Are Annuities Included in the Gross Estate for Tax Purposes?
Understand how annuities are treated in estate taxation, including factors like ownership, beneficiary designations, and taxable amounts.
Annuities can provide a reliable income stream, but they also raise important estate tax questions. A key concern is whether annuities are included in the gross estate when someone passes away, potentially increasing the taxable amount owed to the IRS.
Understanding how annuities factor into estate taxes depends on ownership structure, beneficiary designations, and specific contract terms.
Estate Tax Concepts
The federal estate tax applies to a deceased person’s total assets before distribution to heirs. The IRS calculates this by determining the gross estate, which includes real estate, investments, business interests, and financial instruments like annuities. The taxable estate is then derived by subtracting allowable deductions, such as debts, funeral expenses, and charitable contributions.
For 2024, the federal estate tax exemption is $13.61 million per individual. Estates exceeding this threshold are taxed at rates up to 40%. Some states impose their own estate or inheritance taxes, often with lower exemption limits and varying rates.
Assets are generally valued at their fair market price on the date of death. However, executors can elect an alternate valuation date six months later if it results in a lower estate tax burden. This option is particularly relevant for assets subject to market fluctuations, such as stocks and real estate.
Ownership and Incidents of Ownership
An annuity’s inclusion in the gross estate depends on ownership and control. If the decedent owned the annuity at the time of death, its value is included in the estate. Ownership is not just about whose name is on the contract but also who had control over the annuity’s terms, such as the ability to change beneficiaries, withdraw funds, or modify payout options.
For jointly owned annuities, the IRS may attribute the full value to the deceased owner unless the surviving co-owner can prove they contributed to its purchase. This is especially relevant for spouses, as the portion attributable to the deceased spouse is included in the estate unless it qualifies for the marital deduction, which defers estate tax until the surviving spouse’s death.
Under Internal Revenue Code 2036, if the decedent retained the right to receive payments or control the contract’s disposition, the annuity is included in the estate. Similarly, under Internal Revenue Code 2039, if the annuity was purchased by the decedent and payments continue to a beneficiary due to contractual obligations, the value of the remaining payment stream is included in the taxable estate based on actuarial calculations.
Beneficiary Arrangements
Beneficiary designations affect estate tax exposure and how funds transfer after death. Naming an individual as a beneficiary allows annuity proceeds to bypass probate, expediting distribution. However, this does not necessarily exclude the annuity from the gross estate. If the decedent retained rights over the contract, such as the ability to change beneficiaries or control payouts, the IRS may still include its value in estate calculations.
The payout structure also influences taxation. A lump sum death benefit is fully included in the estate’s valuation. If the annuity provides continued periodic payments to a beneficiary, the taxable portion is based on the present value of those future payments. Annuities with a refund feature, where any remaining balance after the owner’s death is paid to a beneficiary, increase the likelihood of estate inclusion since they guarantee a residual benefit.
If no beneficiary is named or the estate itself is designated, the annuity proceeds become part of the probate estate, potentially delaying distribution and increasing administrative costs. This can also lead to higher estate tax liability, as assets passing through probate are generally included in the gross estate. Proper beneficiary planning, including irrevocable designations, can ensure efficient transfers and minimize tax burdens.
Calculating the Taxable Amount
The portion of an annuity subject to estate tax depends on its value at the time of death and its payout structure. If the annuity is in the payout phase, the taxable portion is based on the actuarial value of any remaining guaranteed payments. For example, if a decedent was receiving lifetime payments with a 10-year period certain and passed away in year four, the remaining six years of guaranteed payments would be included in the gross estate. The IRS uses life expectancy tables and discounting methods to determine the present value of these future payments.
For deferred annuities, the taxable amount is generally the contract’s cash surrender value at the date of death rather than the total future benefits. This is particularly relevant when annuities have accumulated substantial tax-deferred earnings, as only the account value—not hypothetical future growth—is included in the estate. If an annuity includes a death benefit rider that provides beneficiaries with an amount greater than the contract value, the excess benefit is also counted toward the estate’s valuation.