Distribution options will vary depending if you are the surviving spouse or someone other than the surviving spouse. If you're the surviving spouse, you have several options, but the most common is to treat the annuity as your own, keeping all the options the owner had.
As someone other than the surviving spouse, you'll basically have three potential options:
a) Lump-sum payout
b) Full payout over the next five years
c) Elect with 60 days, to annuitize over your own lifetime
If the annuity payments have already begun, you must take payments at least as rapidly as the original owner was taking them.
When a person inherits an annuity, the gains stay with the policy. Depending on the type of annuity, tax will have to be paid on the lump sum received or on the regular fixed payments. The payments received from an annuity are treated as ordinary income, which could be as high as 35% tax depending on your tax bracket.
Supposing that this annuity was purchased with after-tax dollars, ordinary income is owed on all gains, but not on principal. A portion of each annuity payment will be considered a tax-free return of principal, spreading the tax liability out over time, unless you select the lump-sum payout. (Learn more about deferred annuities in our article, Complicated Deferred Annuity Designations.)
This question was answered by Steven Merkel
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