5-Year Rule on Inherited Annuities (2026)

Written & reviewed by Hans Goldstein, EA, Independent Licensed Insurance Producer · CA license 4273294 · NPN 20602398
Admitted to practice before the IRS
Last reviewed 2026-10-03

TL;DR: Non-spouse beneficiaries of a non-qualified annuity must drain the contract within 5 years of the owner's death or take lifetime payments that start within 1 year of death, electing that option within 60 days of the lump sum becoming payable. Otherwise they get hit with a tax bomb. SECURE Act changed inherited IRA rules separately (10-year drain for most non-spouse beneficiaries of qualified annuities). Spousal beneficiaries can continue the contract as their own. Below: the rules, the tax traps, and the stretch alternatives that still work.

The two "5-year rules" people confuse

There are actually three distinct distribution rules people lump together as "the 5-year rule." Get these wrong and your heirs pay tens of thousands in unnecessary tax.

1. NQ annuity 5-year rule (IRC §72(s)): Non-spouse beneficiary of a non-qualified annuity must distribute entire contract within 5 years OR take lifetime distributions that begin within 1 year of death (IRC §72(s)(2)). To avoid being taxed as if you took a lump sum, elect the payout option within 60 days after the lump sum becomes payable (IRC §72(h)); carriers may set their own deadlines. This rule is unchanged by SECURE Act.
2. Roth IRA 5-year rule: Beneficiary can take tax-free distributions if the deceased had held the Roth at least 5 years. Different timer, different consequence.
3. SECURE Act 10-year rule: Non-spouse beneficiary of a qualified IRA annuity must drain within 10 years (replaced the prior "stretch IRA"). Applies to deaths after 2019.

This page focuses on rule #1: the original 5-year rule for non-qualified annuity beneficiaries. The other two are mentioned for contrast.

Spouse vs non-spouse: the dividing line

The 5-year rule does not apply to surviving spouses. A spouse beneficiary has three options:

• Spousal continuation: Treat the annuity as their own. The contract continues as if the spouse were the original owner. No distribution required.
• Annuitize over their lifetime: Convert to a lifetime income stream.
• Lump sum: Take it all (taxable on gains).

Spousal continuation is the default best choice. It preserves the tax deferral and the contract terms.

Non-spouse beneficiaries have two options:

• 5-year drain: Distribute the entire contract within 5 years of the owner's death. Can be spread or lumped within that window. Gains taxed as ordinary income at the beneficiary's bracket.
• Lifetime stretch: Annuitize over the beneficiary's life expectancy, with the FIRST distribution made within 1 year of death. Elect it within 60 days after the lump sum becomes payable (IRC §72(h)) and check your carrier's deadline, which can be shorter.

The tax-bomb scenario (5-year drain into a single year)

Sarah inherits a $400,000 NQ annuity from her father in 2026. Cost basis $150,000; gain $250,000. Sarah is a W-2 earner already in the 24% bracket at $180K AGI.

If Sarah does nothing for 4 years and takes the full $400,000 in year 5:

• $250,000 gain stacks on top of her $180K W-2 income
• Pushes her into the 35% bracket for most of the gain
• Triggers 3.8% Net Investment Income Tax on $200K+ over threshold
• Approximate federal tax: $90,000 on the gain alone

If Sarah instead spreads the gain over 5 years, taking about $50,000 of gain each year (withdrawals come out gain first, so the $150,000 of basis comes out tax-free with the last payment):

• Each year's $50,000 of gain stays in her 24-32% bracket
• No giant one-year spike into the 35% bracket
• The 3.8% NIIT applies to only about $30,000 a year (her $230K income is just over the $200K single threshold), instead of on $200K+ in one year
• Approximate federal tax: about $70,500 total across 5 years (2026 single brackets, standard deduction)

Same $400,000 inheritance. About $20,000 difference in tax based on distribution timing alone.

The lifetime-stretch alternative (often dramatically better)

If Sarah elects lifetime distributions in time (payments starting within 1 year of death, elected within the 60-day window), the annuity pays her ~$11,000/year for her actuarial life (say, 38 years remaining). Each payment uses an exclusion ratio to spread basis return tax-free:

• $11,000/year payment
• Exclusion ratio (basis/expected return): ~$3,950 tax-free per year
• ~$7,050 taxable per year: stays in her 24% bracket on the gain
• 38 years of deferred compound growth on the unpaid balance
• Approximate lifetime federal tax: $59,000 NPV-adjusted

Lifetime stretch wins on tax AND keeps the principal compounding. The problem: the election has a short window (60 days after the lump sum becomes payable, and payments must start within 1 year of death), and many beneficiaries miss the window because the carrier doesn't proactively explain it. They default to the 5-year rule by inaction.

SECURE Act & qualified annuities (IRA annuities)

If the annuity is inside an IRA, the SECURE Act 10-year rule replaces the 5-year rule for non-spouse beneficiaries. Practical rules:

• Non-spouse beneficiaries must drain the IRA annuity within 10 years of death
• No annual RMD required during the 10 years: can defer to year 10 lump
• BUT: if the deceased was already taking RMDs, beneficiary must continue annual RMDs during the 10-year window
• "Eligible designated beneficiaries" (spouses, minor children, disabled, chronically ill, beneficiaries less than 10 years younger) can still stretch over their lifetime

The 10-year window is wider than the 5-year non-qualified window but has the same tax-bomb risk if dumped into one year.

Stretch alternatives that still work in 2026

1. Lifetime stretch on NQ annuities: Still available: payments must start within 1 year of death, elected within the 60-day window. Best option for most non-spouse beneficiaries with long life expectancy.
2. Multi-beneficiary structuring: Naming multiple beneficiaries lets each elect independently. A 38-year-old child can stretch; a 70-year-old sibling might prefer 5-year drain in lower-income years.
3. Trust as beneficiary: If structured as a "see-through" trust, lifetime stretch may be available; if not, 5-year rule applies. Trust drafting matters. Consult an estate attorney.
4. Annuitization before death: If the owner annuitizes the contract during their lifetime, the death benefit becomes the continuing payment stream rather than a lump sum. Sometimes shifts the tax timing favorably.
5. Charitable remainder trust: NQ annuity gain into a CRT eliminates income tax at death; charity gets remainder. Aggressive but legal.

What to do this week if you've just inherited an NQ annuity

• Pull the contract and beneficiary designation form: confirm who the beneficiary is
• Request the cost basis from the carrier (separate from current value)
• Confirm whether the deceased was already annuitizing or in deferral phase
• Calculate your projected tax in both the 5-year-drain and lifetime-stretch scenarios
• Make the lifetime-stretch election inside the 60-day window if it favors you (or even if you're unsure: you can usually switch out of stretch into a partial drain, but you generally cannot switch into stretch once the window passes)
• Don't sign anything the carrier sends until you've modeled the tax outcome

Inherited an annuity? Make the right election before day 60

Independent review of your specific decision.

Non-spouse beneficiaries who default to the 5-year rule often pay 30-40% more tax than necessary. The lifetime-stretch election has a short window: payments must start within 1 year of death, and the payout option should be elected within 60 days after the lump sum becomes payable. Carriers don't always proactively explain this. Get an independent tax-modeled comparison of your 5-year-drain vs lifetime-stretch options before you sign anything.

Weighing this annuity against others? Request a free, independent second opinion on the quote you have before you sign.

First name

Email *

Carrier and approximate contract value

Dollar amount

Send me the read

Hans Goldstein, EA
Admitted to practice before the IRS

Rather talk it through? Or book 15 minutes on Hans’s calendar, or call 213-414-2808.

Hans Goldstein · 213-414-2808 · NPN 20602398, independent licensed insurance producer appointed with multiple A-rated carriers

We’ll email it to you. Hans replies within one business day. Privacy Policy.

Frequently Asked Questions

Related reading

• NQ Deferred Annuity Explained
• Highest Paying MYGA Rate This Week
• MYGA Laddering Strategy
• Annuity vs Life Insurance
• Annuity Commission Disclosure
• Pension Lump Sum vs Monthly

About Hans Goldstein: Independent retirement income specialist. CA Life License #4273294. NPN #20602398. Phone: 213-414-2808. Email: hans@hansgoldstein.com.

Disclosure

This article reflects publicly available product materials, carrier rate sheets, and approximate rates and tax law as of the date stated above. Annuity rates, caps, participation rates, payout factors, crediting methods, commission structures, and pension regulations change frequently. Always confirm current values against the most recent carrier disclosure document, plan summary, and actual contract before making any decision. This is general education, not a personal recommendation or an offer of any product. Hans Goldstein is an independent licensed insurance producer (NPN 20602398) appointed with multiple A-rated carriers across the annuity and long-term care insurance market; producer's specific appointment status with any carrier discussed may vary, and discussion of any carrier is not an endorsement or representation of carrier appointment. No compensation has been received from any carrier in connection with the publication of this article. Always read the actual contract, summary plan description, or pension election form, and consult a licensed advisor and tax professional before purchasing any annuity, accepting a pension election, or executing a rollover. Annuities are long-term contracts with surrender charges and are not suitable for funds you may need before the end of the surrender period. Tax discussion reflects federal tax law as of 2026 and is subject to change. State tax treatment varies. PBGC coverage limits and pension plan termination rules are set by federal statute and may change.