My two sons will inherit a $30,000 annuity from their grandmother. What should I do with the money?

By Quentin Fottrell

'My understanding is that they have five years to withdraw the money'

"My understanding is that they have five years to withdraw the money." (Photo subjects are models.)

Dear Quentin,

My two adult sons are the listed beneficiaries of a small annuity (about $30,000 remaining) that my recently deceased mother left. My understanding is that they have five years to withdraw the money. They will likely take a lump sum now since the amount isn't very large, but I just wanted to be clear on their options. I will suggest that they check whether taking the lump sum would bump them into a higher tax bracket.

Any other thoughts or advice?

The Parent

Don't miss: 'We own our home outright': I am 67 and earn $100,000. Do I take my $30,000-a-year Social Security now or wait?

You can email The Moneyist with any financial and ethical questions at qfottrell@marketwatch.com.

By emailing your questions to the Moneyist or posting your dilemmas on the Moneyist Facebook group, you agree to have them published anonymously on MarketWatch. The Moneyist regrets he cannot reply to questions individually.

In most cases, a straightforward inheritance - cash, annuities, stocks or real estate - does not count as taxable income when received.

Dear Parent,

There's a lot your sons can do with $30,000, but let's address your concerns first.

In most cases, simply inheriting money - whether cash, stocks, real estate or annuities - doesn't count as taxable income when it's received. So, your sons wouldn't automatically jump into a higher federal tax bracket just by receiving the inheritance. That said, certain inherited assets can generate taxable income when sold or withdrawn, which could increase taxes in a given year.

For annuities, the tax rules depend on how they were funded. For non-qualified annuities (funded with after-tax dollars) only the earnings are taxed when withdrawn; the original investment comes back tax-free. Qualified annuities (funded with pre-tax dollars) are taxed as ordinary income when withdrawn. Taxes are due when the money is taken out, not at the time of death. So a lump-sum withdrawal could bump up the taxes for that year.

As Annuity.org explains: "An annuity is a contract between an owner and an insurance company. When the owner dies, the insurer pays the remaining value to the beneficiary. What happens next depends on whether the annuity was still growing (a deferred annuity) or already paying income (an income annuity), as well as the rules set by the IRS and the contract itself." You can read more here.

Related: 'It seems too good to be true': At a steak-dinner retirement seminar, the guy said annuities can outperform the market. Is that true?

The five-year rule

Here's the good news: Federal estate taxes won't be an issue here. They only apply to very large estates and are paid by the estate itself, not the beneficiaries. A $30,000 annuity is well below any threshold, so no estate-tax filing or payment is required. Withdrawals are taxed as ordinary income, but they generally aren't subject to the 3.8% net investment income tax, which mostly applies to other investment income.

Under the five-year rule, most annuities must be withdrawn within five years of the owner's death. Some contracts, however, let beneficiaries take distributions over their life expectancy. This can help manage taxes, although with $30,000, the difference may be modest. Ultimately, the annuity contract determines what options are available. Unlike spouses, non-spouse beneficiaries usually have limited flexibility and can't continue the annuity as their own.

If your sons - or other Moneyist readers - inherited a pre-tax retirement account, like a traditional IRA or 401(k), withdrawals would also be taxed as ordinary income. Most non-spouse beneficiaries must withdraw the entire balance within 10 years, which could push them into a higher tax bracket. Roth IRAs, by contrast, allow tax-free withdrawals, though the 10-year rule still applies.

Related: 'We are comfortable financially': My husband is in his 60s and has $500,000 life insurance. Is this a good time to cancel?

What to do next

Once they receive the funds, there are a few options. Your sons could place the funds in high-yield savings accounts or certificates of deposit, which offer competitive yields of up to 4.20%. Savings-account withdrawal limits are now set by individual banks rather than federal regulation, so terms will vary. CDs offer predictable returns for a fixed term, good for people with a low risk tolerance, while high-yield savings accounts provide more liquidity.

Inherited annuities generally cannot be rolled into an inherited IRA, however. In limited cases, a 1035 exchange may allow a beneficiary to transfer an inherited annuity to another annuity contract with better terms without triggering an immediate "taxable event," but availability depends on the insurer and, of course, the contract.

Beyond investments, your sons could use the inheritance to improve their overall financial health: contributing to retirement plans at work, paying down high-interest debt, building an emergency fund, investing through a brokerage account, or even putting it toward education or travel. At $30,000, there's plenty of room to make it meaningful. Money is to be invested, saved and enjoyed. It's a lifelong balance act.

Don't miss: I'm a senior who barely survives on $1,300 a month. No way could I live on $1,000.

Check out the Moneyist private Facebook group, where members help answer life's thorniest money issues. Post your questions, or weigh in on the latest Moneyist columns.

Previous columns by Quentin Fottrell:

'I'm a realist': I'm 50 with $6.5 million saved. Should I quit my $200,000 job and retire early?

My mother was co-owner of my late grandmother's bank account. Should she share the money with her siblings?

I inherited a $500,000 IRA. Can I reduce the tax burden by using it for my children's education?

By emailing your questions to the Moneyist or posting your dilemmas on the Moneyist Facebook group, you agree to have them published anonymously on MarketWatch.

-Quentin Fottrell

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

06-21-26 1000ET