Can Non-Qualified Annuities Be Inherited?

An annuity is an insurance policy designed to provide a guaranteed income. You pay a premium and the premium grows tax-deferred, based on an interest rate or the stock market. Non-qualified annuities are annuities set up by individuals or a trust and aren't part of a formal retirement plan, such as an Individual Retirement Account. When you start an annuity, you designate beneficiaries, who inherit your annuity when you die, provided there are still funds in the policy.

Designating Beneficiaries

When you set up a annuity, it's critical to designate your beneficiaries. If you don't, the proceeds may not be distributed according to your wishes after you die. If you designate beneficiaries, such as a spouse or children, the annuity proceeds bypass probate and go directly to them. You can designate multiple beneficiaries, and you can designate primary and contingent beneficiaries. Contingent beneficiaries inherit the annuity in the event of the death of the primary beneficiaries. If you need to change beneficiaries, notify your insurance company in writing, and confirm your insurance company has made the change. Beneficiary changes usually aren't effective until they're recorded by the insurance company, rather than when you request the change.

Annuitization Options

Annuities have two phases: an accumulation phase and a payout phase. During the accumulation phase, the annuity earns interest. Immediate annuities are the exception; you pay your premium and immediately start the payout phase. The payout phase is when you annuitize, or set up payments, from the annuity. You can set up the payments as life only, which guarantees an income for life, regardless of how long you live. You can set up life with period certain, which means the payments will last for the rest of your life or for the set period, whichever comes last. Or you can set up period certain, which means the payments will last a specific period of time, and no longer. These affect inheriting an annuity.

Payout Phase Inheritence

If the annuity owner annuitized the annuity (started the payout phase), the payout option the owner chose determines how the annuity is inherited. For example, if he selected the life only option, there would be no inheritance as the annuity ends at death. If he selected "period certain," the payments would continue until the end of the period, and the payments transfer to the beneficiary. For example, if the annuity owner selected a 10-year period certain, and died after three years, the beneficiary or beneficiaries would receive seven years of payments.

Accumulation Phase Inheritance

If the annuity hasn't been annuitized before the annuity owner dies, the beneficiaries can choose to take a lump-sum payment immediately. They can also choose to take payments over time (until the end of the fifth year after the annuity owner's death) or take a lump-sum payment at the end of the fifth year after the annuity owner's death, which allows interest to accumulate. Spousal beneficiaries also have the option of continuing the annuity as if it was their own, letting the annuity accumulate tax-deferred interest, if the annuity was in the accumulation phase when the annuity owner died.

Tax Consequences

Any time you withdraw money from an annuity, including due to death, you owe taxes on the earnings of the annuity. For example, if the annuity owner paid an initial $10,000 in premiums, and the annuity grew to $30,000 when the annuity owner died, the beneficiaries would be responsible for paying taxes on the $20,000 the annuity earned. If you do a lump-sum payout, you would owe the taxes that tax year. If you stretch out the payments over time, you also stretch the taxes over that time period.