Annuities are a recognized tax shelter by the IRS that allows insurance companies to provide a tax-deferred investment to customers. The annuity contract pays a death benefit to the beneficiaries designated by the owner of the annuity when the annuitant dies. If you are the heir to an annuity benefit, you should keep certain rules in mind when deciding how to take your inheritance.
The annuity owner can name anyone he wishes to be the recipient of assets upon the annuitant's death. The owner may be one or more individuals, a family trust, a charity or any other entity. It is the annuity owner's right to designate and change beneficiaries at any given time during the contract. The person listed on the annuity contract as the beneficiary(ies) supersedes wills and trust documents naming others.
Upon the death of the annuitant, the beneficiary has several options to take the annuity payment. The first is to take a lump-sum benefit meaning he cashes the entire annuity contract out and takes the money as a distribution. A beneficiary also has the option to take a series of payments over a five-year period to reduce the annual taxes owed. If the annuity was in the annuitization phase, meaning the annuitant was taking funds based on regular payments not lifespan, the beneficiary has the option to continue these payments based on the existing schedule. If the annuity was in the lifetime income option, beneficiaries may receive nothing unless the policy had a special provision.
Beneficiaries pay taxes on the money distributed to them from an annuity. Annuities treat distributions based on the LIFO method of accounting, meaning Last In First Out, so earnings are always taxed before principal is released. There is an exclusion to this for annuities created prior to Aug. 14, 1982. If part of the annuity basis was already taxed, this portion will be exempt of income tax if the beneficiary takes regular payments on it. Earnings are always added to ordinary income.
- Pixland/Pixland/Getty Images