Inherited Annuity Tax Calculator

Understanding Inherited Annuity Taxes

When an annuity owner passes away, their beneficiaries may inherit the annuity. The tax treatment of this inheritance depends on several factors, including the type of annuity, how it was held by the deceased, and the payout method chosen by the beneficiary. This calculator helps estimate the income tax impact on the inherited annuity earnings.

How Inherited Annuities are Taxed

Annuities are generally tax-advantaged investments. Contributions may have been made with pre-tax or after-tax dollars. The earnings within the annuity grow tax-deferred. Upon withdrawal or distribution, the earnings are typically taxed as ordinary income.

When an annuity is inherited, the beneficiary steps into the shoes of the original owner regarding the tax treatment of the earnings. The principal (original investment) is usually not taxed, but any accumulated earnings are subject to income tax when distributed.

Key Factors Influencing Tax Liability:

• Type of Annuity: Non-qualified annuities (funded with after-tax dollars) have a portion of the withdrawal considered return of principal (non-taxable) and a portion considered earnings (taxable). Qualified annuities (funded with pre-tax dollars) have the entire distribution taxed as ordinary income. This calculator assumes non-qualified annuities, focusing on the taxation of earnings.
• Value at Death: The value of the annuity at the date of the annuitant's death is crucial. This value forms the "basis" for the beneficiary.
• Payout Method: How the beneficiary receives the money significantly impacts tax timing.
  • Lump Sum: The entire taxable gain is received at once and taxed in the year of receipt.
  • Period Certain: Payments are spread over a set number of years. Each payment includes a portion of the earnings, taxed as ordinary income in the year received.
  • Annuitized Payments (Life Expectancy): Payments are received over the beneficiary's life expectancy. A portion of each payment is taxed as ordinary income. This calculator simplifies this by using a "Period Certain" option for predictable tax estimations.
• Tax Bracket: The beneficiary's marginal income tax rates (federal and state) determine the actual tax percentage applied to the taxable earnings.

The 5-Year Rule vs. SECURE Act 2.0:

Under the SECURE Act 2.0 (effective for deaths after December 31, 2022), most non-spouse beneficiaries of inherited retirement accounts (including annuities that function similarly) must withdraw the entire balance within 10 years of the original owner's death. This is a "stand-alone" 10-year rule, meaning it doesn't necessarily require annual distributions, but the entire amount must be distributed by the end of the 10th year. For annuities, the rules can be more complex as they are insurance products, but the spirit of accelerated withdrawal often applies, impacting tax planning.

For deaths before 2020, beneficiaries often had the option to stretch distributions over their own life expectancy. The 5-year rule applied in some specific scenarios. This calculator simplifies by focusing on the immediate tax impact based on payout choices and current tax brackets.

How This Calculator Works:

This calculator estimates the income tax due on the earnings of an inherited annuity. It makes the following assumptions:

• The annuity is a non-qualified annuity, meaning the original investment was made with after-tax dollars.
• The "Inherited Annuity Value" is the total value at the date of the original owner's death.
• The taxable portion is assumed to be the entire inherited value for simplicity in this model, representing the potential gain that needs to be distributed and taxed. In reality, a portion might be return of principal, reducing the taxable amount. Consult a tax professional for exact basis calculations.
• Federal and State Income Taxes are calculated based on the provided marginal tax rates.
• Lump Sum: The entire taxable amount is taxed in the year of receipt.
• Period Certain: The taxable amount is divided equally over the specified number of years, and the tax for the current year is calculated based on that pro-rata share.

Disclaimer: This calculator provides an ESTIMATE only. Tax laws are complex and can change. Consult with a qualified tax advisor or financial planner for personalized advice regarding your specific inheritance and tax situation.

Example Calculation:

Let's say you inherit an annuity worth $250,000 at the date of death. You are in a 24% federal tax bracket and a 5% state tax bracket. You choose to take the entire amount as a lump sum.

• Total Inherited Value (Assumed Taxable Gain for Estimate): $250,000
• Combined Federal & State Tax Rate: 24% + 5% = 29%
• Estimated Tax Due (Lump Sum): $250,000 * 0.29 = $72,500

If you instead chose a 10-year Period Certain payout:

• Annual Taxable Distribution: $250,000 / 10 years = $25,000 per year
• Estimated Annual Tax: $25,000 * 0.29 = $7,250 per year

This calculation highlights how payout choices affect the timing and overall management of tax liabilities.