When an annuity is inherited, the beneficiary can choose to take all the remaining money as a single lump sum; to receive the same annuity payments that the decedent had been receiving; to leave the account as it was, but place it in the beneficiary’s name; or to roll the funds over into a new retirement savings plan. If the annuity was not inherited from a spouse the beneficiary cannot treat it as her own. What she chooses to do affects how the inheritance is taxed.
An annuity is a retirement savings plan. The Internal Revenue Service encourages this type of saving by offering tax breaks for those who put money into annuity funds. To discourage people from removing money prior to retirement, the IRS penalizes those who take money out of their retirement savings before reaching retirement age. A person who inherits an annuity is not subject to the 10 percent early-withdrawal penalty.
Types of Annuities
Tax-deferred annuities can include any kind of annuity that is funded with pre-tax dollars. This includes 403(b) plans, 401(k)s, various types of individual retirement accounts and some purchased annuity contracts. They type of plan a person has depends on what is offered at his place of employment or if it was purchased independently. Nonprofit organizations and public schools typically use the tax-sheltered annuity plan, TSA, also known as a 403(b). Other employers may offer either a 401(k) or certain types of IRAs. Roth plans are not tax-deferred.
When any kind of a tax-deferred annuity is inherited it will be subject to income tax at the time the money is distributed to the beneficiary. She can avoid this by rolling the money over into an account of her own or leaving the annuity alone for as long as possible, which will vary by the beneficiary’s age and the type of annuity. When the money is taken from the annuity, it will be treated in the same manner it would have been if the original owner had survived, with a few exceptions.
Since the annuity is inherited, there are some special rules that apply. Depending on the circumstances, the beneficiary may be able to deduct the portion of the tax as an estate tax deduction if the decedent had begun to receive regular payments from the annuity. A person listed as a survivor on an annuity will have to include all distributed funds as part of her regular income as the funds are received. Estate tax is only due for extremely large estates and do not apply to 98 percent of Americans, according to the IRS.
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