What is an Annuity Beneficiary?

Naming an annuity beneficiary is one of the most important steps in retirement planning, yet it is often treated as an afterthought. Unlike a standard bank account that may go through probate, an annuity allows for a direct transfer of assets to your heirs. However, the rules governing how those heirs receive the money—and how much the IRS takes—are complex.

In 2026, with the full implementation of the SECURE Act 2.0, understanding your options as an annuity owner or a beneficiary is critical to preserving your family’s financial legacy.

What is an Annuity Beneficiary?

An annuity beneficiary is the person or entity designated to receive the remaining value of an annuity contract upon the death of the owner or the annuitant. If no beneficiary is named, the annuity's value may be paid to the estate, which subjects the funds to the time-consuming and costly probate process.

There are two primary levels of beneficiaries:

• Primary Beneficiary: The first person in line to receive the death benefit.

• Contingent Beneficiary: The "backup" who receives the funds only if the primary beneficiary has already passed away.

Spousal vs. Non-Spousal Beneficiaries

The IRS treats spouses and non-spouses very differently when it comes to inherited annuities.

Spousal Continuation

Surviving spouses have a unique advantage known as spousal continuation. This allows the spouse to "step into the shoes" of the original owner, maintaining the contract's tax-deferred status and delaying immediate tax bills. Under SECURE Act 2.0 updates, a spouse can also choose to be treated as the deceased owner for Required Minimum Distribution (RMD) purposes, potentially delaying payouts even longer.

Non-Spousal Beneficiaries

Children, siblings, or friends do not have the option of spousal continuation. They must follow specific distribution timelines, which often result in a faster payout and a more immediate tax burden.

Payout Options for Inherited Annuities

How a beneficiary receives the money depends on whether the annuity was "qualified" or "non-qualified" and the specific language in the contract.

1. The Lump-Sum Distribution

The beneficiary receives the entire account balance at once. While this provides immediate liquidity, it is often the least tax-efficient method, as the entire taxable portion is added to the beneficiary's income in a single year, potentially pushing them into a higher tax bracket.

2. The Five-Year Rule (Non-Qualified Annuities)

For non-qualified annuities (funded with after-tax dollars), many beneficiaries must withdraw the full balance within five years of the owner's death. They can take small amounts over those five years or wait until the very end to withdraw the total.

3. The Ten-Year Rule (Qualified Annuities)

Following the SECURE Act, most non-spouse beneficiaries of qualified annuities (like those held in an IRA) must empty the account by December 31 of the tenth year following the owner's death.

4. Annuitization (The Stretch)

In some cases, a beneficiary can "annuitize" the death benefit, turning it into a stream of income over their own life expectancy. While the "stretch" option for IRAs was largely eliminated for most non-spouse beneficiaries by the SECURE Act, certain "Eligible Designated Beneficiaries"—such as those who are disabled, chronically ill, or not more than 10 years younger than the owner—may still use this method.

Disclosure: The above is not tax advice. Speak to a financial professional or accountant to learn what applies to your case.

Taxation of Inherited Annuities

It is a common myth that inherited annuities are tax-free. In reality, they are usually subject to ordinary income tax.

To manage the tax hit, beneficiaries often use the exclusion ratio, which spreads the tax liability over multiple years by taking periodic payments rather than a lump sum.

Key Considerations for 2026

As of 2026, the Required Minimum Distribution (RMD) age is 73. If an annuity owner dies after they have already started taking RMDs, the beneficiary must continue taking those annual distributions even under the 10-year rule. Failure to take a required distribution can result in an IRS excise tax of up to 25% (reduced from the previous 50% by SECURE 2.0).

Furthermore, naming a Trust as a beneficiary has become increasingly complex. While trusts offer control, they are often subject to the Five-Year Rule and higher compressed tax rates unless structured correctly as a "see-through" trust.