Inherited Annuity: Beneficiary Types, Taxes, and the 10-Year Rule

Taxes on an inherited annuity depend on two things: how the original owner funded it, and who you are to them. If the annuity was qualified (held inside an IRA, 401(k), or 403(b)), every dollar you withdraw is ordinary income. If it was non-qualified (bought with money the owner had already paid tax on), only the earnings above the original investment are taxable. Your relationship to the deceased then controls how fast the money has to come out, which is what really drives the size of your annual tax bill.

Qualified or Non-Qualified: Find Out First

Call the insurance company and confirm which kind of contract you inherited before you elect anything. The rules split cleanly at this point and don’t cross back over.

A qualified annuity sits inside a tax-advantaged retirement account. The original owner funded it with pre-tax dollars, so nothing in the account has ever been taxed. Every distribution is ordinary income to you.

A non-qualified annuity was bought with after-tax money. That after-tax investment is the “cost basis,” and it comes back to you tax-free. Only the growth above basis is taxable.¹

Get the classification wrong and you’ll either overpay or underpay from the first check.

How the Distributions Are Taxed

Qualified Annuities

Every dollar is ordinary income. Form 1099-R from the carrier will show the same figure in the gross distribution box and the taxable amount box.² One piece of relief: the 10% early withdrawal penalty for pulling from a retirement account before 59½ does not apply to inherited accounts, whatever your age. Death of the owner is a statutory exception.³

Non-Qualified Annuities

Every distribution splits into a tax-free return of basis and taxable earnings. How that split gets calculated depends on how you take the money.

Take lump sums or partial withdrawals from a contract you haven’t annuitized, and the IRS uses an earnings-first rule. Every dollar coming out is 100% taxable until all the accumulated gain has been distributed. Only after you’ve pulled out every dollar of earnings do the remaining withdrawals become tax-free returns of basis.¹ That front-loads the tax bill and is what can push a large lump-sum withdrawal into a much higher bracket.

Annuitize the contract instead and the exclusion ratio applies. Divide the investment in the contract by the total expected return, and that percentage of each payment is tax-free. The rest is ordinary income. Once you’ve recovered your full basis, every later payment is fully taxable.⁴

No Step-Up in Basis

Unlike inherited stock or real estate, annuities do not get a stepped-up basis at the date of death. Your basis is what the original owner paid in, not what the contract was worth when they died. All of the growth that built up during their lifetime is taxable to you. For an annuity that doubled in value over 20 years, the embedded gain the original owner never paid tax on is now yours to pay.

Rules for a Surviving Spouse

Qualified Annuities

If your spouse left you a qualified annuity, you can roll the funds into your own IRA and treat the account as always having been yours. Federal law specifically excludes surviving spouses from the definition of an “inherited” IRA for this purpose.⁵ After the rollover, you follow your own required minimum distribution schedule, which currently begins at age 73.⁶

The rollover is usually the strongest move if you don’t need the money now. It keeps tax deferral running and resets the RMD clock to your own age. If your spouse was older and already taking RMDs, rolling over pauses those withdrawals until you turn 73.

You can also elect to be treated as a beneficiary rather than roll over. That narrow choice makes sense if you’re under 59½ and need income now, because beneficiary distributions escape the 10% early withdrawal penalty that would apply to your own IRA.

Non-Qualified Annuities

Non-qualified annuities are governed by IRC Section 72(s), not the SECURE Act. Under that statute, a surviving spouse is simply treated as the new holder of the contract.⁷ You step into the original owner’s shoes, keep the contract in force, and let deferral continue. No forced distributions, no deadlines.

The 10-Year Rule for Most Other Beneficiaries of Qualified Annuities

If you inherited a qualified annuity from someone who died after December 31, 2019, and you are not an eligible designated beneficiary, the entire account has to be emptied by December 31 of the tenth year after the owner’s death.⁸ This is the SECURE Act’s 10-year rule, which replaced the old lifetime stretch.

How much flexibility you have inside those ten years depends on whether the owner had already reached their required beginning date:

Owner died before their required beginning date: no distributions are required in years one through nine. Withdraw on any schedule you want, as long as the account is empty by December 31 of year ten.
Owner died on or after their required beginning date: you must take annual distributions in years one through nine based on your life expectancy, then take whatever remains by the end of year ten. Skipping a year triggers a 25% excise tax on what you should have taken, dropping to 10% if you correct the shortfall within two years.⁹⁶

The second scenario catches people. If the owner was already 73 and taking RMDs, you can’t just wait and take a lump sum in year ten. Final Treasury regulations issued in July 2024 confirmed the annual distribution requirement after several years of uncertainty.

Eligible Designated Beneficiaries

A narrow group is exempt from the 10-year rule and can still stretch distributions over their own life expectancy. The IRS calls them eligible designated beneficiaries:

The surviving spouse (who typically has stronger options above)
Minor children of the deceased owner (not grandchildren or other minors)
Disabled individuals
Chronically ill individuals
Beneficiaries not more than 10 years younger than the deceased owner, such as a sibling close in age⁸

Annual RMDs come from the IRS Single Life Expectancy Table, recalculated each year. For a young disabled beneficiary, the stretch can run for decades and cut the annual tax hit sharply compared with the compressed 10-year timeline.

The exception for minor children has a catch. The life expectancy stretch only runs until the child turns 21. At that point the 10-year clock starts, so the account has to be fully distributed by the time the child turns 31.

Non-Qualified Annuities Inherited by a Non-Spouse

The SECURE Act’s 10-year rule does not apply to non-qualified annuities. IRC Section 72(s) explicitly excludes contracts held in qualified plans, 403(b)s, or IRAs, so 72(s) governs only non-qualified contracts and the SECURE Act governs only qualified accounts.⁷

For a non-spouse beneficiary of a non-qualified annuity, the default rule is a five-year deadline: the entire contract has to be distributed by December 31 of the fifth year after the owner’s death. There’s a valuable exception. If you elect to receive distributions over your own life expectancy and begin those payments within one year of the owner’s death, the five-year rule does not apply.⁷

This life expectancy option is the closest thing left to the old stretch. Act within one year and you can spread the taxable income over decades. Miss the deadline and you’re locked into the five-year timeline with no way back.

If the owner died after annuity payments had already started, the remaining payments must continue at least as rapidly as the method in place at death. Slowing them down isn’t allowed.

When an Estate, Trust, or Entity Is the Beneficiary

Not every annuity passes to an individual, and the results are worse when it doesn’t. For a qualified account paid to an estate, charity, or other non-individual, if the owner died before their required beginning date, the five-year rule applies: the entire account must be distributed by December 31 of the fifth year after death.¹ There is no 10-year option and no life expectancy stretch, because those require a “designated beneficiary,” which must be an individual.

A trust can qualify as a “see-through” trust if it meets certain IRS requirements, in which case the individual beneficiaries of the trust are treated as the designated beneficiaries. If the trust fails those requirements, it drops back into the entity rules and the five-year deadline. Trust income that isn’t distributed to beneficiaries is taxed at trust rates, which hit the top 37% bracket at just $15,650 of income in 2026, compared to $640,600 for a single individual filer.¹⁰

For non-qualified annuities held by an entity, IRC 72(s) treats the “primary annuitant” as the holder, and distribution requirements kick in on that person’s death.⁷

The IRD Deduction Can Cut the Bill

If the deceased owner’s estate was large enough to owe federal estate tax and the annuity was included in that taxable estate, you may be entitled to a deduction for income in respect of a decedent. The annuity was taxed once as part of the estate and will be taxed again as income when you receive distributions. The IRD deduction partially offsets that double tax.

Claim it on Schedule A of Form 1040, Line 16, as an “other itemized deduction.”¹¹ The deduction equals the portion of federal estate tax attributable to the annuity’s income component, and calculating it requires figures from the estate’s Form 706. Coordinate with the executor or the estate’s tax preparer. The deduction applies only to the taxable portion of your distribution, not to any tax-free return of cost basis on a non-qualified contract, and it is not subject to the limits that cap other itemized deductions.

Timing Your Withdrawals

The deadline is one thing; how you fill the space inside it is where the tax savings live.

If you’re a non-spouse beneficiary of a qualified annuity under the 10-year rule and the owner died before their required beginning date, you can time withdrawals however you want across those ten years. Taking everything in one year is usually the worst outcome, because a lump sum stacks on top of your other income and can push you into the 32% or 35% bracket.¹⁰

The math is simple. Say you inherit a $500,000 qualified annuity and your regular income puts you in the 22% bracket. Taking $50,000 a year for ten years may keep most of those withdrawals in the 22% or 24% zone. Take all $500,000 in year one and a large chunk gets taxed at 32% or 35%. Over a decade the difference can easily run $30,000 or more in federal tax.

For non-qualified annuities, the earnings-first rule makes timing even more important on non-annuitized withdrawals. Consider annuitizing if you have substantial gains, because the exclusion ratio spreads taxable income more evenly. If you’re taking withdrawals rather than annuitizing, pull money in years when your other income is unusually low.

Watch the side effects. Large distributions can trigger the 3.8% net investment income tax, raise the taxable share of your Social Security benefits, and push your Medicare Part B premiums up through IRMAA surcharges. None of these show up on the annuity statement, but they add real cost.

Claiming the Annuity

Once you’ve decided which distribution option fits, the paperwork itself is straightforward, though delays get expensive if annual RMDs are in play.

Notify the insurance company of the owner’s death. You’ll usually need a certified copy of the death certificate and the contract number.
Request beneficiary claim forms and read the options carefully before signing. Some elections are irrevocable.
For qualified annuities, an inherited IRA (sometimes called a beneficiary IRA) gets set up in a specific titling format, and the funds transfer directly into it to preserve tax-deferred status. Only a surviving spouse can roll qualified funds into their own IRA.
For non-qualified annuities, ask the carrier for a written breakdown of cost basis and accumulated earnings. You’ll need those figures for every return you file while receiving distributions.
Ask whether the contract’s surrender charge is waived at death. Some contracts waive it, some don’t; if it isn’t waived and the contract is still in its surrender period, a lump-sum election can cost several percent of the contract value.

Move quickly on non-qualified annuities in particular. The life expectancy exception to the five-year rule requires distributions to begin within one year of the owner’s death, and missing that window locks you into the shorter timeline permanently.

1
Internal Revenue Service. Publication 575 (2025), Pension and Annuity Income
2
Internal Revenue Service. 2025 Instructions for Forms 1099-R and 5498
3
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
4
Internal Revenue Service. Publication 939 (12/2025), General Rule for Pensions and Annuities
5
Office of the Law Revision Counsel. 26 USC 408 – Individual Retirement Accounts
6
Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
7
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
8
Internal Revenue Service. Retirement Topics – Beneficiary
9
Federal Register. Required Minimum Distributions
10
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
11
Internal Revenue Service. 2025 Instructions for Schedule A (Form 1040)