Usually, a survivor or beneficiary reports pension or annuity income in the same way the plan participant would have. However, some special rules apply.
You can exclude part of each annuity payment as a tax-free recovery of the employee's investment in the contract if both of these are true:
You're entitled to receive a survivor annuity on the death of an employee.
The employee died before becoming entitled to any annuity payments.
You must figure the taxable and tax-free parts of your annuity payments using the method that applies as if you were the employee:
You might receive benefits as a survivor under a joint and survivor annuity. If so, include those benefits in your income in the same way the retiree would have included them in income.
You might receive a survivor annuity because of the death of a retiree who had reported the annuity under the 3-year rule and recovered all of the cost tax-free. If so, your survivor payments are fully taxable.
The retiree might have been reporting the annuity payments under the general rule. If so, you must apply the same exclusion percentage to your initial survivor annuity payment called for in the contract. The resulting tax-free amount will then remain fixed. Any increases in the survivor annuity are fully taxable.
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This advice is for general information purposes only and may not apply to you. Every tax situation is different. This is not intended to be legal advice. Taxpayers should consult an H&R Block Tax Professional regarding their individual tax situation.