Survivors & Beneficiaries

Generally, a survivor or beneficiary reports pension or annuity income in the same way the plan participant reports it. However, some special rules apply, and they are covered elsewhere in this publication as well as in this section.

Estate tax deduction. You may be entitled to a deduction for estate tax if you receive a joint and survivor annuity that was included in the decedent's estate. You can deduct the part of the total estate tax that was based on the annuity, provided that the decedent died after his or her annuity starting date. (For details, see section 1.691(d)-1 of the regulations.) Deduct it in equal amounts over your remaining life expectancy.

You can take the estate tax deduction as an itemized deduction on Schedule A, Form 1040. This deduction is not subject to the 2%-of-adjusted-gross-income limit on miscellaneous deductions.

Survivors of employees. Distributions the beneficiary of a deceased employee gets may be accrued salary payments, distributions from employee profit-sharing, pension, annuity, or stock bonus plans, or other items. Some of these should be treated separately for tax purposes. The treatment of these distributions depends on what they represent.

Salary or wages paid after the death of the employee are usually the beneficiary's ordinary income. If you are a beneficiary of an employee who was covered by any of the retirement plans mentioned, you can exclude from income nonperiodic distributions received that totally relieve the payer from the obligation to pay an annuity. The amount that you can exclude is equal to the deceased employee's investment in the contract (cost).

If you are entitled to receive a survivor annuity on the death of an employee, you can exclude part of each annuity payment as a tax-free recovery of the employee's investment in the contract. You must figure the tax-free part of each payment using the method that applies as if you were the employee. For more information, see Taxation of Periodic Payments, earlier.

If the employee died before August 21, 1996, you increase the amount of the employee's investment in the contract by the death benefit exclusion. Use the increased amount to figure the tax-free part of payments you receive from the employee's retirement plan. For information about the death benefit exclusion, see Publication 939.

Survivors of retirees. Benefits paid to you as a survivor under a joint and survivor annuity must be included in your gross income. Include them in income in the same way the retiree would have included them in gross income. See Partly Taxable Payments under Taxation of Periodic Payments, earlier.

If the retiree reported the annuity under the Three-Year Rule and had recovered all of his or her cost before death, your survivor payments are fully taxable.

If the retiree was reporting the annuity under the General Rule, you must apply the same exclusion percentage to your initial survivor annuity payment called for in the contract. As discussed in Publication 939, the resulting tax-free amount will then remain fixed. Increases in the survivor annuity are fully taxable.

If the retiree was reporting the annuity under the Simplified Method, the part of each payment that is tax free is the same as the tax-free amount figured by the retiree at the annuity starting date. See Simplified Method under Taxation of Periodic Payments, earlier.

Guaranteed payments. If you receive guaranteed payments as the decedent's beneficiary under a life annuity contract, do not include any amount in your gross income until your distributions plus the tax-free distributions received by the life annuitant equal the cost of the contract. All later distributions are fully taxable. This rule does not apply if it is possible for you to collect more than the guaranteed amount. For example, it does not apply to payments under a joint and survivor annuity.

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