The advantages and disadvantages of inherited annuities

To the actual individual who purchased it, an annuity plan may make a great deal of sense. However, for those who inherit it, it may mean nothing at all. It is quite possible that the inheritor of the annuity earns more than the policyholder and as a result, the payments from the annuity seem insignificant to him. In a case like this, selling off the inherited annuity can be a viable option.

A second reason for selling inherited annuities is the tax that tags along behind it. Any income from an inherited annuity is taxable. Just as the benefactor was taxed, the beneficiary too will be taxed. The inherited annuity may even place the inheritor in a tax bracket higher than his actual income and a higher tax will be levied on his earning, to be settle within five years, unless the annuity is converted into a deferred one.

Unlike other inheritances, where the taxes are minimal or lower when the funds are sold later, annuities cost a great deal more. This is because of the slotting they have within ordinary income tax sources, with the ceiling being an astounding 35 percent, applicable to any gain from it. Furthermore, they are also included in taxable estates. As a result, the major question is to find out how the annuity payment was made.

If the annuity had been a purchase made by the employer of the original policyholder for his benefits, a hundred percent of each payout will be taxed in the highest tax-bracket for the heir. Even if pretax funds such as from the IRA (Individual Retirement Account), were used for the purchase, the same rules apply. However, if the annuity had been purchased with taxed money, some portion of each payout the beneficiary receives will be tax-free for the principal, i.e. only the interest will be taxed.

The tax matrix gets more complicated if the beneficiary is not the policyholder’s spouse. For a spouse, the annuity is passed on as a “spousal continuation”, wher the ownership of the contract passes on to the spouse in the event of the policyholder’s death. The spouse can then avail of deferred payments, which is an option not available for non-spousal inheritors of the annuity contract.

Non-spousal inheritors have three separate options. One is that they withdraw all the money from the scheme within five years of the policyholder’s death and pay whatever tax is due on that amount. Second is the annuitization of the contract to guarantee a lifetime of annuity payments. The third option is starting withdrawal according to regular timetable based on expected years of life. There is, of course, the fourth option of selling it altogether.

Most of the people who are beneficiaries to an annuity choose to either sell it or withdraw the money, if allowed, and be over with the whole deal. The complexities of taxes and its consequences are demoralizing for most people and scare them off. Tax, surely, was name keeping in mind the way it taxes a person with its detailed calculations and exhausting processes.

That is not even to mention the stress and frustration that a person endures for a sum that may have to be foregone and which could have proved valuable if allowed to keep. People generally sell annuities they inherit to obtain the preferable large lump sum instead of insignificant smaller payouts.

Mentally, a single payment seems a better way to use the saved money through other sensible and high-yield investments.

Resources
Discussion:Tax Implications of an Inherited non-qualified annuity
Inherited Annuity & Taxes
taxes on inherited annuities
Annuity Exit Strategies