How Annuity Death Benefits Are Taxed

Annuity death benefits are taxed differently depending on whether the money came from pre-tax or after-tax contributions, and who receives it

When you name a beneficiary on an annuity and die before the contract ends, the death benefit your beneficiary receives is subject to income tax — but only on the earnings portion, not on what you already paid in. If you funded the annuity with pre-tax money (like a rollover from a 401(k)), the entire payout is taxable income to your beneficiary. If you funded it with after-tax money, only the gain is taxable. The tax bill depends on how much you contributed versus how much the annuity earned.

The beneficiary — whether a spouse, child, or other person you named — must report the taxable portion as ordinary income on their tax return for the year they receive the money. They do not pay a separate "death benefit tax." Instead, the income is added to their other income and taxed at their ordinary income tax rate, which could be 10 percent, 22 percent, 24 percent, or higher depending on their total income that year.

Key Takeaways

• Death benefits from annuities are taxable income to the beneficiary, but only the earnings portion if the annuity was funded with after-tax money.
• If the annuity was funded with pre-tax dollars (such as a 401(k) rollover), the entire death benefit is taxable to the beneficiary.
• A surviving spouse can sometimes roll the annuity into their own account and delay taxes, while other beneficiaries must take the money out and pay taxes within a set timeframe.
• The tax rate on the death benefit depends on the beneficiary's total income that year, not on a fixed death benefit tax rate.
• The insurance company will report the taxable amount to the beneficiary and the IRS on Form 1099-R.

Pre-Tax Versus After-Tax Contributions and What Gets Taxed

An annuity funded with pre-tax money — such as money rolled over from a 401(k), traditional IRA, or employer pension plan — means the entire death benefit is ordinary income to your beneficiary. There is no distinction between what you put in and what the annuity earned, because you never paid income tax on any of it when you contributed.

An annuity funded with after-tax money (money you already paid income tax on) means your beneficiary owes tax only on the earnings. For example, if you contributed $100,000 of your own money and the annuity grew to $150,000 when you died, your beneficiary receives $150,000 but pays tax only on the $50,000 gain. Your $100,000 contribution passes to them tax-free because you already paid tax on it.

If you funded the annuity with a mix of pre-tax and after-tax money, the insurance company will calculate what portion of the death benefit is taxable based on the ratio of earnings to contributions. You can find this information in your annuity contract or by asking the insurance company for a cost basis statement.

How Surviving Spouses and Other Beneficiaries Are Treated Differently

A surviving spouse has options that other beneficiaries do not. A spouse can elect to treat the annuity as their own, which means they become the contract owner and can defer taxes until they withdraw money or until they reach their own required distribution age. This can delay the tax bill by years or decades. Alternatively, a spouse can treat themselves as the beneficiary of the original owner, which requires them to take distributions and pay taxes within a set timeframe.

Adult children, grandchildren, and other non-spouse beneficiaries must take the entire death benefit within ten years of the original owner's death under current federal rules (as of 2024). They can spread the withdrawals over those ten years to manage their tax burden, or take it all at once — either way, the taxable portion is income in the year they receive it. Some states and some annuity contracts have different rules, so the beneficiary should check the contract or contact the insurance company.

A minor child may have different rules depending on state law and the annuity contract. Some contracts allow the death benefit to be held in a trust or custodial account until the child reaches adulthood, which can spread the tax liability across multiple years.

Form 1099-R and Reporting the Death Benefit to the IRS

The insurance company will send Form 1099-R to your beneficiary and file a copy with the IRS. This form shows the total amount of the death benefit and the taxable portion. Box 1 shows the total distribution. Box 2a shows the taxable amount (or "unknown" if the company cannot calculate it). Box 7 will show code "4" to indicate this is a death distribution.

Your beneficiary uses the information on Form 1099-R to report the death benefit on their tax return. If the form shows the taxable amount, they report that amount as ordinary income. If the form shows "unknown," your beneficiary or their tax preparer will need to contact the insurance company to get the cost basis and calculate the taxable portion themselves.

The beneficiary must file their own tax return for the year they receive the death benefit, even if they do not normally file. Failing to report the income can result in penalties and interest from the IRS.

State Income Tax on Annuity Death Benefits

Most states tax annuity death benefits as ordinary income, following the same rules as federal tax. However, some states do not have an income tax at all — including Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. If your beneficiary lives in one of these states, they will owe federal tax but not state income tax on the death benefit.

A few states have special rules for retirement account distributions. For example, some states exempt distributions from traditional IRAs or 401(k)s from state income tax, but annuities may not receive the same treatment. Your beneficiary should check their state's tax rules or consult a tax preparer in their state to understand their full tax obligation.

Inherited Annuities and Stretch Distributions

Before 2020, non-spouse beneficiaries could sometimes stretch distributions from an inherited annuity over their own lifetime, which spread the tax bill across many years. The find Act (passed in 2019, effective in 2020) changed this for most beneficiaries. Now, non-spouse beneficiaries must withdraw the entire annuity within ten years, though they can choose when to take the money within that window.

A surviving spouse still has the option to stretch an inherited annuity by treating it as their own and deferring distributions until their own required distribution age (currently age 73). This remains one of the key tax advantages available to spouses.

Some annuity contracts have language that overrides federal rules or adds restrictions. For example, some contracts require the death benefit to be paid out in a lump sum rather than over time. Your beneficiary should review the contract or ask the insurance company what payout options are available.

Frequently Asked Questions

Do I have to pay taxes on an annuity death benefit if I inherit it from a parent?

Yes. The taxable portion of the death benefit is ordinary income to you in the year you receive it. You report it on your tax return and pay income tax at your tax rate. The amount you owe depends on how much of the death benefit is earnings versus your parent's original contribution, and on your total income that year.

Can I avoid taxes on an inherited annuity by rolling it into my own IRA?

Not if you are not the surviving spouse. Non-spouse beneficiaries cannot roll an inherited annuity into their own IRA. A surviving spouse can roll it into their own IRA or treat the annuity as their own, which defers taxes. Non-spouse beneficiaries must take distributions within ten years and pay tax on the taxable portion as they withdraw it.

What happens if the annuity lost money before the owner died — do I still owe tax?

You owe tax only on the earnings portion (if the annuity was funded with after-tax money). If the annuity lost value and is now worth less than what was contributed, the earnings portion is zero or negative, and you owe no income tax on the death benefit. You receive the full amount tax-free. If the annuity was funded with pre-tax money, the entire amount is still taxable regardless of gains or losses.

Will the insurance company withhold taxes from the death benefit?

The insurance company may withhold federal income tax from the death benefit if you do not provide a completed W-9 form or if the contract requires it. The amount withheld is typically 10 percent to 20 percent of the taxable portion. The withholding is credited against your tax bill when you file your return, but it may not cover your full tax obligation if your tax rate is higher.