Rules for Inheriting an IRA Annuity
An individual retirement account annuity is a qualified annuity contract held in a traditional or Roth IRA. To purchase an annuity contract, you make one or more payments to the issuer, usually an insurance company, in return for a stream of payments extending over a set number of years, your lifetime or beyond. Some annuities terminate on your death, while others provide benefits to beneficiaries.
The Internal Revenue Service specifies requirements for an IRA annuity. You can’t forfeit or transfer the annuity contract. Contributions must be flexible and can’t exceed the annual limit on IRAs. You must begin receiving distributions no later than April 1 of the year following the one in which you reach age 70 1/2. Contributions to a traditional IRA annuity are tax-deductible, those to a Roth annuity aren't. If you want to cancel an annuity before it starts making payments, you might have to pay a surrender charge. Annuity payments contain a mix of earnings and return of investment.
A successor annuity continues to make payments after the owner’s death. The beneficiary's payment amount might be different from the one received by the IRA owner, however. The beneficiary might have the option of taking a lump sum distribution instead. The beneficiary of a non-annuity IRA has the right to convert the assets to a annuity contract. This conversion does not create a tax bill.Beneficiaries pay income taxes on withdrawals from traditional IRA annuities. Roth annuities provide distributions that are free of
income taxes. A spouse who assumes ownership of an inherited IRA annuity might be able to stretch out the distribution period based on her life expectancy.
Although the beneficiary of a Roth IRA owes no income tax, a large inherited traditional or Roth IRA might carry estate taxes. As of 2013, the first $5.25 million of an estate’s value is free from these taxes. A beneficiary can reduce or eliminate taxes by disclaiming all or part of an inherited IRA. If the owner specified “per capita” rules on the beneficiary form, the trustee divides the disclaimed portion among the other primary beneficiaries, or if there are none, among the contingent beneficiaries. If the owner chose “per stirpes” rules, the disclaimed portion goes to the disclaimant’s heirs.
A tax-sheltered annuity, or TSA, such as 403(b) employer plan, might contain a balance that a beneficiary inherits. A nonspouse beneficiary has the option of performing a trustee-to-trustee transfer of a TSA to an “inherited IRA,” which is an IRA established in the deceased’s name for the benefit of the beneficiary. An inherited IRA has special rules that prohibit transfers in or out. The TSA’s required distribution rules continue to apply to the inherited IRA. A spouse beneficiary can roll an inherited TSA into a conduit IRA, which is a traditional IRA that only contains rollovers from other accounts. By doing so, the spouse can make a second rollover, this time from the conduit IRA to a new employer plan.