Inherited NQ Annuity Reference Sheet

DEATH OF HOLDER (OWNER) OF NON-QUALIFIED (NQ) ANNUITY
IRC Section 72(s) … “Inherited” NQ Annuity

A)    Spouse Designated Beneficiary … Distribution Options at Death

1.      5 year rule (includes lump sum) … IRC Section 72(s)(1)

2.      Life expectancy rule (Annuitized distribution must start no later than        1 year after the date of death of the holder-owner) … IRC Section 72(s)(2)

3.      Spouse can continue existing contract as his/her own and name a new beneficiary.  Can continue income tax deferral of gain in excess of cost basis all the way until death of the spouse … (IRC Section 72(s)(3)

 B)    Non-Spouse Designated Beneficiary … Distribution Options at Death

1.      5 year rule (includes lump sum) … IRC Section 72(s)(1)

2.      Life expectancy rule (Annuitized distribution must start no later than        1 year after the date of death of the holder-owner) … IRC Section 72(s)(2)

 Note:

PLR 200313016 also allows a life expectancy payout for ‘inherited” NQ annuities based on the Single Life Table of Treas. Reg. 1.401(a)(9)-9. This required annual “inherited” distribution must start no later than 1 year after the death of the holder-owner.  Presumably, this would allow a deferred annuity type of product with an irrevocable annual income withdrawal option to be utilized.  IRS ruled in PLR 200313016 that this method would satisfy the life expectancy requirement of IRC Section 72(s)(2).         

 C)    Trust or Estate as Beneficiary … Distribution Options at Death

1.      5 year rule (includes lump sum) … IRC Section 72(s)(1)

2.      Life expectancy rule … (It is not clear if the Life Expectancy rule can be used where a trust or estate is the beneficiary of a NQ annuity.  No Treasury Regulations or IRS rulings exist for NQ annuities where a trust or estate is the beneficiary.  A trust or estate is not considered to be an individual.)

Technical Note 1:  Generally, the death of the holder (owner) of a NQ annuity terminates the contract and required distributions must commence.  One of the distribution options described above is usually chosen with the existing annuity carrier.  An exception is the option for a spouse beneficiary to continue the contract as his/her own.  This spousal continuation contract is still eligible for a tax free exchange to a NQ annuity with another carrier.

Technical Note 2:  For income tax purposes, the distribution option chosen will be governed by either the “LIFO” distribution rules of IRC Section 72(e) or the “exclusion ratio” rules of IRC Section 72(b).

Technical Note 3:  Where an Irrevocable Trust is the owner of a non-qualified annuity, IRC Section 72(s)(6) says that the “holder” for purposes of post-death distributions of the NQ annuity shall be the primary annuitant.  With an Irrevocable Trust as owner, it’s important to determine who will be the annuitant … either the older parent (grantor of the trust) or the younger adult child (beneficiary of the trust).

Technical Note 4: There is currently no authority in the Code, Treasury Regulations, or Revenue Rulings for post-death transfers of NQ annuity funds from one annuity carrier to another annuity carrier after the holder-owner has died.  However, in PLR 201330016 IRS permitted a post-death transfer of NQ annuity funds as long as the transfer was made directly from the old annuity carrier to the new annuity carrier.  The IRS characterized this transaction as a permitted exchange of annuity contracts within the scope of IRC Section 1035(a)(3).  Each annuity carrier must be consulted to determine their own business practices for this post-death situation.

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