Advanced Underwriting Consultants

Ask the Experts – May 30

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client’s mother passed away on July 10, 2009. My client inherited her mother’s nonqualified annuity but has failed to take any distributions from it since she inherited it. Is it too late to make a stretch election, or must she fully distribute the annuity within 5 years? What are the penalties if she fails to fully liquidate the annuity within 5 years?

Answer: There are multiple issues, but we’ll start with the basic rule. Under Code Section 72(s), an inherited annuity must either be stretched based on the life of the beneficiary or fully distributed within 5 years.

First, it’s not clear when the 5-year period starts. The language in the tax code indicates that the beneficiary must withdraw all the funds by fifth anniversary of the original owner’s death, which would be July 10, 2014 for your client. However, some carriers might interpret this rule to mean 5 years from the end of the year in which the person died—December 31, 2014, for your client. Therefore, your client should has until July 10, 2014, to fully distribute the annuity, but she should check with the carrier first.

Assuming the carrier interprets the 5-year rule to be from the date of death, your client will have no choice but to liquidate the annuity by July 10, 2014, because that’s written in the annuity contract. That is, the life insurance company will distribute the funds from the nonqualified annuity by July 10 whether your client wants the money or not.

Finally, your client must have elected to stretch within one year from her mother’s death, which was on July 10, 2010, if she wanted to stretch out the nonqualified annuity payments based on her life expectancy. Unlike with IRAs, there are no exceptions.

The tax code is not clear as to the timing of distributions when a beneficiary elects to stretch. Section 72(s) only requires that the annuity be distributed “over the life of such designated beneficiary,” so it’s best to check with the carrier to figure out how it handles these types of elections.

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