2026 Annuity Estate Tax Planning After the TCJA Exemption Sunset: How the Drop to ~$7 Million Changes Annuity Strategy

Key Takeaways

• The 2026 federal estate tax exemption is approximately $7 million per individual ($14 million per married couple), down from $13.61 million in 2024—the exemption is inflation-adjusted but permanently reduced by the TCJA sunset
• Annuities are uniquely vulnerable to estate tax because tax-deferred growth compounds the contract value without any offsetting basis adjustment at death, unlike appreciated stocks which receive a step-up in basis
• The estate tax rate on amounts above the exemption is 40% federal, plus applicable state estate taxes that can add another 10–20% in states like Oregon, Washington, and Minnesota
• Annuity ownership structure determines estate tax exposure—annuities owned by the insured are included in the taxable estate, while annuities owned by an Irrevocable Life Insurance Trust (ILIT) or gifted during life may be removed entirely
• Beneficiary designation traps can cause catastrophic tax results—naming “my estate” as annuity beneficiary forces the contract through probate and exposes the full value to estate tax and creditors
• Qualified and non-qualified annuities face different estate tax treatment: qualified annuities (IRA/401k) are always included in the gross estate, while non-qualified annuities are included only if the decedent owned the contract or retained incidents of ownership

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What Changed: The TCJA Estate Tax Exemption Sunset

The Tax Cuts and Jobs Act (TCJA), passed in December 2017, doubled the federal estate and gift tax exemption from roughly $5.6 million to $11.18 million per individual. However, the law included a critical sunset provision: the doubled exemption was temporary and scheduled to revert to pre-TCJA levels (adjusted for inflation) after December 31, 2025.

That sunset has now taken effect. In 2026, the federal estate and gift tax exemption is approximately:

• $7,000,000 per individual (inflation-adjusted estimate for 2026)
• $14,000,000 per married couple (via portability, which allows a surviving spouse to use the deceased spouse’s unused exemption)

This represents a reduction of nearly $6.6 million per person compared to the 2024 exemption of $13.61 million. The practical impact is enormous: estates that were safely below the exemption threshold in 2024 may now be subject to a 40% federal estate tax on every dollar above $7 million.

The 40% Estate Tax Math

Federal estate tax rates above the exemption threshold are steep:

• Estate value at or below $7 million (individual): $0 federal estate tax
• Every dollar above $7 million: taxed at 40%

For example, an estate worth $10 million in 2026 faces federal estate tax of approximately $1.2 million ($10M - $7M = $3M taxable × 40% = $1.2M). In 2024, that same $10 million estate would have owed $0 because it was below the $13.61 million threshold.

This is why the sunset has created an urgent planning crisis—especially for annuity owners whose contracts have grown significantly through tax-deferred compounding.

Why Congress Did Not Act

Despite multiple legislative proposals to extend the higher TCJA exemption, Congress allowed the sunset to proceed. The revenue cost of maintaining the doubled exemption was projected at over $300 billion over ten years, and the political consensus to extend simply did not materialize. While future legislation could potentially raise the exemption retroactively, estate planning professionals universally advise planning under current law rather than hoping for a retroactive fix.

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Why Annuities Are Uniquely Affected by Estate Tax

Annuities present a distinctive problem in estate tax planning that other assets do not share. Understanding these differences is essential for anyone with significant annuity value.

Problem 1: Tax-Deferred Growth Inflates Estate Value

When you hold appreciated stocks or real estate in a taxable account and pass away, your heirs receive a step-up in cost basis to the fair market value at the date of your death. This eliminates all capital gains tax on the appreciation during your lifetime.

Annuities do not receive a step-up in basis. Worse, the accumulated tax-deferred growth inside the annuity actually increases your taxable estate. Here’s why:

• You purchased a non-qualified annuity for $300,000 fifteen years ago
• Through tax-deferred growth, the contract is now worth $800,000
• At your death, the full $800,000 is included in your gross estate
• Your beneficiary receives the annuity and owes ordinary income tax on the $500,000 gain (the difference between $800,000 value and $300,000 basis)
• If your estate exceeds the $7 million exemption, the annuity value also triggers 40% federal estate tax on the portion above the threshold

This creates a devastating double tax: estate tax on the full value, then income tax for the beneficiary on the gains. This is often called the “annuity double tax trap” in estate planning circles.

For more on how inherited annuity taxation works, see our comprehensive guide to inherited annuity tax rules for beneficiaries in 2026.

Problem 2: No Step-Up in Basis

Unlike appreciated securities, annuity contracts carry their original cost basis forward to beneficiaries. If you invested $200,000 and it grew to $700,000, your beneficiary inherits the $200,000 basis. Every dollar of the $500,000 gain is taxed as ordinary income when the beneficiary takes distributions—not as capital gains, which would receive preferential lower rates.

This means annuities are the only major asset class where heirs simultaneously face estate tax (on the full contract value) and ordinary income tax (on the growth portion). Life insurance death benefits, by contrast, are completely income-tax-free and generally estate-tax-free if properly structured.

Problem 3: Forced Liquidation Risk

When an estate owes federal estate tax, the tax is generally due within nine months of the date of death. Annuities are illiquid by nature—especially during the surrender charge period. If a significant portion of the estate’s value is tied up in annuities, the executor may be forced to:

• Surrender the annuity (triggering surrender charges)
• Pay ordinary income tax on the surrendered gains
• Use the reduced proceeds to pay the estate tax

This forced liquidation cascade can destroy 50–60% of the annuity’s value in combined surrender charges, income tax, and estate tax—before any assets reach the intended beneficiaries.

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Annuity Ownership Structures and Estate Tax Exposure

How an annuity is owned matters more than almost any other factor in determining whether it will be subject to estate tax. The same annuity contract can be included in or excluded from the taxable estate depending entirely on the ownership arrangement.

Structure 1: Individual Ownership (Most Common, Most Exposed)

When you own an annuity in your own name, the full death benefit value is included in your gross estate. This is true regardless of who the beneficiary is. Even if you name your children as beneficiaries, the annuity value counts toward your estate tax calculation.

Estate tax exposure: Full contract value included in taxable estate.

Best for: Estates well below the $7 million exemption threshold where estate tax is not a concern.

Structure 2: Joint Ownership with Spouse

When spouses own an annuity jointly (joint tenants with rights of survivorship), the entire value is included in the estate of the first spouse to die. However, the unlimited marital deduction allows all assets passing to a U.S. citizen spouse to be completely free of federal estate tax at the first death.

This defers the estate tax until the second spouse’s death, at which point the full value is included in the surviving spouse’s estate. Portability allows the surviving spouse to use the deceased spouse’s unused exemption, effectively giving a married couple a combined $14 million exemption.

Estate tax exposure: Deferred until second death, then full value included.

Best for: Married couples whose combined estate is below $14 million.

Structure 3: ILIT-Owned Annuity

An Irrevocable Life Insurance Trust (ILIT) is a trust designed to own insurance and annuity contracts outside the grantor’s taxable estate. When an annuity is owned by a properly structured ILIT:

• The annuity value is not included in your gross estate
• The death benefit passes to trust beneficiaries free of federal estate tax
• The trust controls how distributions are made to beneficiaries

However, transferring an existing annuity to an ILIT constitutes a completed gift, which means the annuity’s fair market value uses part of your lifetime gift tax exemption. If the annuity is worth $800,000, that’s $800,000 of your $7 million lifetime exemption consumed.

Estate tax exposure: None, if properly structured and the three-year lookback rule is satisfied (see below).

Best for: High-net-worth individuals whose estates exceed the $7 million exemption.

The Three-Year Lookback Rule

Under IRC Section 2035, if you transfer an annuity or life insurance policy to an ILIT (or any third party) and die within three years of the transfer, the annuity’s value is pulled back into your taxable estate. This anti-abuse rule prevents deathbed transfers.

After three years, the transfer is “clean” and the annuity is permanently outside your estate. This makes early action critical—the sooner you transfer, the sooner the three-year clock expires.

Structure 4: Gifting Annuities During Life

You can gift an annuity contract to another person during your lifetime, which removes the contract from your estate. However, this carries significant consequences:

• The gift uses your lifetime gift tax exemption (currently $7 million in 2026)
• If the annuity has unrealized gains, you (the donor) may still owe income tax on the gains at the time of transfer—the IRS treats certain annuity gifts as taxable assignments
• The recipient takes your original cost basis, meaning they’ll owe ordinary income tax on all gains when they eventually take distributions
• Once gifted, you lose all control over the contract

Gifting annuities is rarely the most efficient strategy compared to ILIT ownership or 1035 exchanges, but it can make sense in specific situations where the annuity has minimal gains or where the donee is in a much lower tax bracket.

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Strategies to Reduce Annuity Estate Tax Exposure

Strategy 1: 1035 Exchange Into a Life Insurance Policy Held in an ILIT

A Section 1035 exchange allows you to exchange an annuity contract for a life insurance policy without recognizing gain on the annuity. While you cannot exchange an annuity directly into a life insurance policy that you own (the IRC only permits life-to-annuity, not annuity-to-life exchanges), you can exchange the annuity into a different annuity and then use distributions from that annuity to fund premiums on a life insurance policy owned by an ILIT.

Here’s the strategy:

1. 1035 exchange your existing annuity into a lower-cost annuity with better withdrawal terms (this preserves tax deferral)
2. Take systematic withdrawals from the new annuity
3. Gift the withdrawals to an ILIT (using your $19,000 annual gift exclusion per recipient in 2026)
4. The ILIT uses the gifts to pay premiums on a permanent life insurance policy
5. At death, the life insurance death benefit passes to beneficiaries completely income-tax-free and estate-tax-free

This effectively converts a taxable annuity (included in your estate) into tax-free life insurance proceeds (excluded from your estate). The math works best when the annuity has substantial value and the insured is in reasonably good health.

For a detailed walkthrough of the exchange process, see our guide to 1035 exchange annuity tax rules for 2026.

Strategy 2: Annuitize to Reduce Estate Value

When you annuitize a contract—converting the lump sum into a guaranteed stream of lifetime income—the remaining contract value typically drops to zero at death (unless you select a period-certain or refund feature). This means:

• The annuity’s lump sum value is removed from your estate
• Only the present value of remaining guaranteed payments (if any) is included
• You receive guaranteed income for life, which can be used for living expenses or to fund other estate planning strategies

Caveat: Annuitization is irrevocable. Once you annuitize, you cannot access the principal. Select a joint-and-survivor option if you want payments to continue to your spouse. See our guide on joint and survivor annuity household planning for how this works.

Strategy 3: Roth Conversion of Qualified Annuities

If you own a qualified annuity (inside an IRA or 401(k)), converting it to a Roth IRA removes the future growth from your taxable estate. You pay income tax now on the conversion, but:

• All future growth is tax-free
• Roth IRAs have no required minimum distributions
• The Roth IRA value is still included in your estate, but the income tax prepayment reduces your estate’s overall value
• Beneficiaries inherit the Roth tax-free (subject to the 10-year distribution rule under SECURE Act 2.0)

This is especially powerful in 2026 because tax rates may be lower now than in future years if additional TCJA provisions sunset or if new tax legislation is enacted. See our full annuity Roth conversion strategy guide for 2026.

Strategy 4: Spousal Planning and QTIP Trusts

For married couples, several advanced strategies can minimize estate tax exposure on annuities:

Credit Shelter Trust (Bypass Trust) Funding: At the first spouse’s death, assets up to the exemption amount ($7 million in 2026) can be placed in a bypass trust for the surviving spouse. The trust assets are not included in the surviving spouse’s estate, even though the spouse can receive income from the trust. Annuities can be used to fund the trust’s income requirements.

QTIP Trust with Annuity Payments: A Qualified Terminable Interest Property (QTIP) trust can receive annuity payments for the surviving spouse’s lifetime, with the remainder passing to children from a prior marriage or other beneficiaries. The QTIP election provides the marital deduction (deferring estate tax), while ensuring the annuity assets ultimately go where the deceased spouse intended.

Second-to-Die Planning: Because portability gives married couples a combined $14 million exemption, many couples don’t face estate tax until the second spouse dies. Planning should focus on the surviving spouse’s estate, which will include all jointly held annuities plus any annuities inherited from the first spouse.

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Beneficiary Designation Traps for Annuity Owners

How you designate beneficiaries on your annuity contracts can have enormous tax consequences. The following are the most common—and most costly—mistakes.

Trap 1: Naming “My Estate” as Beneficiary

Naming your estate as the annuity beneficiary is almost always a mistake. This forces the annuity through probate, exposes the full value to creditors, and guarantees that the contract is included in your taxable estate. It also eliminates the ability of beneficiaries to use the “stretch” or “5-year rule” distribution options available under SECURE Act 2.0.

Trap 2: Failing to Name a Contingent Beneficiary

If your primary beneficiary predeceases you and you haven’t named a contingent beneficiary, the annuity typically reverts to your estate by default—triggering all the problems described above. Always name both primary and contingent beneficiaries on every annuity contract.

Trap 3: Naming a Minor Directly

Minors cannot legally inherit annuity proceeds directly. If you name a minor as beneficiary, the court will appoint a guardian to manage the funds—often at significant cost and with court oversight that may not align with your wishes. Instead, name a trust for the minor’s benefit, or use a Uniform Transfers to Minors Act (UTMA) custodian.

Trap 4: Not Coordinating with Overall Estate Plan

Your annuity beneficiary designations override your will. If your will says “split everything equally among my three children” but your annuity beneficiary designation names only one child, the annuity goes to the one child named. Review all beneficiary designations every 2–3 years, especially after major life events (marriage, divorce, birth of children, death of a beneficiary).

For a comprehensive look at how annuity beneficiary rules have changed under recent legislation, see our guide on SECURE Act 2.0 annuity tax changes for 2026.

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Qualified vs. Non-Qualified Annuity Estate Tax Differences

The type of annuity you own fundamentally affects how it is treated for estate tax purposes.

Qualified Annuities (Inside IRA, 401(k), 403(b))

Qualified annuities are always included in your gross estate at their full fair market value on the date of death. There is no way to exclude a qualified annuity from your estate while you are alive and still own the underlying account. The only strategies are:

• Roth conversion (pay tax now, remove future growth from estate)
• Distribution and gifting (withdraw funds, pay tax, gift the after-tax proceeds)
• Transfer to a trust (uses lifetime gift exemption)

Additionally, qualified annuities create a separate problem: the beneficiary who inherits the account will owe ordinary income tax on every dollar (since all contributions were pre-tax). This is the worst-case scenario for beneficiaries—they face both estate tax (if the estate is over the exemption) and income tax on the inherited balance.

Non-Qualified Annuities (Purchased with After-Tax Dollars)

Non-qualified annuities are included in the taxable estate if:

• The decedent owned the contract at the time of death
• The decedent retained incidents of ownership (the right to change beneficiaries, surrender the contract, or assign the policy)
• The annuity was payable to the decedent or their estate

If the annuity was owned by someone else (such as an ILIT) and the deceased had no ownership rights, the annuity is not included in the gross estate. This is why transferring non-qualified annuities to an ILIT during life (and surviving the three-year lookback period) is such a powerful strategy.

The beneficiary of a non-qualified annuity also faces ordinary income tax—but only on the gain portion (the difference between the contract value and the original cost basis). The cost basis passes to the beneficiary tax-free.

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State Estate Tax Overlay

Even if your estate is below the federal $7 million exemption, state estate taxes can still apply. Twelve states and the District of Columbia levy estate or inheritance taxes, and many have thresholds far lower than the federal exemption.

States with the Lowest Estate Tax Thresholds (2026)

• Oregon: $1 million exemption — estates above this amount face rates up to 16%
• Massachusetts: $1 million exemption — rates up to 16%
• Minnesota: $3 million exemption — rates up to 16%
• New York: $6.94 million exemption (inflation-adjusted) — rates up to 16%, with a unique “cliff” provision that taxes the entire estate if you exceed the threshold by even $1
• Washington: $2.193 million exemption — rates up to 20% (highest in the nation)
• Illinois: $4 million exemption — rates up to 16%
• Hawaii: $5.49 million exemption — rates up to 20%
• Vermont: $5 million exemption — rates up to 16%
• District of Columbia: $4.761 million exemption — rates up to 16%
• Maine: $6.41 million exemption — rates up to 12%
• Connecticut: $9.1 million exemption — rates up to 12%

The State Tax Double Punch on Annuities

For annuity owners in low-threshold states like Oregon or Massachusetts, the state estate tax can apply even when the federal estate tax does not. An Oregon resident with a $1.5 million estate (including a $600,000 annuity) pays no federal estate tax but faces Oregon estate tax of roughly $50,000–$80,000 because the estate exceeds the $1 million state threshold.

This means annuity owners in these states need to plan for two layers of estate taxation simultaneously. Strategies that work for federal estate tax reduction (ILIT ownership, gifting) also reduce state estate tax exposure, but the lower state thresholds mean you need to act sooner—often when your estate is well below the federal exemption.

Six states also levy inheritance taxes (Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania), which are paid by the recipient rather than the estate. Annuity proceeds passing to non-spouse beneficiaries in these states may trigger inheritance tax at rates of 4–18%, depending on the relationship between the deceased and the beneficiary.

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Action Items for Annuity Owners

If Your Estate Is Above the $7 Million Exemption (Individual) or $14 Million (Married)

You face federal estate tax exposure and need to take immediate action:

1. Inventory all annuity contracts: List every annuity you own, including current value, cost basis, ownership structure, and beneficiary designations. Note whether each is qualified or non-qualified.

2. Calculate your total gross estate: Include all assets—annuities, retirement accounts, real estate, investments, life insurance death benefits, business interests, and any other significant holdings.

3. Consult an estate planning attorney immediately: The strategies available to you (ILIT funding, gifting, 1035 exchanges, GRATs, charitable trusts) all require professional implementation. Time-sensitive rules like the three-year lookback for insurance transfers mean delaying even one year can be costly.

4. Transfer annuities to an ILIT before health declines: If you’re insurable, the ILIT-with-life-insurance strategy is one of the most efficient ways to convert taxable annuity value into tax-free death benefits. The sooner you act, the lower the life insurance premiums and the sooner the three-year clock starts.

5. Consider annuitizing contracts you don’t need for liquidity: Annuitization removes the lump-sum value from your estate while providing guaranteed lifetime income. This is particularly effective for older annuity contracts that have passed the surrender period.

6. Review spousal portability elections: If one spouse has already died, ensure the surviving spouse filed Form 706 to preserve portability of the deceased spouse’s exemption—this doubles your available exemption to $14 million.

If Your Estate Is Below the Exemption But Above $3–5 Million

You’re safe from federal estate tax but may be exposed to state estate taxes depending on where you live:

1. Check your state’s estate tax threshold: If you live in Oregon, Massachusetts, Washington, Minnesota, or any state with a threshold below $5 million, your estate could face state-level taxation even without federal exposure.

2. Focus on beneficiary designations: Ensure all annuity contracts have proper primary and contingent beneficiaries—never name “my estate.”

3. Consider partial Roth conversions: Converting qualified annuity funds to a Roth IRA reduces future estate value by pre-paying the income tax, and the conversion itself uses up taxable income in years when your bracket is lower.

4. Review annuity contracts for performance: If you’re holding older annuities with poor terms, a 1035 exchange can improve returns without triggering tax—locking in better rates while you’re still healthy enough to qualify for life insurance if needed later.

5. Document everything for your executor: Create a comprehensive annuity inventory with contract numbers, insurance company contact information, beneficiary designations, and cost basis records. This prevents delays and errors when settling your estate.

If Your Estate Is Below $3 Million

Your primary concern is income tax optimization for beneficiaries, not estate tax:

1. Ensure beneficiaries understand their options: Under SECURE Act 2.0, most non-spouse beneficiaries must fully distribute inherited annuities within 10 years. See our inherited annuity tax rules guide for distribution strategies.

2. Consider converting to Roth before death: If you can afford the tax, converting qualified annuities to Roth during your lifetime means beneficiaries inherit the funds completely tax-free.

3. Review beneficiary designations every 2–3 years: Life changes—marriages, divorces, deaths, births—can make old beneficiary designations obsolete.

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Spousal Annuity Estate Planning: Second-to-Die Strategy

For married couples, the combined $14 million exemption (via portability) means estate tax typically bites at the second death, not the first. This creates a unique planning window.

The First-to-Die Planning Opportunity

When the first spouse dies, the unlimited marital deduction allows all assets—including annuities—to pass to the surviving spouse with zero federal estate tax. However, this is merely a deferral, not an exemption. The surviving spouse’s estate will include everything, and if the combined estate exceeds $14 million, the tax hits at the second death.

The key opportunity at the first death is funding a credit shelter trust with annuity assets up to the $7 million individual exemption. These assets escape estate tax permanently—they’re not included in the surviving spouse’s estate even though the spouse can receive income from the trust. Portability doesn’t need to be elected for assets passing to a credit shelter trust, though filing Form 706 is still recommended to preserve portability as a backup.

Survivor Annuity Considerations

If the deceased spouse owned an annuity with a joint-and-survivor payout, the surviving spouse continues receiving payments. The present value of those remaining payments is included in the surviving spouse’s estate. This means a well-funded joint annuity can push the survivor’s estate over the threshold.

For planning purposes, couples should evaluate whether joint and survivor annuity options make sense given their total estate size. In some cases, selecting a life-only annuity on the primary annuitant (with the payout used to fund a separate life insurance policy owned by an ILIT) produces better after-tax results for high-net-worth estates.

Coordinating with Roth Conversions

Married couples can execute spousal Roth conversions of qualified annuity funds during the “gap years”—after retirement but before Social Security and RMDs begin. Each conversion reduces the eventual taxable estate while locking in current tax rates. The annuity Roth conversion strategy is especially powerful for couples whose combined qualified balances push their estate well above $14 million.

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FAQ

How does the 2026 TCJA estate tax exemption sunset affect my annuity?

The TCJA sunset reduced the federal estate and gift tax exemption from approximately $13.61 million to about $7 million per individual in 2026. Your annuity’s full death benefit value is included in your taxable estate. If your total estate (including the annuity) exceeds $7 million per person or $14 million per married couple, the excess is taxed at 40% federal. Annuities are especially impacted because tax-deferred growth inflates the contract value without providing a step-up in basis at death, potentially creating both estate tax and income tax liability for beneficiaries.

Can I remove my annuity from my taxable estate without surrendering it?

Yes, but the options are limited. You can transfer ownership of a non-qualified annuity to an Irrevocable Life Insurance Trust (ILIT), which removes it from your estate after a three-year lookback period under IRC Section 2035. You can also annuitize the contract, which converts the lump-sum value into a lifetime income stream and typically removes the principal from your estate. For qualified annuities inside an IRA, a Roth conversion can reduce future estate value by pre-paying the income tax. Each strategy has different tax, gift-exemption, and control implications that require professional guidance.

What is the annuity double tax trap in estate planning?

The annuity double tax trap occurs when an annuity is subject to both federal estate tax and beneficiary income tax on the same dollars. At death, the full annuity contract value is included in the taxable estate—potentially triggering a 40% federal estate tax. Then, when the beneficiary takes distributions, they also owe ordinary income tax on the gain portion. Unlike appreciated stocks, which receive a step-up in basis eliminating capital gains tax at death, annuities provide no step-up. This means a $800,000 annuity with a $300,000 basis could face $200,000+ in estate tax and $100,000+ in beneficiary income tax.

Should I name my estate as the beneficiary of my annuity?

Never name your estate as an annuity beneficiary. Doing so forces the annuity through probate, exposes the full contract value to creditors, guarantees inclusion in your taxable estate, and eliminates the beneficiary distribution options available under SECURE Act 2.0. Instead, always name specific individuals (spouse, children) or a properly drafted trust as primary and contingent beneficiaries. If your annuity currently names your estate as beneficiary, contact your insurance company immediately to update the designation.

Does a non-qualified annuity receive a step-up in basis at death?

No. Non-qualified annuities do not receive a step-up in cost basis at the owner’s death. The beneficiary inherits the original owner’s cost basis, meaning all gains inside the contract remain taxable as ordinary income when distributed. For example, if you purchased an annuity for $200,000 and it grows to $600,000 by your death, your beneficiary owes ordinary income tax on the $400,000 gain. This contrasts with appreciated securities in a taxable brokerage account, which receive a full step-up to fair market value at death.

How does state estate tax affect annuities if my estate is below the federal $7 million exemption?

Twelve states and Washington D.C. levy estate taxes with thresholds well below the federal $7 million exemption. Oregon and Massachusetts exempt only $1 million, Washington exempts $2.193 million, and Minnesota exempts $3 million. If you live in one of these states, your annuity is included in your state taxable estate even when no federal estate tax applies. For example, an Oregon resident with a $1.5 million estate including a $600,000 annuity pays no federal estate tax but faces Oregon estate tax of approximately $50,000–$80,000.

Can I use a 1035 exchange to reduce my annuity estate tax exposure?

A 1035 exchange alone does not reduce estate tax exposure because the replacement annuity remains in your taxable estate if you still own it. However, a 1035 exchange can be part of a larger strategy: exchange into a lower-cost annuity with better withdrawal terms, take systematic withdrawals, gift those funds to an ILIT, and have the ILIT purchase a life insurance policy. The life insurance death benefit is income-tax-free and estate-tax-free if owned by the ILIT—effectively converting taxable annuity value into tax-free proceeds.

What happens if I transfer my annuity to an ILIT and die within three years?

Under IRC Section 2035, if you transfer an annuity to an ILIT or any third party and die within three years of the transfer date, the annuity’s fair market value is pulled back into your taxable estate. This anti-abuse rule prevents deathbed transfers. The three-year clock starts on the date of the transfer. After three years, the transfer is permanent and the annuity is excluded from your estate. This is why transferring annuities to an ILIT early—while you’re still healthy—is critical.

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Related Resources

• Inherited Annuity Tax Rules for Beneficiaries in 2026 — How beneficiaries are taxed on annuities they inherit, including the SECURE Act 2.0 10-year rule and distribution options.

• SECURE Act 2.0 Annuity Tax Changes for 2026 — How updated RMD ages, distribution rules, and beneficiary provisions affect annuity planning in 2026.

• Annuity Roth Conversion Strategy 2026 — How converting qualified annuity funds to a Roth IRA reduces estate value and creates tax-free income for heirs.

• 1035 Exchange Annuity Tax Rules 2026 — How to exchange an underperforming annuity tax-free, and how this fits into a broader estate reduction strategy.

• Joint and Survivor Annuity Household Planning — Spousal annuity planning strategies, including how survivor benefits interact with estate tax exposure.

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Plan Your Annuity Tax Strategy

The TCJA exemption sunset has fundamentally changed the estate planning calculus for annuity owners. Whether you’re above or below the new $7 million threshold, understanding how your annuity interacts with estate tax law is essential to protecting your wealth for the next generation.

Use our Annuity Payout Tax Impact Simulator to model different withdrawal, annuitization, and conversion scenarios. See exactly how much tax you’ll pay under different strategies—and identify the path that preserves the most wealth for your beneficiaries.