confused about inherited tax-deferred annuity

[DayDreaming]

My mother passed away recently and I'm sorting through her finances. My father passed away years ago.

I discovered that she had a small tax-deferred annuity with a life insurance company worth about $5k. It listed my father as beneficiary with no secondaries, so my mother's estate receives the death benefit. Actually I'm confused about what exactly this thing is - statements I found say "contract-type: IRA-REGULAR". Paperwork regarding the death benefit only refers to it a tax-deferred annuity. Maybe that doesn't matter for this purpose?

As executor, I was given 3 options for what to do with this:

• Deferral - the estate may continue this annuity for 5 years
• Lump Sum - payable to the estate, with an option to withhold income tax
• Annuitize - the estate may elect to receive annuity payments

Lump sum is the only option that makes sense to me, but I'm wondering about taxes since this is tax deferred money. Since it's payable to the estate, and I'll need to file a tax return for the estate, that's where any taxes owed would be paid, right? The estate may show so little income, I'm thinking that no taxes will be owed. Is that how this works? I just want to make sure I'm handling this correctly.

 

[Slim11]

If its tax deferred IRA, the state if applicable and the feds will want thier money. You really need to find out exactly what the account is. An annuity is a totally diffrent thing. I know nothing about that.

 

[cathy63]

It sounds like a tax deferred annuity that is fully taxable when withdrawn. It would also have been subject to RMDs while your mother was alive, including during 2024. If she didn't take an RMD before her passing, then the estate has to take it by the end of the year, though with such a small balance, I agree that taking the whole thing as a lump sum makes sense.

An estate only gets a $600 exemption, so if there is $5K of income, then $4400 is taxable. The first $3100 of that is at 10% and the rest is at 24%. You could also distribute the income to the heirs and issue K-1s, in which case the tax burden shifts from the estate to the heirs and they would owe ordinary income tax at their own marginal rates.

 

[Slim11]

Provided the will dosen't specify all taxes will be paid by the estate.

 

[cathy63]

I'm not sure a will can override the tax code. Maybe it can, I don't know for sure, but that seems like an odd thing to write into a will. In most cases it's better to distribute the tax burden to the heirs because estate tax brackets hit the highest rates so quickly that the heirs actually end up receiving less.

In this case, the amount is so small it might make sense to pay the tax on the estate's return. But if the heirs don't have other income (e.g. minor grandchildren), then it's better to distribute the funds since they won't receive enough to owe any taxes.

 

[Slim11]

Just happened to me, it may be area dependent. But the will and estate stated that all taxes came out of the estate and trust. And no benificarys would be liable for anything. Since my siblings got way more $$$ then me, I got screwed on the taxes that were paid out.

 

[Texas Proud]

If it is in an IRA who is the custodian?

If it is not in an IRA check to see if the payout is considered life insurance... my mom bought an annuity back in the 80s and when I found out about it it had grown by 2X... so did not want to cash it in... we converted it to an annuity with a life insurance kicker... when she finally passed we got a BIG tax free lump sum as it was now a life insurance policy... and not in an IRA..

 

[DayDreaming]

It sounds like a tax deferred annuity that is fully taxable when withdrawn. It would also have been subject to RMDs while your mother was alive, including during 2024. If she didn't take an RMD before her passing, then the estate has to take it by the end of the year, though with such a small balance, I agree that taking the whole thing as a lump sum makes sense.

I found a statement showing that an RMD was taken in April of this year.

Provided the will dosen't specify all taxes will be paid by the estate.

The will makes no mention of taxes.

In this case, the amount is so small it might make sense to pay the tax on the estate's return. But if the heirs don't have other income (e.g. minor grandchildren), then it's better to distribute the funds since they won't receive enough to owe any taxes.

That's what I'm thinking. Everything in the estate is split 50/50 with my brother and myself, both retired, and I do try to limit my income for ACA purposes.

If it is in an IRA who is the custodian?

If it is not in an IRA check to see if the payout is considered life insurance... my mom bought an annuity back in the 80s and when I found out about it it had grown by 2X... so did not want to cash it in... we converted it to an annuity with a life insurance kicker... when she finally passed we got a BIG tax free lump sum as it was now a life insurance policy... and not in an IRA..

The custodian is a Life Insurance company but it's definitely not a life insurance policy. The RMD statement refers to it as "your qualified retirement account". Actually I just found something saying "your annuity contract was issued as an Individual Retirement Annuity (IRA) and , therefore, an IRA Endorsement formed part of your contract." So I guess that means I'll just treat it as an IRA.

I think what I'll do is take the lump sum, payable to the estate, and I'll have them withhold some income tax. When I do the final tax return for the estate in April... I'll probably get a CPA to to the taxes. I've always done my own, but I think i want a professional to do this one.

 

[Texas Proud]

It actually is not that hard... I bought TT for business which does 1041s... it is over $100 though...

I had 6 beneficiaries and the estate was open 3 years... but it was really easy as there was not that much different types of income..

Remember you also have to do a final 1040 up till time of death...

One thing you did not say is how much you are talking about... if it is small it is no big deal... but if larger you should have it given to the estate beneficiaries... I do not see why you could not distribute it directly to them... or do it where they can roll it over to an IRA...

 

[DayDreaming]

It actually is not that hard... I bought TT for business which does 1041s... it is over $100 though...

I had 6 beneficiaries and the estate was open 3 years... but it was really easy as there was not that much different types of income..

Remember you also have to do a final 1040 up till time of death...

One thing you did not say is how much you are talking about... if it is small it is no big deal... but if larger you should have it given to the estate beneficiaries... I do not see why you could not distribute it directly to them... or do it where they can roll it over to an IRA...

I've never been an executor before and I'm still a bit overwhelmed with everything regarding my mother's recent passing. Maybe by April I'll have changed my mind about using a CPA for her taxes, but right now I'm pretty fuzzy on a lot of details, particularly about what taxes apply to an estate.

My mother has not had to file a 1040 for years because her income was so low. The would apply for this year too, but I guess I should file one anyway so that the IRS has it on record?

The IRA/annuity I'm asking about in this question is only about $5k. I might have this wrong but I was told that since the named beneficiary (my father) is deceased and no secondaries are listed, it must be paid to the estate, where it can then be distributed to the beneficiaries as listed in her will. (There are only 2 beneficiaries, myself and my brother, 50/50).

She has a larger IRA of about $40k where my brother and I are listed as beneficiaries so that should be distributed directly to us, and I'm waiting for paperwork from the bank. I'm hoping that this can be rolled over into IRAs for myself and my brother, and not have to go through the estate account.

There's also a $26k non-qualified annuity that I can't find much information on, and that bank is also sending me some paper work to fill out.

The only other big item will be the sale of the house.

 

[Slim11]

My condolences, its not easy. The IRAs can be rolled over into a seprate benificary IRA in you and your brothers names. You will have to take the RMDs as your mother did. And drain the account during the next 10 years. You will also have to pay taxes on it if it was pre tax money. You can not roll this money into a roth. Sale of the house will get a bump up to today's prices. So really no tax on that if you sell it soon. If you keep it for a bit get an appraisal done. So say the house was bought for 40k and is now worth 900k, the step up value will be the price you get over the 900k. ( it should work the other way if you loose money on the sale, but my lawyers wouldn't do that). This has been my experience the last year in NJ and Florida.

 

[Texas Proud]

Do not get overwhelmed... it is hard when you lose a loved one so take your time...

Yes, fill out a 1040 showing she died... if there is no income that is really easy...

Since you will not be getting much income in the estate (the IRA looks like that is it) it will be really easy... heck, with a little bit of work you could fill out the 1041 yourself without the tax program...

OR... ignore a 1041 return for her and just put the income in your 1040 (your share) and your brother (his share)... I have gotten a 1099 addressed to my Dad;s estate who died in 1980 from a really small O&G well... it is too expensive to get the name changed as I only get about $50 to $100 a year.. I have tried to sell it back to the operator but they do not want to deal with it...

Put your share of the $5K, your share of the house sale (with stepped up basis) and that is that...

 

[DayDreaming]

My condolences, its not easy. The IRAs can be rolled over into a seprate benificary IRA in you and your brothers names. You will have to take the RMDs as your mother did. And drain the account during the next 10 years. You will also have to pay taxes on it if it was pre tax money. You can not roll this money into a roth. Sale of the house will get a bump up to today's prices. So really no tax on that if you sell it soon. If you keep it for a bit get an appraisal done. So say the house was bought for 40k and is now worth 900k, the step up value will be the price you get over the 900k. ( it should work the other way if you loose money on the sale, but my lawyers wouldn't do that). This has been my experience the last year in NJ and Florida.

Yes, I'm hoping that the larger $40k IRA can get rolled over into 2 $20k IRAs. Getting help from this particular bank is very frustrating, but I'll keep after them.

We have a buyer for the house and expect closing in early December, about 3 months after my mother's passing. We're doing a for-sale-by-owner and our lawyer filled out an L-9 tax waiver for us. We haven't had an appraisal done, and I don't think I need one since it's selling soon. Please correct me if I'm wrong?

 

[DayDreaming]

Do not get overwhelmed... it is hard when you lose a loved one so take your time...

Yes, fill out a 1040 showing she died... if there is no income that is really easy...

Since you will not be getting much income in the estate (the IRA looks like that is it) it will be really easy... heck, with a little bit of work you could fill out the 1041 yourself without the tax program...

OR... ignore a 1041 return for her and just put the income in your 1040 (your share) and your brother (his share)... I have gotten a 1099 addressed to my Dad;s estate who died in 1980 from a really small O&G well... it is too expensive to get the name changed as I only get about $50 to $100 a year.. I have tried to sell it back to the operator but they do not want to deal with it...

Put your share of the $5K, your share of the house sale (with stepped up basis) and that is that...

Thanks, I'll have to research how some of this stuff get listed on a 1040 or 1041. Besides this $5k IRA, there might be another few thousand $ odds and ends going into the estate account until it's all distributed. The biggest item in this estate is the sale of the house for about $275k, but I don't think any of that will show as income, it would be a tax exempt inheritance as I understand it. I'll take a look at the 1041, I appreciate the advice.

 

[Slim11]

You should be fine with the house without an appraisal.

 

[gauss]

Yes, I'm hoping that the larger $40k IRA can get rolled over into 2 $20k IRAs. Getting help from this particular bank is very frustrating, but I'll keep after them.

We have a buyer for the house and expect closing in early December, about 3 months after my mother's passing. We're doing a for-sale-by-owner and our lawyer filled out an L-9 tax waiver for us. We haven't had an appraisal done, and I don't think I need one since it's selling soon. Please correct me if I'm wrong?

The lower stress strategy on this might be just to call fidelity and ask them to help you open Beneficiary IRA(s). They can handle transferring your share of your parent's IRA to your new Fidelity Beneficiary/Inherited IRA. You shouldn't need to deal with a bank on this if you don't want to.

FWIW My mother died and left me with an annuity with a life insurance company inside of an IRA. The life insurance company would only allow me to annuitize it or take a (fully taxable) lump sum.

Fidelity saved the day in my case. I was then able to take my required RMDs directly from the new Fidelity account.

-gauss

 

[gauss]

Thanks, I'll have to research how some of this stuff get listed on a 1040 or 1041. Besides this $5k IRA, there might be another few thousand $ odds and ends going into the estate account until it's all distributed. The biggest item in this estate is the sale of the house for about $275k, but I don't think any of that will show as income, it would be a tax exempt inheritance as I understand it. I'll take a look at the 1041, I appreciate the advice.

The house would not be tax-exempt unless the price you sell it for - less any sales expenses - is less than the fair market value on the date of death. There is no exclusion for real-estate sales that are not your "primary residence".

That being said, if you pay a full real estate commission and other costs at closing, and you sell the house promptly before the house can appreciate too much, then it is possible/likely that you will not have any tax due.

 

[all4j]

Daydreaming, you may not realize it but from the data presented it appears you are well better than average on your progress. You have a fighting chance to wrap up by end of year, which would be great. Don’t let my lengthy post deter you, but here’s what I’d do…

• Go ahead & engage a CPA now. They won’t be less busy come tax season & may help make decisions upfront. There are many possible complexities with annuities. Even if you handled 100% right, if there are questions raised, your brother may feel better knowing a pro weighed in. Lawyer handling house closing might also help; at least suggest a CPA? Remember, cpa fees etc are legit executor expenses to be paid by the estate.
• $5k “tax deferred” annuity – aka a “qualified” annuity. I’d also take lump sum. It is likely all taxable, but they should tell you & cpa will need the breakdown. (for example, you may have regular interest from date of death until pay out date). Let cpa advise you on tax withholding, but it may be easier to pay when filing so you don’t have to wait on refund if things change.
• House – while not tax exempt, it is unlikely any tax will be due. It will be classed as long term cap gain if so. Very straight forward & cpa will know exactly how to report
• $40k IRA – likely you can split into 2 inherited IRAs. Custodian may likely re-title before doing anything else, but you may want to consider transferring to where you have IRAs (if you have one). Don’t forget to name beneficiary for yours once re-titled & understand rules for the inherited IRA.
• $26k non-qualified annuity – I’d expect you can have this halved also, but there are some differences with an IRA. It should have a basis & so some, but not all, is taxable when withdrawn. Distributions will come from the taxable portion 1st then the basis. For example, say it was originally bought for $10k & has now grown to $26k. Once split, there will be 2 non-qualified annuities, each with a basis of $5k (non taxable) & $8k ‘earnings’ (taxable). If your 1st rmd is $2k, it will all be taxed as ordinary income. Again, you’ll need to understand how the RMDs are calculated & beneficiaries should be named asap

 

[DayDreaming]

The lower stress strategy on this might be just to call fidelity and ask them to help you open Beneficiary IRA(s). They can handle transferring your share of your parent's IRA to your new Fidelity Beneficiary/Inherited IRA. You shouldn't need to deal with a bank on this if you don't want to.

FWIW My mother died and left me with an annuity with a life insurance company inside of an IRA. The life insurance company would only allow me to annuitize it or take a (fully taxable) lump sum.

Fidelity saved the day in my case. I was then able to take my required RMDs directly from the new Fidelity account.

-gauss

Thanks, gauss, I hadn't thought about attacking this from the other end. All of my savings are at Vanguard, so I'll try working with them on this. Thank you!

 

[DayDreaming]

Daydreaming, you may not realize it but from the data presented it appears you are well better than average on your progress. You have a fighting chance to wrap up by end of year, which would be great. Don’t let my lengthy post deter you, but here’s what I’d do…

• Go ahead & engage a CPA now. They won’t be less busy come tax season & may help make decisions upfront. There are many possible complexities with annuities. Even if you handled 100% right, if there are questions raised, your brother may feel better knowing a pro weighed in. Lawyer handling house closing might also help; at least suggest a CPA? Remember, cpa fees etc are legit executor expenses to be paid by the estate.
• $5k “tax deferred” annuity – aka a “qualified” annuity. I’d also take lump sum. It is likely all taxable, but they should tell you & cpa will need the breakdown. (for example, you may have regular interest from date of death until pay out date). Let cpa advise you on tax withholding, but it may be easier to pay when filing so you don’t have to wait on refund if things change.
• House – while not tax exempt, it is unlikely any tax will be due. It will be classed as long term cap gain if so. Very straight forward & cpa will know exactly how to report
• $40k IRA – likely you can split into 2 inherited IRAs. Custodian may likely re-title before doing anything else, but you may want to consider transferring to where you have IRAs (if you have one). Don’t forget to name beneficiary for yours once re-titled & understand rules for the inherited IRA.
• $26k non-qualified annuity – I’d expect you can have this halved also, but there are some differences with an IRA. It should have a basis & so some, but not all, is taxable when withdrawn. Distributions will come from the taxable portion 1st then the basis. For example, say it was originally bought for $10k & has now grown to $26k. Once split, there will be 2 non-qualified annuities, each with a basis of $5k (non taxable) & $8k ‘earnings’ (taxable). If your 1st rmd is $2k, it will all be taxed as ordinary income. Again, you’ll need to understand how the RMDs are calculated & beneficiaries should be named asap

Thank you! At times this all seems very complicated, sometimes I think I'm over-complicating things. I appreciate the advice.