I Just Inherited an Annuity. If I Wait Past One Year, Will I Lose My Best Payout Option?

Inheriting an annuity comes with a deadline that’s easy to miss. Your contract typically offers multiple payout options, including a choice that stretches distributions across your lifetime. The window to elect that option stays open for only one year. The wrong election or a delayed decision compresses your inheritance and tax bill into far fewer years.

Why Inherited Annuities Follow Different Rules

Nonqualified annuities purchased outside an IRA or employer plan follow Section 72(s) of the Internal Revenue Code, not the SECURE Act’s inherited IRA rules. ¹ That means you don’t automatically get a 10-year withdrawal window. Instead, federal law creates two potential paths for distributing the contract.

The five-year rule doesn’t require equal annual withdrawals. You may be able to take nothing in early years and withdraw the balance later, depending on the contract terms. The entire remaining interest must be distributed within five years after the owner’s death.

The life-expectancy option provides much more time. It allows you to receive payments over your own lifetime, stretching distributions across decades instead of five years, but the contract must offer this payout method, and you must elect it within one year of the original owner’s death. Miss that deadline, and the five-year rule applies automatically with no second chance.

The One-Year Election That Changes Everything

If your contract offers a life-expectancy distribution method, qualifying income must generally begin within one year of the owner’s passing. Waiting beyond that window eliminates this choice, leaving a five-year span as your remaining federal alternative.

Suppose the original owner died on August 15, 2026. Life-expectancy payments would generally need to commence by August 15, 2027. Your endpoint falls on August 15, 2031.

Now assume the inherited annuity is worth $300,000. Here is a simplified example that does not include investment growth, fees and the insurer’s actual calculations:

This longer timeframe is not guaranteed. It simply demonstrates the difference between spreading $300,000 across decades versus compressing it into a shorter span.

The federal one-year window does not replace the insurer’s claim procedures. Available options remain subject to each contract’s specific language, so reviewing the document and death-claim forms before selecting a distribution approach matters.

A financial advisor can help you evaluate inherited annuity payout options and their potential tax consequences.

What’s at Stake in the Tax Bill

Inherited nonqualified annuities generally do not receive a step-up in basis. While you typically won’t owe taxes on the original premiums paid into the contract, the investment earnings remain subject to ordinary income tax when withdrawn.

How you receive the money also affects your tax bill. Periodic annuity payments typically divide each payment into a taxable earnings portion and a tax-free return of principal using the IRS exclusion ratio. Lump-sum withdrawals generally recognize the taxable earnings all at once.

Surviving spouses usually have greater flexibility than other beneficiaries. In many cases, a surviving spouse can continue the annuity as the new owner and defer taxes until withdrawals begin. Other beneficiaries generally must begin taking distributions sooner, subject to the contract’s terms and applicable tax rules.

If you’re eligible to elect life-expectancy payments, missing the one-year election deadline may permanently eliminate that option. Instead, you could be required to withdraw the remaining funds over a shorter period, potentially accelerating taxable income into fewer years.

A financial advisor can help you develop a tax-efficient distribution strategy for an inherited annuity.

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