Have a deferred retirement annuity you might not get to use? You can pass its tax-deferred earnings advantage to your annuity beneficiary and supply her income over much of her life.
A non-qualified annuity is one you funded with after tax dollars. You can provide your assigned annuity beneficiary – after you die – with a lifetime income stream from it. Its holdings can be “stretched out” over the beneficiaries’ lifetime, creating what’s known as a non-qualified stretch annuity.
The ability to stretch out distributions to a beneficiary comes from IRC section 72(s) which requires non-lump-sum annuity distributions to begin within one year of the annuity owner’s death. But the option to stretch out this distribution must be elected within 60 days of after the benefit is payable. So this rule preserves the non-qualified annuity’s tax-deferral advantage for the beneficiary and allows him to avoid a high taxation rate that an all-at-once payout would produce.
How long can your beneficiary stretch annuity payments?
He can either have payments made to him over the IRS’ projected remaining life expectancy for his age or simply have the payments annuitized under one of the insurance company’s annuitization options.
These options would be a life annuity (retirement annuity), a life annuity with a period-certain guarantee or a customizing distribution over a designated period. Depending on the age of the beneficiary, the annuity issuer may require that the term of years be reduced to the IRS’s projected remaining life expectancy for him.
According to the IRS table I for ‘projected’ single life expectancy , a 40 year old beneficiary has 43.6 years statistically projected to live. If this beneficiary chose to take yearly payments under the IRS required distribution scheme, his first annual payment would equal the value of the annuity at the end of the year of the owner’s death divided by 43.6 years. The subsequent annual payment would be the previous year end annuity divided by 42.6 (i.e. one less than 43.6). The following year would be a similar evaluation but divided by 41.6 (i.e. one less than 42.6), etc.
Stretching annuity payments over a long time can really increase the total amount of money generated by the retirement annuity.
The 5 year alternate distribution term
If you don’t invoke the one-year rule to permit the stretch annuity options, then the beneficiary must receive all the annuity holdings within 5 years after the owner’s death. The tax-deferral growth advantage remains in effect. So the beneficiary could choose to deferral all withdrawals to the end the 5 year period before emptying the retirement annuity.
Note: Annuities once annuitized cannot be surrendered for value. Income from deferred annuities is taxed as ordinary income and withdrawals prior to age 59 ½ are subject to a 10% penalty. Income from annuitization is taxed part as ordinary income and part as return of capital. Any guarantees are based on the claims paying ability of the insurance company. Annuities should be considered long term investments. Annuities are insurance products and subject to insurance related fees and expenses.