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 generally 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 deduction under § 691(c) is available only if federal estate tax was attributable to that IRD — a partial offset relevant mainly to taxable estates. The annuity contract and carrier may also impose payout options that are more restrictive than the federal outer limits.

The § 72(s) distribution rules

This discussion is expressly limited to nonqualified annuity contracts, which have their own post-death payout rules in IRC § 72(s). If the holder of a nonqualified annuity dies after the annuity starting date, remaining payments must continue at least as rapidly as under the distribution method in effect at death (§ 72(s)(1)(A)). If death occurs before the annuity starting date, the remaining interest generally must be distributed within five years (§ 72(s)(1)(B)), subject to the designated-individual and surviving-spouse rules in IRC § 72(s)(2)–(3). A trust is not itself an individual for that statutory exception. An annuity held inside an IRA or employer retirement plan is governed principally by IRC § 401(a)(9) and the qualified-account rules, not § 72(s) alone.

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