Stretch Annuity

What Is a Stretch Annuity?

A stretch annuity (also known as a legacy annuity) is an annuity option where tax-deferred allowances are passed on to the beneficiaries, offering them more flexibility and control over maintaining the investment. The beneficiary thus has fewer restraints on wealth transfer, and he or she is able to receive a larger sum of benefits stretched over a longer period of time. This type of annuity is generally non-qualified, which means that it is not held inside of an IRA.

Key Takeaways

  • A stretch annuity (legacy annuity) allows for easier wealth transfer for annuitants to their beneficiaries after they die.
  • Because annuity benefits can be extended to children or grandchildren, estate taxes and asset transfers can be minimized.
  • Stretch annuities are uncommon and differ from joint-life annuities that provide continued spousal benefits after the annuitant's death.

How a Stretch Annuity Works

Legacy annuities or stretch annuities are not offered by many insurers. This type of annuity can be advantageous because the beneficiary isn't burdened with paying a huge tax bill on his or her gains. This often can be stressful for a family that has just dealt with the loss of a loved one. The idea is that the annuity contract can be “stretched” over multiple generations instead of just a single owner or couple.

What happens to an annuity after the death of the owner largely depends on the type of annuity plan. The owner, or annuitant, elects the annuity type and any beneficiaries at inception, though beneficiaries may be changed by the annuitant prior to death. There are several types of annuity payout plans. For some, payment ends with the death of the annuitant, but others provide for payment to a spouse or other beneficiary for years afterward.

Stretch vs. Joint-Life Annuity

A stretch annuity is different from a joint-life annuity. A joint-life annuity guarantees payment for both your lifetime and that of your beneficiary. Upon your death, your spouse or other beneficiary continues to receive payments until his or her death. Payments to beneficiaries can be the full amount payable to the annuitant during his or her lifetime or a reduced amount, depending on the elections made by the annuitant at inception.

By stretching the annuity, the person who takes out the contract gets no payments. Instead, lifetime income is provided to the owner’s beneficiary based on the inherited contract value and the beneficiary’s life expectancy when the payouts commence. According to IRS rules, beneficiaries must withdraw a minimum annual amount based on their life expectancy, starting within one year of the original owner’s death.

The tax benefit is provided because the beneficiary’s tax liability is stretched over multiple years, as opposed to receiving an inherited annuity in a lump sum, which means the taxes are due in the year of distribution based on the amount inherited and the beneficiary’s tax bracket. These types of annuities are often part of estate planning by wealthier families. 

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