Making the Most of Inherited IRAs and Non-Qualified Annuities

Many people believe that when they inherit an IRA or a non-qualified annuity, they’re stuck with whatever investments the original owner chose. In reality, these accounts don’t always have to stay exactly the same, and with the right planning, beneficiaries can often move these assets into investments that better suit their needs, while also making them more tax-efficient.

 

Let’s explore the options available and clear up some common misconceptions.

 

Inherited Nonqualified Annuities: More Options Than You Might Think

 

A widespread myth is that inherited non-qualified annuities must be cashed out immediately, resulting in a large tax bill, or liquidated within five years. While these are choices, many annuity contracts offer a “stretch” option.

 

The Stretch Option

• Withdrawals are based on the beneficiary’s own life expectancy.
• Required minimum distributions (RMDs) must begin within a year of inheriting the account.
• The remaining balance stays invested, continuing to grow tax-deferred.
• Taxable gains are withdrawn first; once gains are exhausted, the original investment comes out tax-free.

Why it’s important:  Stretching withdrawals spreads out the tax burden and extends the time assets remain invested.

 

Post-Death 1035 Exchange: Moving to a Better Fit

 

If an inherited annuity doesn’t match a beneficiary’s needs, perhaps due to high fees, limited investment choices, or lack of protective features, it may be possible to use a  post-death 1035 exchange.

This process transfers an inherited annuity to a new one without immediate taxation of gains, as long as the product is eligible and both the sending and receiving carriers permit it.

 

Situations where this can help:

• Lower-cost options are available elsewhere
• More flexible investment strategies are desired
• Beneficiary wants features like downside protection not offered in the current product

Inherited IRAs: Navigating the SECURE Act Changes

 

The SECURE Act of 2019 removed the stretch IRA option for most beneficiaries, replacing it with a “10-year rule” (often called “out in ten”) requiring full distribution of the account within a decade. In 2024, new regulations added RMD requirements for some beneficiaries under the 10-year rule, depending on when the original owner began RMDs.

 

Planning opportunities:

• Roth conversions before death can help, because inherited Roth IRAs under the 10-year rule have no RMDs.
• Certain annuity death benefits or insurance strategies may enhance the value of inherited accounts.

If the inherited IRA doesn’t fit your investment objectives, a  direct trustee-to-trustee transfer  is often possible.

 

Key points:

• Indirect (60-day) rollovers are not allowed for inherited assets except for spousal beneficiaries rolling assets into their own IRA.
• Attempting an indirect transfer could trigger taxes on the entire pre-tax balance.

Preselected Death Benefit Options: Control from the Grave

 

Some account owners want to prevent beneficiaries from spending an inheritance too quickly. Certain contracts allow the owner to limit withdrawal methods through  preselected death benefit options.

Common restrictions include:

• Annuitization for a set number of years or for life
• Life expectancy-based stretch withdrawals only
• Limiting withdrawals to RMD amounts, with the option to lift restrictions later

These strategies can promote responsible use of inherited funds and preserve the benefits of long-term, tax-deferred or tax-free growth.

 

The Bottom Line

 

If you inherit an IRA or a nonqualified annuity, remember: you’re not necessarily locked into the investments chosen by the original owner. Strategies such as stretching withdrawals, completing a post-death 1035 exchange, or transferring assets to offerings that align with your goals can help reduce taxes and keep your money working for you longer.