A stretch annuity lets a beneficiary receive inherited annuity payments over an extended period rather than all at once. Spreading payments over time can create a steadier income stream and may limit how much taxable income is recognized each year. The remaining balance continues to grow tax-deferred while payments are made, which can support longer-term planning needs. This approach can be helpful for managing inherited assets, but not all annuity contracts permit stretch options, and recent rules affect how they work for different types of accounts. A financial advisor can review the contract, compare payout structures and help model how each option may affect your tax situation over time.
How a Stretch Annuity Works
A stretch annuity applies when the owner of an annuity dies and leaves the contract to one or more beneficiaries. Instead of receiving a lump sum, the beneficiary can elect to receive periodic payments, typically over their life expectancy or a fixed number of years. This stretch allows the remaining value of the annuity to continue growing on a tax‑deferred basis.
Beneficiaries receive a combination of principal and earnings with each payment. Only the earnings portion is subject to income tax. By extending the payout schedule, beneficiaries can manage how much taxable income they recognize each year. This ultimately may help them remain in lower tax brackets.
It’s important to note that not all annuities may stretch. Some contracts require payout within five years of the owner’s death, while others allow lifetime distributions under specific conditions. The availability of this option depends on whether the annuity is qualified or non‑qualified. While a qualified annuity uses pre‑tax dollars in an IRA or 401(k), a non-qualified annuity uses after‑tax dollars.
Who Can Use a Stretch Annuity
Eligibility for a stretch payout depends on the beneficiary’s relationship to the annuity owner and the type of account.
Spousal beneficiaries usually have the most flexibility. A surviving spouse can assume ownership of the annuity so they can continue deferring distributions while maintaining tax‑deferred status. This effectively turns the inherited contract into their own annuity, allowing them to choose when to start income payments.
Non‑spouse beneficiaries, such as children or grandchildren, may be able to use the stretch option if the contract allows it. However, they must begin receiving payments within a year of the owner’s death and follow the timeline dictated by their insurer or the IRS.
Under the SECURE Act, most inherited qualified retirement accounts (including annuities within IRAs) must now be distributed within 10 years. However, this rule does not always apply to non‑qualified annuities, which may still permit life‑expectancy‑based payout schedules.
Stretch Annuity Taxation Rules
Taxation for a stretch annuity depends on whether the annuity was funded with pre‑tax or after‑tax money.
For non‑qualified annuities, only the earnings portion of each payout is taxable. The IRS uses an exclusion ratio to determine the portion of each payment that represents taxable gain versus a return of principal. For instance, if an inherited annuity is worth $150,000 and was originally funded with $100,000, about one‑third of each payment is considered income.
For qualified annuities, such as those purchased with IRA or 401(k) funds, the entire distribution is taxable since contributions were pre‑tax. In both cases, spreading the income over time allows beneficiaries to manage their tax liability.
A lump‑sum payout can push income into a higher bracket, while stretching payments extends the liability across years or decades. Beneficiaries should also note that annuity income may affect Medicare premiums or taxable Social Security benefits in retirement.
Stretch Annuity Pros and Cons
The key trade‑off with a stretch annuity is between flexibility and tax efficiency. Those who need immediate access to funds may prefer a lump sum, while others who value predictable income may benefit from the stretch option.
Pros of Stretch Annuities
- Tax deferral. Earnings continue growing tax‑deferred during the payout period.
- Lower tax burden. Smaller annual distributions can help beneficiaries stay in a lower tax bracket.
- Steady income. Stretch annuities provide a reliable income stream instead of a one‑time windfall.
- Estate planning benefits. They help preserve wealth and provide long‑term support for heirs.
Cons of Stretch Annuities
- Limited availability. Not every insurer or contract supports stretch distributions.
- Complex rules. Beneficiary age, relationship and annuity type all affect eligibility.
- Reduced flexibility. Once you choose a payout schedule, it’s often irrevocable.
- Potential administrative fees. Some insurers charge annuity fees for managing extended payouts.
Example Scenarios of a Stretch Annuity in Action
Say you inherit a $300,000 non‑qualified annuity. The original investment was $200,000, so $100,000 represents taxable gains. Instead of taking a lump sum, you choose a 15‑year stretch payout.
Each year, you would receive around $20,000, with roughly two‑thirds considered taxable income. This approach could potentially keep your annual tax bill manageable, while the remaining balance continues to grow tax‑deferred.
As another example, say you inherit your spouse’s annuity and choose to assume ownership. Because you’re a spousal beneficiary, you can delay withdrawals until you retire. This allows the annuity to continue compounding tax‑deferred, effectively preserving its value for future income.
Planning Ahead With Stretch Annuities
Both estate planning and tax planning play a major role in how a stretch annuity is handled. Owners who want to provide long‑term income to their heirs should check whether their contract allows a life‑expectancy payout option and name individuals, not entities, as beneficiaries.
It’s also helpful to coordinate the annuity’s stretch strategy with other estate planning tools, such as trusts or retirement accounts, to avoid conflicts or unintended tax consequences. Periodic reviews ensure that beneficiary designations remain current. This is particularly critical after major life events, such as marriage, divorce or the birth of a child.
If your annuity contract does not currently include a stretch provision, your financial advisor may recommend transferring it to one that does through a 1035 exchange. if appropriate for your situation.
Bottom Line
A stretch annuity lets beneficiaries receive inherited annuity payments over a longer period instead of taking the entire amount at once. Spreading payments can create a more predictable income stream and may reduce the taxable income reported each year. This option can support long-term planning needs, but it depends on the contract and the rules that apply to the annuity.
Retirement Planning Tips
- Because annuity rules can differ between providers as legislation continues to evolve, it’s a good idea to consider working with a financial advisor who understands both the income and estate‑planning implications. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s Social Security calculator can help you estimate future monthly government benefits.
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