Taxes on Annuity Death Benefits
The death benefits from an annuity are unprotected to income tax. The amount of taxes due will depend on the amount of money involved and how it is inherited.
The term death assistance can apply to either the funds in the plan or to a life insurance policy attached to it.
Annuities are a tax-deferred investment which method that taxes are due when funds are taken out of one. consequently taxes will be due if a person inherits all of the money in one or takes all of the funds out. Many people get quite a shock because they are not expecting the funds or the increase in their tax bill.
Any money that you receive from an annuity including funds you inherit from one is reportable income. That method it could increase your tax bracket and your tax rate. If there’s a large amount of money in a plan it will affect your tax rate. Any increase in the value of an indexed or variable annuity that you inherit will be regarded as an increase in income by the IRS.
Annuity Payments vs. Death assistance
The only time you will be taxed on annuity funds you inherit is if they are distributed directly to you. If you simply take over the payments you will only have to report the payments on your taxes. The funds in the plan itself will nevertheless be tax deferred.
So you can keep your tax bill lower by simply becoming the beneficiary of the plan. This will only be of assistance to people over 59½ years old because the IRS will charge a 10% tax penalty on money persons under that age receive from annuities. If Giorgio had an annuity and named his 65 year old brother Sid as the beneficiary Sid could receive the payments.
Make sure you read the annuity contract carefully before you set such an arrangement up. It will only be allowed if the plan allows you to take that step. Another option might be to roll the funds over into another kind of annuity. That can preserve their tax-deferred position. You will have to check with the IRS or a tax advisor to see if that is possible before attempting it.
Inheriting an Annuity
If you inherit an annuity you should be prepared to pay some additional taxes. Most people that inherit will not be able to continue as a beneficiary so they will have to take all of the funds out. That method they will have to report that income and pay taxes on it.
There are some ways to reduce your tax liability if this happens. One is to invest that money in a tax-deferred retirement investment such as a deferred annuity, an immediate annuity with deferred payments or an IRA. You may nevertheless have to pay some additional taxes but you could lower future tax bills. You will not have to pay taxes into funds you put into such plan until you take the money out.
A good way to keep this money out of your reportable income is to put it into a deferred annuity or an immediate annuity with deferred payments. In such an arrangement you can put payments until you retire. By taking that step most of your additional income will be in a tax-deferred arrangement that will provide you with a regular stream of income after you retire. You should only have to pay income tax on the payments and not the principal of the money in the plan.