What Is an Inherited Annuity?
An inherited annuity is an annuity contract passed to a beneficiary after the original owner or annuitant passes away. As the beneficiary, your main payout options are typically a lump-sum distribution, the five-year rule (withdrawing the full balance within five years), a nonqualified stretch that spreads payments over your life expectancy, or spousal continuation if you are the surviving spouse and choose to keep the contract as your own. In every case, any gains are taxed as ordinary income, while amounts representing the original after-tax contributions are generally returned tax-free. The right choice depends on your tax situation, the type of annuity, and your income needs, so it is wise to review your options carefully.
Last updated: July 2026
I am by no means a financial wizard. So, I was taken aback several years ago when a friend asked for some serious financial advice. He had recently received an inheritance and was looking for suggestions on what he should do with the money.
I immediately rattled off the obvious. Pay off your debt, build an emergency fund, or save the money for a down payment — in particular a car that he had been eying up. I even suggested that he take a small percentage of the inheritance and go on a weekend getaway.
I also stressed the importance of putting some of this money towards his retirement savings. After all, I told him, you’re going to need a big war chest to maintain a comfortable post-work life. Before deciding, it helps to understand how annuity withdrawals work and how they are taxed, since an inherited annuity’s gains are taxed as ordinary income. If the contract is a single life annuity, the payout structure can differ from other annuity types, and running the numbers with annuity formulas can clarify what each option is worth. Strategic approaches to 401k rollovers and annuity management can enhance passive income for seniors substantially, and thoughtful planning can even help you retire earlier than you expected.
