An annuity lets you name one or more beneficiaries who inherit the contract’s remaining value when you die, and the annuity beneficiary rules built into federal tax law and the contract itself determine how much they receive, when they must take it, and how it’s taxed. The money moves directly from the insurance company to the person, trust, or charity you named, skipping probate. What happens next depends on three things: the beneficiary’s relationship to you, whether the annuity is qualified or non-qualified, and the payout option the beneficiary selects.
Who You Can Name as a Beneficiary
When you buy an annuity, the insurer has you fill out a beneficiary designation form. The primary beneficiary has the first right to the remaining contract value. Contingent beneficiaries receive the funds only if every primary beneficiary has already died or declines the payout.
A beneficiary can be a person, a trust, a charity, or your estate. A trust gives you more control over how and when the money is paid out, which matters if the person you want to benefit is young, financially inexperienced, or has special needs. A charity keeps the transfer simple. Naming your estate, on the other hand, sends the annuity into probate and gives up one of the main advantages of the designation in the first place. You can change any of this later by submitting a change-of-beneficiary form to the insurance company.
Naming a Minor
Insurers generally will not pay annuity proceeds directly to a child under 18. If you name a minor, the company will typically hold the funds until a court appoints a guardian or custodian, which adds delay and cost. Two cleaner options: set up a custodial account under your state’s Uniform Transfers to Minors Act and name the custodian on the designation, or route the proceeds through a trust that spells out how the money should be managed until the child reaches an age you choose.
Per Stirpes vs. Per Capita
If you name more than one beneficiary, decide what happens when one of them dies before you. A per stirpes designation passes a deceased beneficiary’s share to that person’s own children. If you name your three children equally under per stirpes and one dies before you, that child’s third goes to their children rather than to the surviving siblings.1U.S. Office of Personnel Management. What Is a Per Stirpes Designation Per capita usually splits the deceased beneficiary’s share among the surviving named beneficiaries, and nothing flows down to the deceased beneficiary’s heirs. Picking one on the form prevents arguments later.
Spousal Continuation
A surviving spouse has an option no other beneficiary gets. If you name your spouse as the sole beneficiary of a non-qualified annuity, federal law under 26 U.S.C. § 72(s)(3) lets them step in as the new owner of the contract instead of taking a distribution.2Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts That means no forced payout, no five-year rule. The annuity keeps growing tax-deferred, and the spouse can start or continue receiving payments, name new beneficiaries of their own, or simply let the contract accumulate value.
For this to work, the spouse usually has to be listed as the sole beneficiary. Being a joint owner alone doesn’t cut it, and neither does being listed alongside other individuals or a trust.
Payout Options for Non-Spouse Beneficiaries
Everyone else who inherits an annuity chooses from a set of distribution methods. Which methods are available depends on whether the annuity is qualified (inside an IRA, 401(k), or similar plan) or non-qualified (bought with after-tax money), and whether the original owner had already started receiving payments.
Lump Sum
The simplest choice is one payment for the entire death benefit. The contract ends immediately. The catch is that the taxable portion counts as ordinary income in a single year, which can push the beneficiary into a higher bracket.
Five-Year Rule for Non-Qualified Annuities
For a non-qualified annuity, if the owner dies before the annuity starting date, federal law requires the balance to be fully distributed within five years of death.2Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts Within that window, the beneficiary can withdraw on any schedule, including nothing until the final year, as long as the account is empty by the deadline.
Life Expectancy Payments
A designated beneficiary of a non-qualified annuity can instead elect to receive payments spread over their own life expectancy. The payments must begin within one year of the owner’s death.2Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts Stretching the money over years keeps each annual payment smaller and often in a lower tax bracket. Not every insurer offers this option, so check the contract before assuming it’s available.
The 10-Year Rule for Qualified Annuities
Annuities held inside IRAs, 401(k)s, or other employer plans follow a different track. Since the SECURE Act took effect in 2020, most non-spouse beneficiaries who inherit a qualified account have to empty it within 10 years of the owner’s death.3Federal Register. Required Minimum Distributions That replaced the older “stretch” that let distributions run over a lifetime.
Whether you have to take annual withdrawals inside those 10 years depends on when the owner died relative to their required minimum distribution start date:
- If the owner died before their RMD start date, you can withdraw on any schedule you want, as long as the account is empty by December 31 of the year containing the 10th anniversary of death.3Federal Register. Required Minimum Distributions
- If the owner died on or after their RMD start date, you must take annual minimum distributions in years one through nine and empty the account by the end of year 10.3Federal Register. Required Minimum Distributions
Some beneficiaries are exempt from the 10-year rule and can still stretch distributions over their own life expectancy. These “eligible designated beneficiaries” are a surviving spouse, a minor child of the deceased (until age 21), a beneficiary who is disabled or chronically ill, and anyone not more than 10 years younger than the original owner. When a minor child reaches 21, the 10-year clock starts running from that point.3Federal Register. Required Minimum Distributions
How Much the Beneficiary Actually Receives
The dollar figure is set by the contract’s death benefit provision. A standard death benefit on a deferred annuity typically guarantees the greater of the current account value or the total premiums paid, less any withdrawals. That floor protects the beneficiary from inheriting less than what was contributed, even if the underlying investments dropped.
Some contracts include optional riders that lock in higher values. A common version records the account’s highest anniversary value, so an account that peaked at $150,000 three years ago but has since fallen to $120,000 still pays the beneficiary $150,000. Other riders apply a fixed annual growth rate to the base amount regardless of market performance. Riders carry an added annual fee.
If the owner dies during the surrender charge period, most insurers waive those charges when paying the death benefit. The beneficiary gets the full amount rather than the reduced figure that would have applied to a voluntary early withdrawal.
Taxes on an Inherited Annuity
The taxable portion of any inherited annuity is ordinary income to the beneficiary, governed by 26 U.S.C. § 72.2Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts How much of the payout is taxable depends on the type of annuity.
A qualified annuity was funded with pre-tax dollars inside a retirement account. Because no tax was ever paid on the contributions or the growth, the entire distribution is taxable as ordinary income. Federal rates for 2026 run from 10% to 37%, depending on the beneficiary’s total taxable income for the year.4Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
A non-qualified annuity was bought with after-tax dollars, so tax is owed only on the earnings, not on the return of the original owner’s investment. The IRS uses an exclusion ratio, comparing the investment in the contract to the expected return, to figure out what fraction of each payment is excluded from income.2Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts The beneficiary ends up paying tax on the growth alone.
The 10% early withdrawal penalty that normally applies to retirement plan distributions before age 59½ does not apply to a beneficiary receiving money after the account holder’s death, no matter the beneficiary’s age.5Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions A parallel exemption covers non-qualified annuity death payouts.2Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts Regular income tax still applies; the extra 10% doesn’t.
One boundary worth knowing: annuities do not get a step-up in tax basis at death the way stocks or real estate do. Federal law specifically excludes annuities described in § 72 from the general step-up rule.6Office of the Law Revision Counsel. 26 U.S. Code 1014 – Basis of Property Acquired From a Decedent Gains inside the contract are treated as income in respect of a decedent, so the beneficiary inherits the original owner’s cost basis and owes income tax on all the accumulated earnings.7Office of the Law Revision Counsel. 26 U.S. Code 691 – Recipients of Income in Respect of Decedents
Keeping Your Designation Current After Divorce
Divorce doesn’t automatically strip an ex-spouse from your annuity beneficiary designation. If you don’t update the form, your ex may still collect the full death benefit. Some states have statutes that revoke an ex-spouse’s designation on divorce, but for annuities held inside employer plans governed by ERISA, the U.S. Supreme Court held in Egelhoff v. Egelhoff that federal law preempts those state statutes.8Legal Information Institute. Egelhoff v. Egelhoff The plan administrator has to follow the designation on file, even if it still names the former spouse.
Non-qualified annuities aren’t governed by ERISA, so state law controls, and the rules vary. The safe move in either case is to file an updated beneficiary form with the insurance company as soon as a divorce is finalized. If a divorce decree assigns the annuity to one spouse, confirm the beneficiary designation matches the court order.
How a Beneficiary Claims the Money
After the owner dies, the beneficiary contacts the issuing insurance company to start the claim. You’ll usually need the insurer’s claim form, a certified copy of the death certificate, and the policy number. If the policy has been lost, expect to sign a lost-policy certification. In some cases the insurer will ask for additional records.
Once the insurer verifies the paperwork and confirms your identity as the named beneficiary, you pick the payout option. Processing generally runs a few weeks after everything is submitted. Move quickly, because some deadlines run from the date of death rather than from the date you file: the one-year window for electing life-expectancy payments on a non-qualified annuity is the most common trap.
What Happens With No Named Beneficiary
If you never name a beneficiary, or every named beneficiary dies before you and no contingents are listed, the annuity’s value defaults to your estate.9Internal Revenue Service. Retirement Topics – Beneficiary That sends the funds through probate, with the usual delays and legal costs.
The bigger loss is on the tax side. An estate that inherits a qualified annuity generally has to distribute the entire balance within five years and can’t use the 10-year rule or life-expectancy stretch available to individual beneficiaries. Reviewing your beneficiary designations every few years, and after any marriage, divorce, birth, or death in the family, is the easiest way to keep the money going where you want it to go.