Let’s dig a little deeper on legacy planning and talk about taxes on the death benefit to the annuity beneficiary, both for a taxable and non-taxable account. Is a retirement annuity the most tax advantageous way to gift to a beneficiary at death? And while I am on the topic of a tax deferred account, such as an IRA, I will also discuss the payout options for a fixed index annuity since the Secure Act has changed how inherited IRAs are to be distributed to non-spousal beneficiaries.

Table of Contents:

00:00 – Introduction
01:29 – Refresher on Annuities and Taxes
02:10 – Taxation of Death Benefit for Inherited IRA
02:54 – Is there a more tax advantageous way to gift a death benefit?
04:23 – Introduction on The SECURE Act
04:52 – Impact of the Act on Fixed Annuity in an Inherited IRA
06:04 – Taxation of Death Benefit in Taxable Account

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Many people choose to invest in annuities as a way to secure their financial future. An annuity is a financial product that guarantees a steady income stream for a certain period of time. However, as with any investment, there are certain tax implications to consider. One of the most common questions asked by annuity investors is whether the death benefit paid to the annuity beneficiary is tax-free.

The answer is not a simple “yes” or “no.” Rather, it depends on several factors, including the type of annuity and how the beneficiary chooses to receive the death benefit. Here’s a closer look at the tax implications of annuity death benefits:

Types of Annuities

There are two main types of annuities: fixed and variable. Fixed annuities provide a set payout for a specific period of time or for life. Variable annuities offer a more flexible payout based on the performance of the underlying investments. The tax treatment of the death benefit differs for each type of annuity.

Fixed Annuities

With fixed annuities, the death benefit is typically paid out in a lump sum to the beneficiary. This payment is not subject to income tax as long as the amount of the benefit does not exceed the amount paid into the annuity. For example, if an investor paid $100,000 into a fixed annuity and the death benefit paid to the beneficiary is $150,000, the additional $50,000 would be subject to income tax.

Variable Annuities

Variable annuities can be a bit more complicated when it comes to taxes. The death benefit paid out to the beneficiary may be taxed as ordinary income to the extent that the annuity has accumulated value. This means that if the investor paid $100,000 into the annuity but it has grown to $150,000, the $50,000 growth would be taxed as ordinary income to the beneficiary.

However, if the beneficiary chooses to receive the death benefit payments over time rather than in a lump sum, the income tax liability may be spread out over a longer period. This is called a “stretch” distribution and can provide tax advantages for the beneficiary.

Other Considerations

It’s important to note that there may be other taxes associated with annuities, including estate tax and inheritance tax. These taxes can vary depending on the specific circumstances surrounding the annuity and the beneficiary. Additionally, the tax laws around annuities can be complex and subject to change, so it’s always a good idea to consult with a financial advisor or tax professional before making any decisions related to annuities.

Conclusion

In conclusion, the tax implications of annuity death benefits depend on several factors, including the type of annuity and how the beneficiary chooses to receive the payment. Fixed annuities typically offer tax-free death benefits, while variable annuities may be subject to income tax. It’s important to consider all tax implications when making decisions around annuities and to seek the advice of a financial advisor or tax professional.