When a person owns a non-qualified deferred annuity and leaves it to a designated beneficiary other than a surviving spouse, the beneficiary will then have several different options to receive the funds. It is important to understand the different options and then to choose wisely for the greatest benefit.
The five-year rule option, if selected, means that the entire balance must be distributed to the beneficiary within five years of the death of the account holder. Annuity income taken under this plan will be taxed according to the gains, and the gains are the first funds distributed.
The non-qualified stretch option allows beneficiaries to calculate their life expectancy, then taking annual minimum distributions. Doing so allows them to enjoy continued tax-deferred status for the annuity’s cash value and lower income taxes while drawing the minimum required amounts. Finally, annuitization is the third option. In this distribution type, the proceeds are annuitized, and the person may then use a shorter-than life expectancy payout or a single-life payout option. This option transfers the investment risk to the insurance company and allows the person to receive the exclusion ratio treatment on the benefits they receive while they are alive.
Non-spouse annuity beneficiaries who want to grow the amount in the annuity while also having lower yearly taxes may want to choose the non-qualified stretch option. The owners of annuities who wish to distribute them to their heirs after they die may want to discuss the various options with their estate planning attorney. When non-spousal beneficiary designations are under consideration, they may want to also discuss how the different types of distribution options may impact how much the person is taxed. Legal counsel may be able to explain the consequences of each option to both the owner and the potential beneficiaries.