A Lasting Legacy: The Non-Qualified Annuity Stretch Option

A Lasting Legacy: The Non-Qualified Annuity Stretch Option

January 26, 2023

The last thing you want when you receive an inheritance is for it to create new financial burdens. But it can happen. For instance, tax obligations on a lump-sum inheritance can quickly shrink its value and create financial headaches. Or, if you aren’t prepared to manage a large inheritance properly you could mishandle it in a way that gets you into legal trouble. The list goes on.

That’s why it’s so important to try to ensure you choose the right investment vehicle for your inheritance. There are many options, of course, and in this blog, we’re going to focus on one: A stretch option within a non-qualified fixed index annuity (meaning one not set up under a qualified retirement plan such as an IRA or 401k).

A stretch option allows you to "stretch" out the distribution of the annuity over your life expectancy, rather than having to withdraw the entire balance within a certain period. This can help to minimize taxes while also maximizing the potential value of the inheritance and ensuring that the funds last for as long as you need them. But let’s discuss all this in more detail.

What is the difference between a lump-sum and a stretch option?

Anytime you are left an inheritance, you have two options for how to receive it: lump-sum or stretch. There are benefits to both, as well as potential problems. As with any type of investment or financial strategy, the best option for you will depend on your individual goals and situation — and your decision should be considered carefully with the help and guidance of a qualified financial advisor, ideally one who specializes in retirement income.

Benefits of a lump-sum:

  • You get immediate access to the full after-tax value of your inheritance.

Potential problems of a lump sum:

  • The full value is taxed all at once, leaving less for each beneficiary.
  • Some beneficiaries may not be prepared or responsible enough to handle a lump-sum payment.

Benefits of a stretch:

  • The inheritance is parsed out in equal payments over your lifetime.
  • The balance of the account remains tax deferred.
  • Payments continue for as long as a balance continues.
  • If you die before the balance is depleted, you can transfer payments to a child or other contingent beneficiary.

Potential problems of a stretch:

  • There may be fees or penalties for taking early or larger withdrawals.

So, how do you know if a non-qualified annuity with a stretch option is a good strategy for taking your inheritance? Again, there are many questions to consider, and all should be considered with the help and guidance of your advisor. Those questions include the following:

  • Have you examined the tax implications of taking a lump-sum payment and discussed them with your advisor?
  • Do you have a plan for investing the lump sum that is designed to help protect it and grow it over time?
  • Are you worried about how long your inheritance may last?
  • Are you interested in creating a new, more reliable income stream?

Now let’s say you’ve answered these questions with the help of your advisor and you’re leaning toward a decision, but you still have more questions, one of which is: How will my payments be calculated if I choose the stretch option?

How are payments determined on a non-qualified annuity stretch option?

Your annual stretch payment is typically determined by dividing the account value by your life expectancy. That life expectancy factor is calculated using the IRS’s Uniform Single Life Table, which can be found on IRS.gov. Here is an example:

Let’s say you have inherited a $250,000 death benefit that you put into a non-qualified annuity with a stretch provision. Now let’s say you are 55, which means that, according to the IRS Single Life Table, your life expectancy is 31.6 years. After making the calculation, your first annual distribution would be $7,911, and the potential gross total of your distributions over time would be just over $374,000. Plus, if you should die before age 75 and before all the assets are depleted, your child or another contingent beneficiary could receive the payments for the remaining 11.6 years of the “stretch.”

Bear in mind that your stretch payment won’t be the same each year because it gets recalculated based on the change in your life expectancy and the account’s value on December 31 of the previous year. Also, be aware that you may take your stretch payments as installment withdrawals on a monthly, quarterly, or semi-annual basis — so long as the full amount of each annual payment is taken. You may also be able to withdraw additional money from the account each year, although typically you can’t add more money to it.

How can I learn more about the non-qualified annuity stretch option?

So, is that all you need to know about the non-qualified fixed index annuity stretch option? Definitely not! While an annuity can be an ideal option for certain investors depending on their goals and situation, it’s also important to understand that annuities are one of the most varied and complex financial tools available. It’s important for you to not only choose the right kind of annuity but the right specific annuity of that type. That, again, is best done with the help of a qualified professional.

If you're interested in learning more about non-qualified annuities and how they can help you achieve your financial goals, we encourage you to reach out to our team at Chamberlin Financial. We have the experience to help you understand the complex rules and regulations that apply to non-qualified annuities — including those with stretch provisions — and can help you to make the best choices based on your goals, priorities, and situation.