A daughter who inherits her father’s $300,000 annuity faces tax on its $150,000 growth, even as his home receives a new basis. He funded the contract with after-tax savings, and the balance doubled before his death.
The father dies in 2026, leaving the assets to his 60-year-old daughter. He bought the house for $120,000, and it is worth $420,000 when he dies.
Section 1014 generally resets inherited property’s basis to its fair market value on the owner’s date of death. The daughter’s basis in the house becomes $420,000, so a sale at that price produces no gain in the example.
The contract follows a different rule. Subsection (c) excludes a right to income in respect of a decedent from the basis adjustment, while Section 691(a) assigns that income to the person who acquires the right through the owner’s death.
Inherited annuity beneficiaries have a one-year window for life-expectancy payments
Beneficiaries choosing life-expectancy payments must begin them within one year of the contract holder’s death or lose that option. Heirs younger than 59½ do not owe the 10% early-withdrawal penalty on an inherited contract.
The payout schedule affects when a beneficiary receives the taxable earnings. It does not turn those earnings into property eligible for a basis reset.
A basis reset covers appreciated property but not income-producing inheritances
The same dividing line applies to other assets. Appreciated property can receive a new basis, while several retirement and deferred-income assets do not.
| Inherited asset | Treatment described in the tax rules |
|---|---|
| Appreciated stocks, brokerage holdings and real estate | Basis generally resets to fair market value at death |
| Family-business interests and collectibles | Can receive the basis adjustment |
| Traditional IRAs, 401(k)s, annuities, pensions, deferred compensation and unpaid wages | No step-up; payments or withdrawals are taxable income |
The annuity returns the father’s original contributions tax-free as his investment in the contract. Its growth is income in respect of a decedent, taxed at ordinary rates that reach 37%.
A nonqualified annuity uses money that has already been taxed. An exclusion ratio divides each payment between returned principal and earnings, with tax applying to the earnings portion. A beneficiary who cashes out receives a Form 1099-R reporting the taxable amount.
Qualified contracts funded with IRA or retirement-plan money work differently because the original contributions were pre-tax. In that case, 100% of each payment is taxable.
The 2026 lump-sum example produces a $40,876 federal tax bill
For tax year 2026, filed in 2027, the example assumes the daughter files single and earns $106,100 in wages. After a $16,100 standard deduction, her taxable income is $90,000 and her federal tax is $14,512 before the annuity payout.
Adding the contract’s taxable growth brings her taxable income to $240,000. The additional dollars fill the 22% and 24% brackets; income above $201,775 falls in the 32% bracket under the example’s assumptions.
The calculation also includes the 3.8% net investment income tax. The annuity earnings count toward net investment income, and modified adjusted gross income of $256,100 exceeds the $200,000 threshold for a single filer.
Taking the taxable amount at once produces a federal tax bill of $40,876 in the illustration. Spreading withdrawals over five years lowers that amount by $6,446. The figures depend on the stated wages and filing status.
Period-certain contracts can leave heirs the remaining scheduled checks
An income annuity with a period-certain guarantee can continue paying beneficiaries when its owner dies before the guaranteed period ends. A $300,000 contract bought at age 70 with a 10-year guarantee leaves children the checks still scheduled if the owner dies before age 80. If the guarantee has expired, payments end at death.
Personal finance expert Suze Orman described the tax treatment of inherited growth this way:
“will have to pay ordinary income tax on any money that they have inherited above what you originally put in”
Payments added to an heir’s wages can place some income in the 22% to 24% federal brackets. The cited estimate puts the tax as high as $2,400 for every $10,000 received.
Date-of-death records and appraisals establish the value used for inherited property
The executor or family establishes each asset’s fair market value on the date of death. Brokerages can provide date-of-death statements within a few weeks of a request. Real estate calls for a formal appraisal because that value becomes the basis for later calculations.
An estate facing estate tax may elect an alternate valuation six months after death. The elected value then sets the heirs’ basis. The federal estate exemption stands at $15 million per person in 2026 under current law.
The holding period also resets, making inherited assets long-term in the heir’s hands even if sold soon after the inheritance. Assets transferred during the owner’s lifetime generally retain the giver’s original basis instead.
New Jersey applies a “half step-up” when a spouse dies: only the deceased spouse’s share steps up. Community-property states step up both halves.
LIMRA forecast strong annuity sales in 2026 after a record year
LIMRA’s U.S. Individual Annuity Sales Survey recorded $464.1 billion in U.S. sales in 2025, up 7% from the prior year. Single premium immediate annuities, which exchange a lump sum for scheduled payments, rose 6% to $14.4 billion; these products are often paired with a period-certain guarantee.
In March 2026, Bryan Hodgens, then head of LIMRA research, said 4.1 million Americans turn 65 each year and many lack pensions or other income for basic expenses. LIMRA forecast strong annuity sales in 2026 despite expected economic weakness.
This article is for informational purposes only and does not constitute tax advice. Consult a qualified tax professional or CPA about your specific situation.
