Clear Money Guide
Guide and tool overview
See the questions covered here, then open the interactive utility.
Updated August 1, 2026. Quick answer: a nonqualified annuity you inherit gives you three routes, and at one flat tax rate they all produce the same total tax — because each one eventually taxes exactly the gain in the contract. What differs is when that income arrives and how much of it lands in a single year. Take it as a lump sum and the whole gain is income this year. Take it under the five-year rule and, because IRC §72(e)(2)(B) allocates withdrawals to income first, the early years are fully taxable and the last years are tax-free basis. Take it over your life expectancy under §72(s)(2) and IRC §72(b) splits every payment in a fixed ratio, so the taxable amount is level and small. The calculator below computes all three on your numbers.
The statutory routes, and where they are set out
This page is the arithmetic. The routes themselves, quoted from the statute, are laid out at what happens to an annuity when the owner dies — the §72(s)(1) five-year rule, the §72(s)(2) life-expectancy alternative with its one-year start deadline, and §72(s)(3) spousal continuation. The gain-first ordering that drives the five-year column is at money comes out of an annuity gain first, basis last. Nothing here restates those; it prices them.
Compare the routes on your own numbers
Enter the contract value at death, the owner’s cost basis (the after-tax money originally put in), your marginal rate, and a life expectancy for the beneficiary.
What this does and does not model. It applies one flat marginal rate you supply, and projects no growth on the contract after death. It is an educational estimate, not tax advice and not a filed return.
Because every route eventually taxes exactly the gain, a single flat rate produces the same total tax for all three. The number that actually decides the choice is how much taxable income lands in one year, which is what the table reports. Spreading income only saves tax if it keeps you in a lower bracket — that is a judgement about your future brackets, not arithmetic this tool can do for you. Confirm anything that changes a filing decision with a CPA.
How to read the result
The equal-total-tax finding is the point, not a limitation. A great deal of writing on inherited annuities implies that spreading payments is inherently cheaper. It is not, at a constant rate. Spreading is worth money when it keeps income under a bracket edge, under an IRMAA tier, or under a threshold that phases something out — and the way to see that is the middle column, the most taxable income in any one year. If your contract has a large gain and you are still working, the lump sum can push a single year into a much higher bracket for no reason.
The five-year column surprises people. Equal withdrawals do not mean equal tax. Gain comes out first, so you can face three fully taxable years followed by two tax-free ones. If you are choosing the five-year route to spread income, that front-loading is working against you.
Before you rely on any of it: confirm the contract value and the cost basis with the insurer in writing, because basis is the input people most often guess at, and it is the difference between a taxable gain and none at all. And check whether the contract is nonqualified at all — an annuity inside an IRA follows entirely different rules: the qualified-versus-nonqualified difference and an annuity held inside an IRA.
A death benefit is a decision with a deadline attached.
The §72(s)(2) route has to begin within a year of the death, and the contract value is money already in hand. The matching service below introduces you to advisers who pay to meet you.
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