Inherited Annuity 101: What Happens When You Inherit One

When you inherit an annuity, you inherit a contract with a deadline attached. You generally choose between a lump sum, spreading payments over five years, or stretching them over your life expectancy, and a surviving spouse can usually continue the contract as their own. The gains are taxable income to you.

This article is general education, not tax or legal advice. Inherited-annuity rules turn on contract language and your relationship to the owner, so confirm your specific situation with a tax professional before you elect anything.

An inherited annuity arrives like a certified letter with a reply-by date. There is money in it, which is the part everyone focuses on. There is also a window in which you have to answer, which is the part almost nobody is told about, and the answer you give (or fail to give) locks in how the money is paid and how much tax you hand back.

That is the difference between an annuity and most other things people inherit. A house sits there. A bank account sits there. An annuity contract has clauses that start running the day the owner dies, and some of the better options expire quickly. Beneficiaries who call the insurer in week one usually have every choice available. Beneficiaries who call in month six sometimes do not.

So the goal of this guide is simple: help you understand what you are holding and what your real choices are, before a claim form makes the decision for you.

What did you actually inherit?

You inherited a contract, not an account. An annuity is an agreement with an insurance company, and its death provisions were written in before you ever heard of it. Two facts about the contract determine almost everything that follows: whether the money inside is qualified or non-qualified, and whether the original owner had already started income payments.

Everything downstream (your deadlines, your options, your tax bill) traces back to those two facts. Get them confirmed in writing from the insurer before anyone gives you advice.

What should you do in the first 60 days?

Slow down and gather facts, because most of the irreversible mistakes happen fast. The single most common one is checking the lump-sum box on the claim form because it is the first option listed, which can pull years of deferred gain into one tax year at your highest marginal rate.

What are your payout options?

There are generally four, and they are not equally available to everyone. The contract sets the menu; the tax code sets the outer limits.

Note the asymmetry: the lump sum is always available, and the option that usually serves you best is the one with the tightest deadline and the least likelihood of being mentioned first.

Does it matter whether you are the spouse?

Enormously. Spousal continuation is the single biggest fork in the road, and it exists for spouses only.

If you are the surviving spouse, continuing the contract is usually worth serious consideration even if you plan to take money out later, because continuing preserves optionality and taking a lump sum destroys it. Our guide on spouse vs non-spouse inherited annuity walks the full comparison, and annuity spousal continuation covers the mechanics.

What if the annuity was inside an IRA?

Then the IRA rules govern, not the annuity’s own death provisions. For most non-spouse beneficiaries of an owner who died in 2020 or later, the SECURE Act’s 10-year rule applies: the entire account must be emptied by December 31 of the tenth year after the year of death. The contract living inside the IRA does not create an exemption.

• Eligible designated beneficiaries are exempt from the 10-year rule. That group is a surviving spouse, a minor child of the owner (until age 21), a disabled or chronically ill beneficiary, and anyone not more than 10 years younger than the owner.
• Under the IRS final RMD regulations issued in July 2024, beneficiaries subject to the 10-year rule must also take annual distributions in years one through nine if the owner died on or after their required beginning date. The IRS confirmed no penalty for missed distributions in 2021 through 2024, so this effectively begins with 2025.
• The IRS is still finalizing pieces of this. In Announcement 2026-7, issued February 23, 2026, Treasury said certain proposed amendments to the RMD regulations will not apply until at least six months after final rules are published in the Federal Register. Confirm current guidance before you set a schedule.
• Every dollar coming out of an inherited qualified annuity is ordinary income to you. There is no basis to shelter it.

The full mechanics live in the 10-year rule for inherited annuities.

What happens if you do nothing?

Something still happens, and it is rarely the outcome you would have picked. Inaction is itself an election in most contracts.

• The five-year clock runs anyway. For a non-qualified contract, section 72(s) starts counting from the date of death, not the date you get around to filing a claim.
• The stretch window closes. Once the carrier’s election period passes (often 60 days), the life-expectancy option is usually off the table permanently.
• The insurer may force a distribution. Many contracts allow the carrier to pay out under the default provision once a deadline lapses, and that default is frequently the least tax-efficient path.
• Interest may stop crediting. Some contracts stop crediting interest on a death benefit after a set period, so waiting can cost you money as well as options.
• The tax bill does not go away. Deferred gain in an inherited annuity is income in respect of a decedent under IRC section 1014(c). There is no step-up in basis, so delay does not erase anything.

Does an inherited annuity count as income for Social Security?

It depends which Social Security question you mean, and the two answers are different. For the retirement earnings test, the answer is no. For the taxation of your benefits, the answer is yes.

That last line is the practical takeaway. Spreading the payout is not only a bracket play; it can also protect the taxability of your benefits, which is a cost people discover the following April.

Moving forward

Back to the certified letter. The envelope has money in it and a reply-by date on it, and the reply-by date is the part you control for a limited time. You do not have to decide today. You do have to find out how long “today” lasts, in writing, from the insurer.

The order that works: confirm what kind of contract it is, confirm whether it was annuitized, confirm the election deadline, then choose. If the numbers are large enough that the tax outcome matters, get a professional in the room before the claim form is signed rather than after. AnnuaLife’s advisor match can connect you with a Certified Annuity Advisor who reads contracts for a living and can tell you what your specific carrier allows. Then read what beneficiaries actually owe so the tax side holds no surprises.

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