If annuity payments have not begun, the entire contract must be distributed within five years of the owner's death, or be annuitized over time not to exceed the new owner's life expectancy, as long as payments start within a year of the original owner's death. The new owner will be taxed upon surrender or annuitization as the original owner would have been taxed, except that if the annuity is surrendered, the distribution won't be subject to the 10 percent federal penalty tax. Contingent deferred sales charges may apply upon the death of the owner, if the owner is not also the annuitant.
If the designated beneficiary is the owner's spouse, the above distribution requirements do not apply. Instead, the spouse can become the new owner and tax deferral can continue. In either event, the value of the annuity will be included in the original owner's estate for estate tax purposes, but will avoid the delays and expense of probate, if paid to a named beneficiary.
Some companies allow non-qualified annuity beneficiaries to defer paying taxes on annuity death benefits by "stretching" their beneficial interests within five years or over their life expectancies, either from the original contract of through a tax-free exchange to a more competitive immediate annuity.
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