If your loved one passed away and left you with an annuity, you have plenty of options. While the regular and reliable income could have been best for him, you may find that a lump sum would better serve your financial needs. Cashing out the annuity can allow you to pay off debt, pay for college or cover other significant expenses. While you may have already started thinking of ways to spend the money, there are some considerations to examine first.
TL;DR (Too Long; Didn't Read)
Your options for cashing out an inherited annuity will ultimately depend on how the annuity buyer has set it up.
Cash-Out Options for Beneficiaries
The precise options you have may vary based on how the annuity buyer set up the account. However, there are generally three ways for beneficiaries to access the annuity funds.
The first is a lump-sum distribution. This option is what most people think of when they consider "cashing out." If you choose a lump-sum distribution, you will receive the remaining funds in one payment.
The second option is a nonqualified stretch. With this choice, you receive regular payments throughout your life expectancy. This is similar to how the annuity owner received the funds.
The Five-Year Rule
The third option for withdrawal is known as the five-year rule. If the deceased person left the annuity to a trust, charity or estate, the five-year rule is the only available option. If the person left the annuity to a loved one, this is simply another option.
With the five-year rule, you can take the proceeds of the annuity immediately, which is the interest earned. Then, over the five years, you can take out some of the money. At the end of the five-year period, you can cash out the remaining sum, and you must then pay taxes on the proceeds.
Tax Considerations for Annuities
Before you decide which option is best for you, it's important to consider how taxes will affect you. If you are the spouse of the person who left the annuity, you can continue to receive the payments without any immediate effect on your taxes. However, non-spouse beneficiaries must pay taxes on the income with each payment.
If a non-spouse beneficiary chooses a lump-sum payout, she must pay taxes on the interest the annuity earned over the life of the investment. Some beneficiaries choose the five-year rule because it gives them years to prepare for the tax burden.
Other Inherited Annuity Fees
If you choose to cash out your inherited annuity either through a lump sum or by using the five-year rule, you will be subject to fees from the financial institution. These fees can vary widely depending on the terms of the annuity, your age and other factors. It's important to check with the institution before you go through with a withdrawal.
Mackenzie Maxwell believes that a well-made budget is a key to a happy household. She starting combining this interest with her passion for writing in 2016. Mackenzie has written for financial sites like The Balance and local financing organizations.