An annuity grows tax-deferred, pays out as ordinary income, and follows its own set of rules at exchange and at death. This page defines every tax term that shows up on a statement, a 1099-R or a beneficiary claim form, with the rule it comes from.
Annuity taxation comes down to four questions. What kind of money is in the contract, how much of it is your own already-taxed basis, what event is pulling money out, and who is receiving it. Every term on this page answers one of those four.
The rules below are federal and come from Internal Revenue Code section 72, the 1.401(a)(9) regulations and IRS Publications 575 and 590-B. States mostly follow the federal result but a few add their own wrinkles. MAS does not give tax advice; use this page to ask your tax professional better questions.
Usually the wrong answer when
Tax deferral is the wrong reason to buy an annuity when you are in a 0% or 10% bracket today and expect the same later, when the money is already inside an IRA or 401(k) and gains nothing from a second tax wrapper, or when you will need the gain before 59½ and would pay the 10% additional tax to get it. In those cases buy the annuity for its guarantees or not at all.
Eight terms that every other tax rule builds on. Know whether the money is qualified, know your basis, and most of the rest follows.
What does it mean that an annuity is tax-deferred?
DefinitionTax deferral means the interest or gain credited inside an annuity is not taxed in the year it is earned; it is taxed only when money comes out of the contract.
A bank CD sends you a 1099-INT every year whether you spend the interest or not. A non-qualified Deferred annuity sends nothing until you withdraw, surrender, annuitize or die. The gain compounds on the full pre-tax amount in the meantime, which is the whole advantage (IRS Publication 575).
Deferral is a timing benefit, not a tax cut. The gain is eventually taxed as Ordinary income, never at capital gains rates, and someone pays that tax: you, your spouse or your beneficiary. See Compounding vs taking interest for the math on letting it ride.
Illustrative
$100,000 at 5% for 10 years. Taxed yearly at 24%, the money grows at 3.8% after tax to about $145,200.
Deferred, it grows to $162,900, and after paying 24% on the $62,900 gain at the end you keep $147,800. Deferral added about $2,600, and more if your bracket is lower when you withdraw.
Related: Qualified vs non-qualified · Ordinary income · Gains-first taxation · Compounding vs taking interest · MYGA vs CD
What is the difference between a qualified and a non-qualified annuity?
DefinitionA qualified annuity holds pre-tax retirement money (traditional IRA, 401(k), 403(b)) and is taxed under retirement plan rules; a non-qualified annuity holds money that has already been taxed and is governed by Internal Revenue Code section 72 alone.
The contract itself is the same product either way. What changes is the tax wrapper around it, and that wrapper decides almost every rule on this page.
Roth IRA money is qualified but follows its own rules; see Roth IRA annuity.
Watch for
Carriers code the contract as qualified or non-qualified at issue and it cannot be changed later. Funding a non-qualified application with an IRA check, or the reverse, creates a taxable distribution. Check the Application box before you sign.
Related: Tax deferral · Cost basis · Annuity inside an IRA · RMD age · Roth IRA annuity
How much of my annuity can I take out tax-free?
DefinitionCost basis, called investment in the contract by the IRS, is the total after-tax money you put into a non-qualified annuity, less any tax-free amounts already taken out; it comes back to you free of income tax.
On a single-premium non-qualified contract the basis starts as the premium. It grows with any additional after-tax deposits and shrinks with each tax-free return of basis. It carries over unchanged through a 1035 exchange (IRS Publication 575).
On a traditional IRA annuity the basis is normally zero, because the contributions were deducted. The exception is non-deductible IRA contributions tracked on Form 8606, which create basis across all your IRAs together.
Illustrative
You pay $100,000 for a non-qualified MYGA. Five years later it is worth $127,600. Your basis is $100,000, your Gain is $27,600, and a full surrender puts $27,600 on your return while returning $100,000 untaxed.
Watch for
Basis does not include interest, bonuses or index credits, and a rider charge does not raise it. After a 1035 exchange the new carrier relies on the old carrier’s reported basis; if the old carrier’s records were wrong, fix them before the exchange, not after.
Related: Gain · Gains-first taxation · Basis carryover · Exclusion ratio · No step-up in basis
What counts as the taxable gain in my annuity?
DefinitionThe gain is the contract’s cash value, measured before any surrender charge, minus your cost basis; it is the portion of any withdrawal that is taxable.
Section 72(e)(3) measures gain using the cash value “determined without regard to any surrender charge.” That means the surrender charge does not shrink the taxable amount on a partial withdrawal. The carrier reports the gain in box 2a of your Form 1099-R.
Gain includes credited interest, index credits, premium bonuses and any amounts the carrier adds. It is taxed as Ordinary income whenever it leaves the contract, whether you take it or your beneficiary does.
Illustrative
Account value $130,000, surrender charge 6%, basis $100,000. You surrender and receive $122,200 after the charge. The taxable gain is still $30,000, not $22,200, because gain is measured before the charge.
Watch for
A contract with a surrender charge can produce a taxable gain larger than the cash you actually receive. Ask the carrier for the “taxable amount” on a hypothetical withdrawal before you request it.
Related: Cost basis · Gains-first taxation · Ordinary income · Surrender charge · Form 1099-R
Is annuity gain taxed as capital gains?
DefinitionNo. All annuity gain is taxed as ordinary income at your regular federal bracket; the long-term capital gains rates that apply to stocks and funds never apply to an annuity.
Section 72 treats every dollar of gain the same way regardless of what produced it. Index-linked credits inside a Fixed index annuity are ordinary income even though they track a stock index. The same is true of Variable annuity subaccount growth (IRS Publication 575).
Ordinary income rates run higher than capital gains rates for most retirees with meaningful income. That is why the tax deferral comparison in Tax deferral uses the same rate at the end, and why a taxable brokerage account can win for equity money held a long time.
Watch for
A large one-year gain, such as a full surrender or a Lump sum to a beneficiary, can push you into a higher bracket, raise your Medicare premiums two years later through IRMAA, and increase the taxable share of Social Security. Spread large withdrawals across years where you can.
Related: Gain · Tax deferral · Lump sum to a beneficiary · Exclusion ratio
What is the 1099-R my annuity company sent me?
DefinitionForm 1099-R is the IRS form a carrier issues for any distribution from an annuity, IRA or retirement plan; it reports the gross amount, the taxable amount and a code describing the type of payment.
Carriers must send it by January 31 for the prior year’s payments (IRS Form 1099-R instructions). The boxes that matter:
- Box 1, gross distribution: everything paid out, including withholding.
- Box 2a, taxable amount: the gain portion on a non-qualified contract, or the full amount on a traditional IRA. “Taxable amount not determined” may be checked if the carrier lacks basis records.
- Box 4: federal income tax withheld.
- Box 7, distribution code: 1 for early distribution with no known exception, 2 for early with an exception, 4 for death, 7 for normal, 6 for a 1035 exchange, G for a direct rollover, among others.
A completed 1035 exchange still generates a 1099-R with code 6 and a zero taxable amount. That is normal.
Watch for
A code 1 in box 7 when you qualified for an exception does not cost you the exception; you claim it on Form 5329. A missing 1099-R for a transfer you thought was tax-free is a sign to call the carrier before filing.
Related: Gain · Federal withholding elections · 10% additional tax before 59½ · 1035 exchange · 60-day rollover
Will the carrier take taxes out of my annuity payments?
DefinitionFederal income tax is withheld from annuity payments by default unless you elect otherwise; periodic payments are withheld like wages using Form W-4P, and one-time payments use a flat default rate you can change or waive on Form W-4R.
Two forms, two regimes (IRS Publication 575):
- Periodic payments (annuitized income, systematic withdrawals): withheld as if wages, based on the W-4P you file with the carrier. File nothing and the carrier uses the form’s default assumptions.
- Non-periodic payments (a one-time withdrawal, a surrender, a lump-sum death benefit): a flat default percentage applies unless you request a different rate or no withholding on Form W-4R.
Either way the owner can elect out of withholding on an annuity or IRA payment. Payments from an employer plan that are eligible for rollover but paid to you are the exception: withholding there is mandatory and cannot be waived, which is why a direct rollover is preferred.
Watch for
Withholding is not the tax; it is a prepayment. Electing zero withholding on a large surrender leaves the whole bill for April and may trigger an underpayment penalty. Electing it does not change what you owe.
Related: Form 1099-R · 60-day rollover · Trustee-to-trustee transfer · Lump sum to a beneficiary
Why did a few hundred dollars disappear when my annuity was issued?
DefinitionA state premium tax is a tax a handful of states charge the carrier on annuity premiums, which the carrier passes through by deducting it from your deposit at issue or at annuitization.
Most states exempt annuity premiums. In the states that do not, the rate is typically a low single-digit percentage, often higher on non-qualified money than on qualified money. Some carriers deduct it at issue; in the few states that allow it, others wait and deduct it only if you annuitize.
Which states charge it, and at what rate, varies. The rate is set by the state where the owner lives at the time, not by the carrier.
Illustrative
A $100,000 non-qualified deposit in a premium-tax state at 2% is credited as $98,000 on day one. At a 5% guaranteed rate the contract needs about five months just to recover the tax.
Watch for
If you live in a premium-tax state, ask the carrier whether it deducts at issue or at annuitization. Only California, Nevada and West Virginia allow the tax to be paid at annuitization, and in those states a contract you never annuitize may avoid it. Elsewhere the carrier pays the tax up front, even if it bills you later. Moving states before annuitizing can also change the result.
Related: Premium · Account value · Annuitization · Funding
Money taken from a non-qualified annuity before it is annuitized follows one ordering rule: gain comes out first. These five terms cover that rule and its exceptions.
If I withdraw $10,000, is any of it my own money back?
DefinitionGains-first (LIFO) taxation means withdrawals from a non-qualified deferred annuity are treated as coming from earnings first, fully taxable, and only after all gain is out do withdrawals become a tax-free return of basis.
Publication 575 states that amounts received before the annuity starting date are “allocated first to earnings (the taxable part) and then to your cost.” LIFO stands for last in, first out: the growth went in last and comes out first. This applies to partial withdrawals, free withdrawals, Interest-only withdrawals and Loans and pledges.
The rule reverses once you annuitize. Annuity payments use the Exclusion ratio, which spreads basis evenly across every payment.
Illustrative
Contract value $130,000, basis $100,000. You withdraw $20,000: all $20,000 is taxable gain. Next year you withdraw $15,000: $10,000 is the remaining gain and taxable, $5,000 is basis and tax-free, and the contract now holds $95,000 of basis and no gain.
Watch for
Buyers who take “just the interest” each year are taking 100% taxable money every year, while the gain inside the contract keeps growing. If you want a mix of basis and gain in each payment, annuitize or consider a SPIA funded by 1035 exchange.
Related: Cost basis · Gain · Exclusion ratio · Partial withdrawals · Pre-August 1982 contracts
My annuity is from 1980. Does gains-first apply to it?
DefinitionContracts with investment made before August 14, 1982 follow the old rule: withdrawals come first from that pre-1982 basis tax-free, and only then from gain.
Publication 575 states that for these contracts distributions are allocated first to the investment made before August 14, 1982, which comes back tax-free, then to earnings on that investment, then to later contributions and their earnings under the normal gains-first rule. Withdrawals of pre-August 14, 1982 investment are also exempt from the 10% additional tax under section 72(q)(2)(F).
The carrier tracks the split. Ask for a statement showing pre-1982 and post-1982 basis separately before any withdrawal.
Watch for
A 1035 exchange preserves this grandfathered treatment; the pre-1982 basis carries to the new contract. A surrender and repurchase does not. Never let an agent replace one of these contracts without confirming in writing that the pre-1982 character carries over.
Related: Gains-first taxation · Cost basis · 72(q) exceptions · Basis carryover · 1035 vs surrender and rebuy
How is a partial withdrawal taxed compared to a full surrender?
DefinitionA partial withdrawal from a non-qualified deferred annuity is taxable to the extent of the gain in the contract at that moment, measured before surrender charges; a full surrender taxes all remaining gain at once.
The carrier compares the cash value (before surrender charge) to your Cost basis. The difference is gain, and the withdrawal is taxable up to that amount. Anything you withdraw beyond the gain is basis and tax-free, and the result shows on your Form 1099-R in box 2a.
Timing a partial withdrawal across tax years can keep you in a lower bracket than one large surrender. On a contract with little gain, a partial withdrawal may be nearly tax-free even in year one.
Illustrative
Value $110,000, basis $100,000. A $25,000 withdrawal is $10,000 taxable and $15,000 tax-free. A full surrender of $110,000 is $10,000 taxable and $100,000 tax-free: same tax, different cash, and the partial keeps the deferral going on $85,000.
Related: Gains-first taxation · Full surrender · Partial surrender · Free withdrawal provision · 10% additional tax before 59½
Can I split my money into several small annuities and withdraw basis from one of them?
DefinitionThe aggregation rule treats all non-qualified deferred annuity contracts issued by the same carrier to the same owner in the same calendar year as one contract when calculating the taxable part of a withdrawal.
Section 72(e)(12) applies to contracts entered into after October 21, 1988 and treats “all annuity contracts issued by the same company to the same policyholder during any calendar year” as a single contract. The gain across all of them is pooled, so a withdrawal from the contract with the least gain is still taxed on the combined gain first.
The rule does not reach contracts from different carriers, contracts issued in different calendar years, or qualified contracts.
Illustrative
You buy two $50,000 MYGAs from the same carrier in March and June. Three years later each is worth $58,000. Withdrawing $10,000 from one is taxed on the combined $16,000 of gain: all $10,000 is taxable, not $8,000.
Watch for
Splitting premium across carriers (see Splitting premium across carriers) or across calendar years avoids the rule legitimately. Carriers do not always flag it on the 1099-R, so your tax preparer needs to know you own more than one contract.
Related: Gains-first taxation · Partial withdrawals · Splitting premium across carriers · Cost basis
Can I borrow against my annuity or use it as collateral?
DefinitionA loan from, or a pledge or assignment of, a non-qualified annuity is taxed as if you had withdrawn the amount borrowed or pledged, gain first, with the 10% additional tax if you are under 59½.
Section 72(e)(4)(A) says a loan, assignment or pledge of any portion of the contract value “shall be treated as received under the contract.” You never see the cash, but the carrier issues a Form 1099-R for the amount treated as distributed. A later repayment does not reverse the tax.
Employer plan loans under 72(p) are a different regime with their own limits. Borrowing against or pledging an IRA annuity makes the entire contract’s fair market value taxable (Publication 590-A), unlike the pledged-portion rule for non-qualified contracts. See Collateral assignment for the contract side.
Illustrative
You pledge a $120,000 contract with $100,000 basis as collateral for a $30,000 bank loan. The IRS treats $30,000 as distributed: $20,000 of gain is taxable this year, and $10,000 of basis is returned. The bank gets its collateral; you get the tax bill.
Watch for
Carriers that offer “annuity loans” on non-qualified contracts are offering a taxable distribution with interest on top. If you need liquidity, a free withdrawal is almost always cheaper.
Related: Gains-first taxation · Collateral assignment · Assignment · 10% additional tax before 59½
The 10% additional tax is the cost of using a retirement vehicle for non-retirement money. These four terms cover when it applies, when it does not, and one ownership trap that removes deferral entirely.
What is the penalty for taking money out of an annuity before 59½?
DefinitionThe 10% additional tax is a federal tax, on top of ordinary income tax, applied to the taxable part of any annuity distribution taken before age 59½ unless an exception applies.
Section 72(q)(1) imposes it on non-qualified annuities; section 72(t) imposes the same 10% on IRAs and employer plans. It applies only to the taxable portion.
On a non-qualified contract that means the gain, because basis comes back tax-free (IRS Publication 575). On a traditional IRA annuity it applies to the whole distribution.
You report it on Form 5329 unless the carrier’s Form 1099-R already shows an exception code. The exceptions are listed under 72(q) exceptions and 72(t) substantially equal payments.
Illustrative
Age 55, non-qualified contract worth $130,000 with $100,000 basis. You withdraw $20,000, all of it gain, so you owe ordinary income tax on $20,000 plus $2,000 in additional tax. At a 24% bracket the withdrawal costs $6,800 and nets $13,200.
Watch for
The 10% is measured on the taxable amount, not on the withdrawal, so a contract with little gain carries little penalty. The real cost of early access is usually the Surrender charge, which the carrier charges regardless of age. Compare both before deciding the annuity is “locked.”
Related: 72(q) exceptions · 72(t) substantially equal payments · Gains-first taxation · Surrender charge · MYGA vs CD
When can I take money out before 59½ without the 10% penalty?
DefinitionThe 72(q) exceptions are the situations in which a distribution from a non-qualified annuity before 59½ escapes the 10% additional tax, including death, disability, substantially equal periodic payments and immediate annuities.
Section 72(q)(2) lists them. The ones that matter for a typical buyer:
- Age: the owner has reached 59½.
- Death: payments to a beneficiary after the owner dies.
- Disability: the owner is disabled as defined in section 72(m)(7).
- Substantially equal periodic payments: a series of payments for life or life expectancy; see 72(t) substantially equal payments.
- Pre-August 14, 1982 investment: withdrawals allocable to it; see Pre-August 1982 contracts.
- Immediate annuity: a single-premium contract whose payments start within one year of purchase under section 72(u)(4); see Income start window.
- Plan termination purchase: an annuity bought by an employer on termination of a qualified plan and held until separation from service.
Notably absent from 72(q): first-home purchase, higher education, medical expenses and unemployment health premiums. Those are 72(t) exceptions for IRAs and plans and do not help a non-qualified annuity owner.
Watch for
“Disability” means unable to engage in any substantial gainful activity because of a condition expected to last indefinitely or result in death. A carrier’s Disability waiver of surrender charges uses its own definition and does not by itself prove the tax exception.
Related: 10% additional tax before 59½ · 72(t) substantially equal payments · Pre-August 1982 contracts · Income start window · Disability waiver
How do I take income from my annuity before 59½ without the penalty?
DefinitionSubstantially equal periodic payments (SEPP) are a fixed schedule of withdrawals, calculated under IRS methods and based on your life expectancy, that avoid the 10% additional tax from an IRA or employer plan under 72(t) or from a non-qualified annuity under 72(q).
You pick one of the IRS-approved methods (required minimum distribution, fixed amortization or fixed annuitization), calculate the annual payment, and take it every year. The schedule must continue for the longer of five years or until you reach 59½ (IRS Publication 590-B; IRC 72(q)(3), 72(t)(4)).
Both 72(q) and 72(t) carry the exception; the mechanics are the same. Carriers can set up the payments as Systematic withdrawals. A contract with an RMD-friendly or SEPP-friendly provision avoids surrender charges on them; otherwise the free withdrawal amount is the limit.
Illustrative
Age 52, $400,000 IRA annuity, 5% assumed rate, amortization method over the Single Life Table factor of 34.3 years: roughly $24,600 a year. You must take about that amount every year until age 59½, seven and a half years, with no changes.
Watch for
Change the amount, take an extra withdrawal, or stop early and the IRS recaptures the 10% on every prior payment, with interest. A SEPP is a commitment, not a convenience. Isolate the SEPP in its own contract so the rest of your money stays flexible.
Related: 10% additional tax before 59½ · 72(q) exceptions · Systematic withdrawals · RMD-friendly free withdrawals · RMD age
Can my corporation or trust own a tax-deferred annuity?
DefinitionUnder the non-natural owner rule, a deferred annuity owned by a corporation, partnership or other entity that is not a human being loses tax deferral, and its annual growth is taxed as ordinary income each year.
Section 72(u)(1) provides that a contract held by a person who is not a natural person is not treated as an annuity for income tax purposes. The income on the contract is includible in the owner’s income every year, exactly as if the money were in a taxable account.
The exceptions in 72(u)(3) and the agent rule matter most. A trust or other entity holding the contract “as an agent for a natural person” keeps deferral, which covers most revocable living trusts and many irrevocable trusts with human beneficiaries. Also excepted: estates acquiring the contract at death, qualified plans and IRAs, immediate annuities, and structured settlement contracts.
Watch for
A trust with a charity or another entity among its beneficiaries may not qualify as an agent for a natural person. Carriers approve trust ownership on their own forms, but carrier approval is not an IRS ruling. Have the trust reviewed before funding a large contract.
Related: Trust as owner · Tax deferral · Owner · Trust as beneficiary
Once a contract is annuitized, or a SPIA starts paying, the tax rule flips from gains-first to a fixed split in every payment. The exclusion ratio governs that split; it is defined here and only summarized on the Immediate annuities (SPIA) page.
How much of each annuity payment is tax-free?
DefinitionThe exclusion ratio is the percentage of each annuity payment that is treated as a tax-free return of your cost basis; it equals your investment in the contract divided by the expected return, and the rest of each payment is taxable ordinary income.
Publication 575 sets the method. Divide your Cost basis by the Expected return (total payments expected over your life expectancy or the fixed period). That fraction of every payment is excluded from income.
For a non-qualified SPIA or an annuitized deferred contract, the carrier calculates it and reports the split on each year’s Form 1099-R.
For annuity starting dates after 1986, the exclusion stops once total excluded amounts equal your basis; see After the basis is recovered. Life expectancy comes from the IRS tables in Publication 939, not from the carrier’s pricing tables. The explainer below lets you run your own numbers.
Illustrative
$100,000 single premium buys a life-only SPIA paying $600 a month, with an IRS life expectancy of 20 years. Expected return is $600 × 12 × 20 = $144,000, so the exclusion ratio is $100,000 ÷ $144,000 = 69.4%.
Each month $416 is tax-free and $184 is taxable. After 240 payments the basis is recovered and the full $600 becomes taxable.
Watch for
The exclusion ratio makes annuitized income look lightly taxed in the early years, which is real, but the tax-free part is your own money coming back. Compare the taxable portion to what Gains-first taxation would produce on the same dollars before deciding annuitization is the “tax-efficient” choice.
Related: Expected return · After the basis is recovered · Cost basis · SPIA · Annuitization
What does “expected return” mean on my annuity tax worksheet?
DefinitionExpected return is the total amount you and any other annuitant can expect to receive under the contract, calculated as the annual payment times the number of years in the IRS life expectancy table or the fixed period.
Publication 575 defines it as “the total amount you and other eligible annuitants can expect to receive under the contract.” For a Life only payout, multiply the annual payment by the life expectancy multiple from IRS Publication 939 Table V (or Table VI for Joint and survivor payouts). For a Period certain only payout, multiply by the number of years certain.
Life-with-refund and life-with-period-certain options require an adjustment to the investment in the contract for the refund feature before the ratio is figured. The carrier handles this, but you can check it against the IRS worksheets.
Illustrative
Joint and survivor SPIA paying $800 a month, ages 70 and 68, Publication 939 Table VI multiple 21.5 years. Expected return = $800 × 12 × 21.5 = $206,400. With $150,000 invested, the exclusion ratio is 72.7%.
Watch for
Expected return uses the IRS table, not your health or the carrier’s actuarial pricing. If you outlive the table, every payment after basis recovery is fully taxable. If you die early, the unrecovered basis is deductible on your final return.
Related: Exclusion ratio · After the basis is recovered · Life only · Joint and survivor · Period certain only
What happens to my taxes if I outlive the life expectancy the IRS used?
DefinitionOnce the tax-free portions of your payments add up to your full cost basis, every later payment is 100% taxable; if you die before recovering your basis, the unrecovered amount is deductible on your final income tax return.
Publication 575 limits total exclusions to your investment in the contract for annuity starting dates after 1986. The carrier tracks the running total and switches the Form 1099-R to fully taxable in the year the basis runs out. Contracts annuitized before 1987 keep the exclusion ratio for life, even past basis recovery.
If the annuitant dies first, section 72(b)(3) allows the unrecovered investment as an itemized deduction on the final return, not subject to the usual 2% floor. A refund feature paid to a beneficiary is tax-free up to the unrecovered basis.
Illustrative
Using the $600 a month SPIA with $416 excluded: after 240 months, $99,840 of basis is recovered, and the small remainder goes in month 241. From then on the full $600 is taxable, for life.
Watch for
Retirees who annuitized at 65 and are still receiving payments at 90 are often surprised when the “tax-free part” disappears. Build that change into any long-range income plan, and tell your tax preparer when the switch happens.
Related: Exclusion ratio · Expected return · Life with cash refund · SPIA · Longevity risk
If I annuitize my IRA, how are the payments taxed?
DefinitionPayments from an annuitized traditional IRA or pre-tax employer plan are fully taxable as ordinary income, because there is no after-tax basis to exclude; the payments also satisfy the RMD for that contract.
With zero basis the exclusion ratio is zero. Every payment is ordinary income, withheld under W-4P rules, and reported with a code 7 (at 59½ or older) on the Form 1099-R. Once an IRA annuity is in payout, the payments themselves count as the required distribution for that contract; see RMDs from an annuity in an IRA.
If an employer plan or 403(b) holds after-tax contributions, the Simplified Method in Publication 575 spreads that basis across a set number of payments based on your age at the starting date. If an IRA holds nondeductible contributions, the payments follow the Form 8606 pro rata rules in Publication 590-B. A Roth IRA annuity is the opposite case: qualified payments are entirely tax-free. See Roth IRA annuity.
Illustrative
$300,000 traditional IRA annuitized at 70 for $1,800 a month. All $21,600 a year is taxable. No further RMD calculation is needed for that contract, but the payout schedule must itself meet the RMD rules, which a carrier-issued life or joint-life payout does.
Watch for
Annuitizing an IRA is irrevocable, and so is the tax pattern. A level payment that is comfortable today becomes fully taxable income you cannot turn off when your bracket changes. Compare a QLAC, which lets you defer part of the IRA instead.
Related: Exclusion ratio · RMDs from an annuity in an IRA · Roth IRA annuity · QLAC · Annuity inside an IRA
Explainer: exclusion ratio split
Illustrative. Enter your investment in the contract, the monthly payment, and the IRS life expectancy in years (from Publication 939 Table V or VI, or the period certain). Assumes a non-qualified contract with an annuity starting date after 1986 and no refund feature.
Carriers compute the official ratio and report it on Form 1099-R. Not tax advice.
Moving annuity money without triggering tax is routine when the paperwork is right and expensive when it is not. Non-qualified money moves by 1035 exchange; IRA money moves by transfer or rollover. Nine terms cover both.
How do I move my annuity to a better contract without paying tax?
DefinitionA 1035 exchange is a direct, carrier-to-carrier transfer of a non-qualified annuity (or life policy) into a new annuity under Internal Revenue Code section 1035, with no tax on the gain and the original cost basis carried over.
Section 1035(a)(3) allows an exchange of “an annuity contract for an annuity contract or for a qualified long-term care insurance contract.” The regulation requires the same owner (obligee), and keeping the same annuitant is carrier practice and the safe course. The money must move directly between carriers; you never take possession. The old carrier reports it on a Form 1099-R with code 6 and zero taxable amount.
Typical uses: moving a matured MYGA to a new one (Rolling into a new MYGA), replacing a poorly performing contract, or funding a SPIA with an old deferred contract so the gain is spread by the Exclusion ratio. Exchanges often take a few weeks, longer when checks are mailed; see Transfer timelines.
Illustrative
Old contract: $150,000 value, $100,000 basis, surrender period over. A 1035 exchange moves $150,000 to a new MYGA with $100,000 basis and $50,000 of untaxed gain. A surrender and repurchase instead would put $50,000 on this year’s return.
Related: Basis carryover · Partial 1035 exchange · 1035 vs surrender and rebuy · Replacement · Rolling into a new MYGA
Can I move only part of my annuity to a new contract tax-free?
DefinitionA partial 1035 exchange moves a portion of a non-qualified annuity directly into a new contract; basis and gain are split between the two contracts in proportion to the cash value moved.
The IRS allows partial exchanges and allocates basis pro rata (Rev. Rul. 2003-76 and Rev. Proc. 2011-38). Move 40% of the cash value and 40% of the basis goes with it, and both contracts remain tax-deferred. Common uses: funding a SPIA with part of a deferred contract, or splitting one contract between two products.
Under Rev. Proc. 2011-38, the IRS looks at any amount received from either contract within 180 days of a partial exchange, other than payments received as an annuity for life or for 10 or more years. In that case the IRS applies general tax principles rather than automatically recharacterizing the exchange. The withdrawal, or part of the exchange, can end up taxable.
Illustrative
Contract: $200,000 value, $120,000 basis. You exchange $80,000 (40%) into a SPIA. The SPIA has $48,000 of basis; the remaining deferred contract has $120,000 value and $72,000 basis.
Watch for
Carriers sometimes treat a partial exchange as a partial surrender if the paperwork does not clearly request a 1035. Confirm the new carrier’s form says “partial 1035 exchange,” and plan no withdrawals from either contract for 180 days.
Related: 1035 exchange · Basis carryover · Exclusion ratio · SPIA · Partial withdrawals
Can I turn an old life insurance policy into an annuity?
DefinitionA life insurance policy can be exchanged tax-free for an annuity under section 1035(a)(1), carrying the policy’s cost basis (premiums paid less dividends received) into the annuity; the reverse, annuity to life policy, is not permitted.
Section 1035 allows life-to-life, life-to-annuity, life-to-endowment, and annuity-to-annuity exchanges, but never annuity-to-life. The policy’s cash surrender value moves to the annuity and the premiums you paid become the annuity’s basis (IRS Publication 575).
The interesting case is a policy whose premiums paid exceed its cash value. That built-in loss cannot be deducted on a surrender, but after a 1035 to an annuity the higher basis typically shelters future annuity gain until the loss is used up.
Illustrative
Whole life policy: $60,000 cash value, $85,000 premiums paid. Exchange to a MYGA: value $60,000, basis $85,000. The annuity can grow to $85,000 before any withdrawal produces taxable gain.
Watch for
Exchanging a life policy gives up the death benefit, and the proceeds of life insurance are generally income-tax-free to a beneficiary while annuity gain is not. Weigh the heirs’ outcome, not only yours. Policy loans must be handled before the exchange or they can become taxable boot.
Related: 1035 exchange · Basis carryover · Cost basis · Death benefit
Can I use my annuity gain to pay for long-term care insurance without tax?
DefinitionA non-qualified annuity can be exchanged tax-free, in whole or in part, for a qualified long-term care insurance contract under section 1035(a)(3), turning taxable annuity gain into premiums for care coverage whose benefits are generally tax-free.
The Pension Protection Act added qualified long-term care contracts to section 1035(a)(3), effective for exchanges after December 31, 2009. IRS Notice 2011-68 says a full or partial exchange may be treated as tax-free if the requirements of section 1035 are otherwise met, and Rev. Proc. 2011-38 governs partial exchanges. The exchange must be direct, carrier to carrier, and the receiving contract must be a tax-qualified LTC policy or a hybrid annuity-LTC contract.
The same law allows LTC rider charges deducted from a non-qualified annuity’s cash value to come out without being taxed; they reduce basis instead (section 72(e)(11)). See LTC benefits from an annuity on the provisions page.
Illustrative
$150,000 deferred annuity with $50,000 of gain. Assuming basis is allocated pro rata per Rev. Proc. 2011-38 (the Notice does not prescribe it), a partial 1035 of $10,000 a year to pay a stand-alone LTC premium moves about $3,333 of gain each year untaxed. Surrendering $10,000 to pay the same premium would be $10,000 of taxable gain under gains-first.
Watch for
Not every LTC product accepts 1035 money, and a traditional LTC insurer may require annual partial exchanges rather than one lump. The exchange converts a liquid asset into an insurance premium you cannot get back; make sure the coverage is wanted on its own merits.
Related: 1035 exchange · Partial 1035 exchange · LTC rider · Hybrid annuity-LTC · LTC benefits from an annuity
After a 1035 exchange, does the new contract start with a fresh basis?
DefinitionNo. In a 1035 exchange the cost basis of the old contract becomes the cost basis of the new one, so the untaxed gain travels with the money and remains taxable when it eventually comes out.
Section 1035(d) applies the non-recognition rules, so your investment in the contract is unchanged by the exchange (IRS Publication 575). The old carrier reports the basis to the new carrier on the exchange paperwork. The new carrier’s statements will show the premium received as the exchange amount but the tax basis as the carried-over figure.
The same carryover applies to pre-August 1982 basis, to a built-in loss from a life policy exchange, and in proportion on a Partial 1035 exchange.
Illustrative
Contract A: $100,000 basis, $140,000 value, exchanged to Contract B. Contract B shows $140,000 “premium” on the annual statement and $100,000 “cost basis” on the tax record. The $40,000 gain is deferred, not erased.
Watch for
Basis errors compound through exchanges. If the old carrier reports the exchange amount as basis by mistake, the new carrier’s 1099-R will understate your taxable gain and the IRS can assess the difference later with interest. Check the first annual statement from the new carrier.
Related: 1035 exchange · Cost basis · Partial 1035 exchange · Life policy to annuity
Should I just cash out and buy the new annuity with the proceeds?
DefinitionSurrendering a non-qualified annuity and buying a new one with the cash taxes all the gain in the year of surrender; a 1035 exchange of the same money defers it. The exchange is almost always the better route when there is gain in the contract.
The surrender route only makes sense when the gain is tiny, when you are in a very low bracket this year, or when a contract has a loss you want to realize (a loss on a surrender is deductible only in limited circumstances; ask a tax professional).
Watch for
Agents who are not set up to process 1035 exchanges sometimes steer clients to “just take a check.” That turns a tax-free move into a taxable one for the agent’s convenience. Insist on the exchange form.
Related: 1035 exchange · Full surrender · Basis carryover · Keep vs surrender decision · Replacement
How do I move my IRA annuity to a new carrier without a tax problem?
DefinitionA trustee-to-trustee transfer moves IRA money directly from one custodian or carrier to another without the owner taking possession; it is not a distribution, is not reported as income, and can be done as often as you like.
The new carrier sends a transfer request to the old custodian, which wires or mails the funds directly. Because you never receive the money, there is no 60-day deadline, no withholding, no once-a-year limit and usually no Form 1099-R (IRS Publication 590-B). It is the IRA equivalent of a 1035 exchange.
A direct rollover from an employer plan to an IRA works the same way and is reported with code G. For the mechanics and typical timing see Funding and Transfer timelines.
Watch for
Make sure the check, if there is one, is payable to the new custodian “for benefit of” you, not to you personally. A check in your name is a 60-day rollover with all its traps. Also confirm any Rate lock at the new carrier outlasts the old custodian’s processing time.
Related: 60-day rollover · 1035 exchange · Funding · Transfer timelines · Rate lock
I received an IRA check. How long do I have to put it into the new annuity?
DefinitionA 60-day rollover is an IRA or plan distribution paid to you that you redeposit into an IRA within 60 days; done correctly it is tax-free, but it is limited to one IRA-to-IRA rollover in any 12-month period and carries withholding and deadline risk.
The clock starts the day you receive the funds. Miss the 60th day and the whole amount is taxable, plus the 10% additional tax if you are under 59½, unless the IRS grants a waiver (IRS Publication 590-B). The one-per-12-months limit applies across all your IRAs together, not per account.
Plan distributions paid to you are subject to mandatory withholding; to roll over the full amount you must replace the withheld portion from other money. All of this is avoided by a Trustee-to-trustee transfer.
Illustrative
$200,000 401(k) payout check made out to you arrives with $40,000 withheld. To complete a full rollover you must deposit $200,000 into the IRA within 60 days, finding $40,000 from savings and recovering the withholding at tax time.
Watch for
A second 60-day rollover within 12 months is a taxable distribution and an excess contribution, no matter how innocent. If a check is coming to you, call the new carrier the day it arrives and have the deposit documented.
Related: Trustee-to-trustee transfer · Federal withholding elections · 10% additional tax before 59½ · Funding
Can I convert my IRA annuity to a Roth, and what amount gets taxed?
DefinitionA traditional IRA annuity can be converted to a Roth IRA, and the taxable amount is the contract’s full fair market value on the conversion date, including the actuarial value of any income rider, death benefit or other guarantees, not just the cash surrender value.
Treasury regulations under section 408A require the conversion amount to reflect the contract’s fair market value, and IRS guidance applies the same actuarial present value concept used for RMDs: the account value plus the actuarial present value of additional benefits. The carrier provides the figure on request. The RMD exclusions for modest benefits do not carry over to a conversion.
The converted amount is ordinary income in the year of conversion. The contract stays with the same carrier, re-coded as a Roth IRA, and future qualified payments are tax-free. See Roth IRA annuity.
Illustrative
IRA annuity with a $200,000 account value, a $260,000 income rider benefit base and a $230,000 enhanced death benefit. The carrier values the contract at $218,000 for conversion. You pay tax on $218,000, not $200,000, even though $200,000 is what you could withdraw.
Watch for
A contract with a rich Income rider or Enhanced death benefit rider can carry a conversion value well above its surrender value, and the tax is due in cash from other money. Get the carrier’s conversion valuation in writing before you decide, and consider converting in pieces over several years.
Related: Roth IRA annuity · Actuarial present value rule · Ordinary income · Income rider · Enhanced death benefit rider
Required minimum distributions apply only to qualified annuities. The age depends on your birth year, the calculation depends on how the contract is valued, and an annuitized contract follows its own path.
At what age do I have to start taking money out of my IRA annuity?
DefinitionThe RMD age is the age at which required minimum distributions from a traditional IRA or employer plan must begin: 73 for people born 1951 through 1958, and 75 for people born 1960 or later; the first RMD can be delayed to April 1 of the following year.
The SECURE 2.0 Act set the schedule in IRC 401(a)(9)(C)(v), and 26 CFR 1.401(a)(9)-2(b)(2) implements it:
The first RMD may be delayed to April 1 of the year after you reach the RMD age (IRS Retirement Topics: RMDs); the second is due December 31 of that same year, so delaying stacks two taxable distributions in one year. Missing an RMD triggers an excise tax of 25% of the shortfall, reduced to 10% if corrected within two years.
Roth IRAs have no RMD during the owner’s life. Non-qualified annuities have none at all.
Watch for
An IRA annuity in the surrender period still owes its RMD. Most carriers waive the charge on the RMD attributable to that contract (RMD-friendly free withdrawals), but confirm it is in the contract. If you were born in 1959, plan on 73 and check for a correction before the year you turn 73.
Related: RMDs from an annuity in an IRA · Actuarial present value rule · QLAC and RMDs · RMD-friendly free withdrawals · RMDs while taking income
How is the RMD figured when my IRA is in an annuity?
DefinitionFor a deferred annuity in an IRA, the RMD is calculated on the contract’s value at the prior December 31, divided by the IRS life expectancy factor, like any other IRA; once the contract is annuitized, the annuity payments themselves are the RMD for that contract.
Two phases under the 1.401(a)(9) regulations:
- Before annuitization: the carrier reports a December 31 fair market value, which includes the actuarial present value of riders. You divide by the Uniform Lifetime Table factor. You may take the RMD from this contract or from another IRA; IRA RMDs can be aggregated.
- After annuitization: the payment stream must meet the regulations’ payout rules (life, joint life or a permitted period certain), and the payments satisfy the RMD for that contract. Nothing more is required from it.
Income rider withdrawals do not annuitize the contract, so the account-balance method still applies while you take rider income; see RMDs while taking income. A QLAC is excluded from the balance entirely.
Illustrative
IRA annuity valued at $300,000 on December 31, owner turning 75 this year, Uniform Lifetime factor 24.6. RMD is $300,000 ÷ 24.6, about $12,200. If the contract’s income rider pays $15,000 a year, that withdrawal covers the RMD with room to spare.
Watch for
Taking an RMD from a separate IRA to protect an annuity in its surrender period is allowed and often smart. Taking it from the annuity above the free amount is not; the surrender charge applies to the excess unless the contract is RMD-friendly.
Related: RMD age · Actuarial present value rule · RMDs while taking income · RMD-friendly free withdrawals · Annuitizing qualified money
Why is my RMD based on a number higher than my account value?
DefinitionThe actuarial present value rule requires the value of a deferred annuity in an IRA, for RMD purposes, to include not just the account value but the actuarial present value of additional benefits such as income rider guarantees and enhanced death benefits.
Under 26 CFR 1.401(a)(9)-6(m)(2), the entire interest under an annuity contract equals the dollar amount credited to the employee or IRA owner plus “the actuarial present value of any additional benefits”. The carrier does the math and reports the combined figure on Form 5498 as the December 31 fair market value.
The regulations provide exceptions when the additional benefits are modest: a return-of-premium death benefit, or benefits whose actuarial value is small relative to the account value, can be ignored. A rich lifetime income guarantee usually cannot. Roth conversion valuation under 26 CFR 1.408A-4 does not use these RMD exclusions.
Illustrative
Account value $200,000, income rider benefit base $280,000 with a 5% payout starting next year. The carrier values the rider’s guarantee at $50,000 and reports $250,000 as fair market value. Your RMD is based on $250,000, about 25% higher than the cash in the contract.
Watch for
This rule surprises owners of income FIAs every December. The higher RMD comes out of the account value, which can erode the contract faster than the rider illustration assumed. Ask the carrier for its RMD valuation method before buying an income rider inside an IRA.
Related: RMDs from an annuity in an IRA · RMD age · Roth conversion of an annuity · Income rider · Enhanced death benefit rider
Defined elsewhere
- QLAC and RMDs: a qualifying longevity annuity contract is excluded from the IRA balance used to figure RMDs until its income starts (26 CFR 1.401(a)(9)-6(q)(4)); the full treatment is on the deferred income page.
What a beneficiary owes, and how fast they must take the money, depends on whether the contract is qualified, who the beneficiary is, and whether the owner had reached the required beginning date. Ten terms, two rule sets: section 72(s) for non-qualified contracts and the 1.401(a)(9) regulations for IRAs.
If my spouse dies, do I owe tax on the annuity?
DefinitionA surviving spouse named as beneficiary can continue a non-qualified annuity as the new owner under section 72(s)(3), or treat an inherited IRA annuity as their own, with no tax due at the first death and the deferral intact.
Section 72(s)(3) says that when the designated beneficiary is the surviving spouse, the spouse is treated as the holder, and the death-distribution rules do not apply. The contract, its basis and its gain continue as if nothing happened. The spouse’s own age then governs the 10% additional tax before 59½ and the eventual 72(s) rules at the second death.
For an IRA annuity, a spouse may roll the contract into their own IRA or elect to treat it as their own, using their own RMD age. A spouse may also remain a beneficiary, which can help when the spouse is under 59½ and needs penalty-free access. See Spousal continuation for the contract mechanics.
Watch for
Most carriers allow continuation only when the spouse is the sole primary beneficiary. At those carriers, naming “my spouse and children equally” forfeits it for the spouse’s share. Some contracts also pay a death benefit step-up only on a payout, not a continuation; see Death before or during income.
Related: Spousal continuation · Five-year rule · RMD age · Eligible designated beneficiary · Death before or during income
If I take the inherited annuity as a lump sum, what do I owe?
DefinitionA beneficiary who takes a non-qualified annuity’s death benefit in one payment owes ordinary income tax on the entire gain in the year received; the owner’s cost basis comes back tax-free, and the 10% additional tax never applies to death payments.
The carrier pays the Death benefit, issues a Form 1099-R with code 4, and reports the gain in box 2a. Death is a 72(q) exception, so a 40-year-old child pays no additional tax. On an inherited traditional IRA annuity the whole lump sum is taxable, because there is no basis.
The gain is Income in respect of a decedent, so if the estate paid federal estate tax the beneficiary may deduct the portion attributable to the annuity gain.
Illustrative
Inherited contract: $250,000 value, $150,000 basis. A lump sum adds $100,000 of ordinary income to the beneficiary’s return in one year. Spread over five years under the Five-year rule, it is $20,000 a year and often a lower bracket.
Watch for
Carriers often default to a lump sum if the beneficiary does not elect otherwise within the time allowed, sometimes 60 days from the claim. The Death claim process page explains the forms. Ask for the payout options in writing before signing anything.
Related: Five-year rule · Nonqualified stretch · Income in respect of a decedent · Death claim process · Ordinary income
How long can a non-spouse beneficiary leave an inherited annuity alone?
DefinitionThe five-year rule under section 72(s)(1)(B) requires a non-qualified annuity’s entire value to be distributed within five years of the owner’s death when the beneficiary does not elect a life-expectancy payout; the money can stay deferred inside the contract until it is withdrawn.
The beneficiary can take the money any time in the five years: all at once, in pieces, or all at the end. Tax follows the withdrawals under Gains-first taxation, so a beneficiary can spread the gain across up to six tax years. The contract keeps earning interest in the meantime.
For IRAs the five-year rule survives only for non-designated beneficiaries (an estate, a charity, a trust that does not qualify as see-through) when the owner died before the required beginning date. Individuals inheriting an IRA follow the Inherited IRA annuity 10-year rule or the Eligible designated beneficiary rules instead.
Illustrative
Owner dies in March 2026. The beneficiary of a $200,000 contract with $120,000 basis must empty it by March 2031. Taking $40,000 a year, the first $80,000 is taxable gain and the last $120,000 is tax-free basis.
Watch for
Carriers may require the beneficiary to elect the five-year option on the claim form; silence can default to a lump sum. Also check whether the contract continues to credit the same rate during the five years or drops to a fixed holding rate.
Related: Annuitizing within one year · Nonqualified stretch · Lump sum to a beneficiary · Inherited IRA annuity 10-year rule · Spousal continuation (tax side)
Can a beneficiary turn an inherited annuity into lifetime income?
DefinitionUnder section 72(s)(2), a non-spouse beneficiary can take a non-qualified annuity as payments over their own life or life expectancy instead of within five years, provided the payments begin within one year of the owner’s death.
The statute requires the payout to start “not later than 1 year after the date of the holder’s death.” The beneficiary can annuitize with the same carrier or, if the carrier permits, keep the contract deferred and take annual life-expectancy withdrawals; see Nonqualified stretch. Each payment carries an Exclusion ratio based on the owner’s basis.
Once the one-year window passes, the only remaining choice is the Five-year rule. Carriers are not required to offer the life-expectancy option, and some do not.
Illustrative
A 60-year-old inherits a $300,000 contract with $200,000 basis. Annuitizing over the Publication 939 Table V life expectancy of 24.2 years pays about $1,400 a month. Expected return is about $406,560, so the exclusion ratio is about 49% and roughly half of each payment is tax-free until the basis is recovered.
Watch for
The one-year clock runs from the date of death, not from when the claim is filed. Estates that take eight months to locate the contract leave the beneficiary four months to decide. Beneficiaries should ask about this option on the first call to the carrier.
Related: Five-year rule · Nonqualified stretch · Exclusion ratio · SPIA · Death claim process
What is a “stretch” on an inherited non-qualified annuity?
DefinitionA nonqualified stretch lets a beneficiary keep an inherited non-qualified annuity deferred and take only annual required amounts based on their own life expectancy, spreading the gain over decades; it is the carrier’s administrative version of the 72(s)(2) life-expectancy option.
The carrier calculates an annual minimum from the IRS single life table for the beneficiary’s age, recalculated each year on the remaining balance. The beneficiary can always take more, and payments must start within one year of death (Annuitizing within one year). Because the contract is not annuitized, withdrawals are taxed gains first rather than by exclusion ratio.
Unlike the IRA stretch, which the SECURE Act cut down to the Inherited IRA annuity 10-year rule for most beneficiaries, the non-qualified stretch is still available. The carrier, not the IRS, decides whether to offer it.
Illustrative
A 45-year-old inherits a $200,000 contract, single life factor about 41. Year one minimum: $200,000 ÷ 41, about $4,900. The remaining $195,000 keeps compounding tax-deferred, and the gain is reported a little at a time for the beneficiary’s lifetime.
Watch for
Not every carrier administers a stretch, and a beneficiary cannot 1035 an inherited contract to one that does without the IRS’s blessing in a private letter ruling. If leaving the contract to children is part of the plan, ask the carrier about its beneficiary options before you buy.
Related: Annuitizing within one year · Five-year rule · Inherited IRA annuity 10-year rule · Gains-first taxation · Beneficiary
I inherited my parent’s IRA annuity. How fast do I have to empty it?
DefinitionUnder the 10-year rule, a beneficiary of an IRA owner who died in 2020 or later, and who is not an eligible designated beneficiary, must withdraw the entire account by December 31 of the year containing the 10th anniversary of the death; if the owner had already reached the required beginning date, annual distributions must also continue in years one through nine.
The 2024 final regulations at 26 CFR 1.401(a)(9)-5 set two tracks:
- Owner died before the required beginning date: no annual minimum. Any schedule works as long as the account is empty by December 31 of year 10.
- Owner died on or after the required beginning date: “the requirement to take an annual distribution continues to apply for every distribution calendar year”, based on the beneficiary’s life expectancy, and the balance must still be gone by December 31 of year 10.
For an IRA annuity in the surrender period, the ten years usually outlast the surrender schedule, so a beneficiary can wait for the charges to fall before taking large amounts. Spouses, minor children, disabled or chronically ill beneficiaries and those close in age use the Eligible designated beneficiary rules instead.
Illustrative
Owner dies at 78 in 2026, having started RMDs. The 50-year-old daughter must take a life-expectancy-based amount each year 2027 through 2035 and empty the account by December 31, 2036. Spreading $400,000 over ten years at $40,000 a year is often a full bracket lower than a lump sum.
Watch for
IRS relief notices waived the annual-distribution penalty for 2021 through 2024 for beneficiaries of owners who died in 2020 through 2023 on or after their required beginning date (Notice 2024-35); the annual requirement applies from 2025. Missing a year now carries the same 25% excise tax as any missed RMD. See RMD age.
Related: Eligible designated beneficiary · Five-year rule · RMD age · Nonqualified stretch · Beneficiary
Who still gets to stretch an inherited IRA over their lifetime?
DefinitionAn eligible designated beneficiary (EDB) is a surviving spouse, the owner’s minor child, a disabled or chronically ill person, or anyone not more than 10 years younger than the owner; EDBs may take an inherited IRA over their own life expectancy instead of the 10-year rule.
The five categories come from 26 CFR 1.401(a)(9)-4(e) and IRS Publication 590-B:
- Surviving spouse: may also treat the IRA as their own; see Spousal continuation (tax side).
- Minor child of the owner: life-expectancy payments until the child’s 21st birthday, then the 10-year rule starts.
- Disabled: as defined in section 72(m)(7).
- Chronically ill: as defined in section 7702B(c)(2), generally certified for an indefinite period.
- Not more than 10 years younger: a sibling, partner or friend close in age.
Status is fixed on the date of death. A grandchild, an adult child, or a trust that does not qualify as see-through for an EDB is not an EDB and follows the Inherited IRA annuity 10-year rule.
Illustrative
A 72-year-old leaves an IRA annuity to a 65-year-old brother. He is within 10 years and an EDB: he may take distributions over his roughly 22-year life expectancy. The same IRA left to a 40-year-old daughter must be emptied in 10 years.
Watch for
Disability and chronic illness require documentation to the carrier or custodian by October 31 of the year after death. Without it the beneficiary is treated as non-eligible. Keep the physician’s certification with the claim file.
Related: Inherited IRA annuity 10-year rule · Spousal continuation (tax side) · RMD age · Beneficiary · Trust as beneficiary
Does the gain in an annuity disappear at death like it does with stocks?
DefinitionNo. Annuities receive no step-up in basis at death; the beneficiary inherits the owner’s original cost basis, and all deferred gain is taxable to the beneficiary as ordinary income when withdrawn.
Section 1014, which steps up the basis of inherited stocks, real estate and funds to date-of-death value, does not apply to annuities described in section 72 (IRC 1014(b)(9)(A)) or to income in respect of a decedent (IRC 1014(c)). The beneficiary steps into the owner’s shoes: same basis, same gain, same ordinary income rate.
This is the biggest single tax disadvantage of a non-qualified annuity compared to a taxable brokerage account held for heirs. Stock bought for $100,000 and worth $250,000 at death passes to heirs with a $250,000 basis; the same growth in an annuity passes with $150,000 of taxable gain attached.
Illustrative
Two siblings each inherit $250,000: one an index fund with a $100,000 original cost, the other an annuity with $100,000 basis. The fund heir can sell immediately with no tax. The annuity heir owes ordinary income tax on $150,000 as it comes out.
Watch for
If leaving money to children is the main goal and you will not need the gain yourself, a non-qualified annuity is often the wrong vehicle for growth money. It still fits for guaranteed income or principal protection you will use in your own lifetime. See When an annuity doesn’t fit.
Related: Income in respect of a decedent · Cost basis · Lump sum to a beneficiary · Estate tax inclusion · When an annuity doesn’t fit
What does “IRD” mean on my inherited annuity paperwork?
DefinitionIncome in respect of a decedent (IRD) is income the deceased owner had earned but never paid tax on, such as the gain in an annuity or the balance of a traditional IRA; it is taxed to whoever receives it, with a deduction for any federal estate tax paid on it.
Section 691 governs IRD. The annuity gain is both included in the owner’s estate for estate tax and taxed as income to the beneficiary, which would be double taxation. Section 691(c) allows the beneficiary an itemized deduction for the federal estate tax attributable to the IRD item (IRS Publication 559).
Most estates owe no federal estate tax, so the deduction rarely applies, but when it does it can be large. Executors should give beneficiaries the estate tax computation so the deduction can be claimed.
Illustrative
An estate pays $400,000 of federal estate tax, of which $40,000 is attributable to a $100,000 annuity gain. The beneficiary reports $100,000 of ordinary income as withdrawn and may deduct $40,000 proportionally as the income is received.
Watch for
The IRD deduction is often missed because the beneficiary’s tax preparer never sees the estate return. If an estate paid tax and you inherited an annuity or IRA from it, ask the executor for the Form 706 before filing.
Related: No step-up in basis · Estate tax inclusion · Lump sum to a beneficiary · Gain
Is my annuity part of my taxable estate?
DefinitionYes. The date-of-death value of an annuity you own, or the value of survivor payments under a joint annuity you funded, is included in your gross estate for federal estate tax, under section 2033 for an un-annuitized deferred contract and section 2039 for an annuitized one, even though it passes by beneficiary designation outside probate.
Section 2033 includes an un-annuitized deferred contract as property the decedent owned, valued at the death benefit. Section 2039 pulls in the value of payments a beneficiary receives under an annuitized contract the decedent paid for.
For a Joint and survivor SPIA it is the actuarial value of the survivor’s remaining payments, in proportion to the premium the decedent paid. A Life only SPIA has no value at death and nothing is included.
Inclusion matters only for estates above the federal exemption, which most are not, and in the states that levy their own estate or inheritance tax at lower thresholds. The income tax on the gain is a separate matter; see Income in respect of a decedent.
Watch for
Beneficiary designation avoids probate, not tax. Owners who assume “it goes straight to the kids so it is not in the estate” are wrong on the estate side and often on the income side too. Bring the contract to whoever prepares the estate plan.
Related: Income in respect of a decedent · No step-up in basis · Death benefit · Joint and survivor · Beneficiary
Four situations that do not fit the groups above but come up constantly: Roth money, employer plans, gifts and divorce.
Can I hold an annuity in a Roth IRA, and is the income really tax-free?
DefinitionAn annuity funded with Roth IRA money follows Roth rules: qualified withdrawals and annuity payments are entirely tax-free, there is no RMD during the owner’s life, and the exclusion ratio is irrelevant because nothing is taxable.
A distribution is qualified once the 5-year period is met and the owner is 59½, dies, becomes disabled or buys a first home (IRS Publication 590-B). A MYGA or Fixed index annuity inside a Roth grows tax-free rather than tax-deferred, and an Income rider or SPIA funded by a Roth pays income that never shows up as taxable on the return and does not raise Medicare premiums or Social Security taxation.
Beneficiaries of a Roth IRA annuity still face the Inherited IRA annuity 10-year rule or EDB rules on timing, but their withdrawals are tax-free too once the 5-year period is met. The carrier codes the contract as a Roth IRA at issue; it cannot be mixed with traditional money in one contract.
Illustrative
$200,000 Roth IRA into a SPIA at 70 paying $1,250 a month. Every payment is tax-free for life, and none of it counts in the income that determines IRMAA or the taxable share of Social Security.
Watch for
A Roth is the one place where an annuity’s tax deferral adds nothing and its guarantees are the only reason to buy. Pay for guarantees you want; do not pay rider fees inside a Roth for tax reasons that do not exist there.
Related: Roth conversion of an annuity · Qualified vs non-qualified · Annuitizing qualified money · Inherited IRA annuity 10-year rule · Annuity inside an IRA
My 401(k) offers an annuity option. How is that taxed?
DefinitionAn annuity held inside a 401(k) or other employer plan is taxed under the plan’s rules: pre-tax contributions and growth are fully taxable when paid, RMDs follow the plan’s required beginning date, and the contract can usually be rolled to an IRA when you leave.
The SECURE Act made in-plan annuities more common by giving employers a safe harbor for choosing a carrier and letting participants move the contract to an IRA if the plan drops it. Distributions are reported on a Form 1099-R and subject to the plan’s mandatory withholding unless rolled directly; see Federal withholding elections.
Plan RMDs can be delayed past the normal RMD age while you are still working for that employer, if you own 5% or less of the company. A QLAC bought inside a plan follows the same premium limit as one bought in an IRA. Roth 401(k) money inside an annuity follows Roth rules.
Related: Qualified vs non-qualified · RMD age · Trustee-to-trustee transfer · Pension lump sum vs pension payout · QLAC
Can I give my annuity to my child?
DefinitionGiving away a non-qualified annuity, or changing the owner to someone other than your spouse, is a taxable event: the owner is taxed on all gain in the contract at the time of the transfer, as if it had been surrendered, and the gift may also count against the gift tax exclusion.
Section 72(e)(4)(C) treats a transfer of a non-qualified annuity for less than full value as a distribution of the gain to the transferor. The owner pays ordinary income tax on the gain and the 10% additional tax if under 59½, and the new owner takes a basis equal to the old basis plus the gain recognized. Transfers between spouses, or incident to divorce, are excepted; see Annuities in divorce.
IRAs cannot be gifted at all during life; any transfer to another person is a distribution. The only way to pass an annuity to the next generation without this tax is through the Beneficiary designation at death.
Illustrative
You change the owner of a $150,000 contract with $100,000 basis to your daughter. You owe ordinary income tax on $50,000 this year even though no cash changed hands. Her basis becomes $150,000.
Watch for
Carriers process Change of owner forms without warning you about the tax. Agents who suggest “just put it in the kids’ names” to simplify an estate are creating a tax bill. Add the child as beneficiary instead and let the death rules do the work.
Related: Change of owner · Annuities in divorce · Beneficiary · Gain · No step-up in basis
How is an annuity split in a divorce without a tax hit?
DefinitionAn annuity transferred between spouses or former spouses incident to divorce is not taxed at the transfer under section 1041 and the 72(e)(4)(C) spousal exception; the receiving spouse takes over the basis and pays tax only when money comes out.
The carrier can either change the owner to the receiving spouse or, on most contracts, split one contract into two with basis allocated pro rata. The transfer must be pursuant to the divorce or separation instrument. IRA annuities divide under section 408(d)(6) by a direct transfer to the former spouse’s IRA; employer plan annuities require a qualified domestic relations order.
The surrender charge and Market value adjustment still apply to any withdrawal either spouse takes afterward, and a split contract may put each half under a premium band break point. An Income rider on a split contract may not survive the split intact; see Divorce and an income rider.
Illustrative
A $300,000 contract with $200,000 basis is split 50/50. Each spouse holds $150,000 of value and $100,000 of basis, no tax due. If one spouse then surrenders, that spouse alone owes tax on $50,000 of gain.
Watch for
Cashing out the annuity to write a settlement check is the expensive route: the owning spouse pays tax on all the gain plus any surrender charge. Insist the decree specify a transfer or split of the contract itself, and get the carrier’s divorce-transfer form before the decree is final.
Related: Divorce and an income rider · Gifting an annuity · Change of owner · Trustee-to-trustee transfer · Basis carryover
My Annuity Store is a licensed insurance agency. This reference is general education, not a recommendation for any product or carrier, and it is not tax or legal advice. MAS does not give tax advice; confirm your situation with a tax professional. Figures reflect federal law as of October 2026 and are summarized from IRS publications and the Internal Revenue Code. Call 855-277-8088 or email info@myannuitystore.com with questions.
