Naming a Trust as an Annuity's Beneficiary: What Changes at Death

Owner versus beneficiary

Whether a trust should own a deferred annuity during life is governed by IRC § 72(u) and covered on its own page. This page answers a separate question: you own the annuity individually, and you have named — or are considering naming — a trust as the beneficiary who receives it at your death. People do this for good reasons: to control how the money reaches a young or vulnerable heir, or to hold it in a special-needs or spendthrift trust. The trade-off is on the tax side, and it is worth seeing clearly first.

The gain is income in respect of a decedent — no step-up

A deferred annuity holds untaxed gain: the difference between its value and what was paid in has never been taxed. At the owner’s death, that gain does not vanish and it does not get a fresh start. It is income in respect of a decedent (IRD) under IRC § 691 — income the decedent had earned but not yet recognized — and whoever receives it (the trust, and ultimately the beneficiaries) is taxed on it as ordinary income as it comes out.

Critically, IRD does not receive the date-of-death basis step-up that most inherited assets get. Section 1014, which resets basis to date-of-death value, expressly does not apply to a right to receive an item of income in respect of a decedent (IRC § 1014(c)). So unlike an inherited brokerage account or house, the annuity’s gain is fully taxable to the recipient. (A partial offset exists: if the annuity value was also subject to estate tax, the recipient may claim an income-tax deduction for the estate tax attributable to the IRD under § 691(c) — relevant mainly to taxable estates.)

The §72(s) distribution rules

A non-qualified annuity has its own post-death payout rules in IRC § 72(s) — the annuity analog to the required-distribution rules for retirement accounts. If the owner dies before the annuity starting date, the default is stark: the entire interest must be distributed within five years of death (§ 72(s)(1)(B)).

The statute provides one escape from the five-year rule. If the death benefit is payable to a designated beneficiary, it may instead be paid over that beneficiary’s life or life expectancy, beginning within one year of death (§ 72(s)(2)) — the “stretch.” A surviving spouse who is the beneficiary can go further and simply continue the contract as the new owner (§ 72(s)(3)). The entire question, then, is whether the trust qualifies as a “designated beneficiary.”

Why a trust usually isn’t a “designated beneficiary”

For § 72(s), a designated beneficiary means any individual designated as a beneficiary by the holder (§ 72(s)(4)). A trust is not an individual. On the face of the statute, then, naming a trust as the annuity’s beneficiary means the life-expectancy stretch of § 72(s)(2) is unavailable, and the five-year rule applies — the gain must come out, and be taxed as ordinary income, within five years of death.

Some insurers will administer a “see-through” or look-through approach for a trust that meets certain conditions, borrowing from the retirement-account rules, but § 72(s) itself does not contain the see-through trust regime that the retirement-account regulations do. Whether a given carrier will stretch to the underlying trust beneficiaries is a contract-and-administration question, not a statutory guarantee — which is exactly why this should be confirmed with the carrier, in writing, before relying on it.

How this differs from an inherited IRA

It is easy to conflate this with the retirement-account rules, and they are genuinely different regimes. Inherited IRAs and 401(k)s are governed by IRC § 401(a)(9), which the SECURE Act rewrote into a ten-year rule for most non-spouse beneficiaries and which has a developed see-through-trust regulation. Non-qualified annuities are governed by § 72(s), with its five-year default and its narrower individual-only definition of a designated beneficiary. Advice built for one does not automatically hold for the other. We cover the retirement-account side — inherited IRAs, the ten-year rule, and when a trust beneficiary makes sense there — in the retirement-account planning cluster as it ships.

Sources & methodology