified annuity. Contributions to this plan are generally made by an individual directly to a financial institution through which the owner sets up the plan. These contributions must be made from income that has already been taxed by the government. A qualified annuity, on the other hand, is a plan commonly set up through an employer that allows the owner to make contributions prior to taxation.
When an annuity begins to payout to the original owner of the account, if the annuity is qualified and was subject to the same tax rules as the 401(k) into which they want to rollover the annuity, the owner generally has the option of rolling over the account. The annuitant or the beneficiary of the annuity may also be able to roll the annuity over into an IRA if the annuitant or beneficiary is the spouse of the original owner. Non-spouse beneficiaries do not generally hold the right to roll an annuity over into a personal IRA.
An annuity is designed so that taking the distributions as they were originally scheduled provides the most profitable means of collecting the funds. However, since a beneficiary must pay taxes on the earnings in an annuity, those earnings may end up raising him to a new tax bracket, which may actually end up lowering his yearly net income. At this point, the beneficiary may choose to sell a non-qualified annuity through a financial adviser and receive a single, lump sum payment equal to a fraction of the funds that remain in the annuity.