Are Inherited Annuities Taxable in PA? Rates, Rules, and Deadlines

Yes. Inherited annuities are taxable in Pennsylvania, and usually on more than one front. A beneficiary can face Pennsylvania inheritance tax at rates from 0% to 15% depending on the relationship to the person who died, federal income tax on the distributions, and, for non-qualified annuities, Pennsylvania income tax on the earnings portion. The size of each bill depends on who you are to the decedent, what kind of annuity it was, and how you choose to take the money.

Pennsylvania Inheritance Tax Rates by Relationship

Pennsylvania applies its inheritance tax to the value of the annuity at the date of death, and the rate turns entirely on your relationship to the decedent:¹

Surviving spouse: 0%
Parent inheriting from a child aged 21 or younger: 0%
Direct descendants and lineal heirs: 4.5%
Siblings: 12%
All other heirs: 15%

Charitable organizations, exempt institutions, and government entities are also exempt. Property owned jointly between spouses is exempt as well. If you inherit an annuity from your spouse, Pennsylvania takes nothing on the transfer itself.

Annuities that represent a return on an investment, meaning a single premium was paid, are taxable and get reported on REV-1510 Schedule G of the REV-1500 Inheritance Tax Return for resident decedents.² Annuities do not qualify for the $3,000 exclusion Pennsylvania allows for certain other transfers made within a year of death.

Federal Income Tax: Qualified vs. Non-Qualified Annuities

The single biggest driver of your federal tax bill is whether the annuity was funded with pre-tax or after-tax money.

Qualified Annuities

If the annuity sat inside a 401(k), IRA, or other retirement account, the original owner never paid income tax on the contributions. Every dollar you receive is taxable as ordinary income.³ A $300,000 qualified annuity taken as a lump sum adds $300,000 to your taxable income in the year you take it, which can push you into a much higher federal bracket.

Non-Qualified Annuities

Non-qualified annuities were bought with after-tax money, so federal income tax applies only to the earnings, not the original investment.³ The catch is the order: inherited non-qualified annuities follow a last-in, first-out rule. Withdrawals come out of the gains first, so you pay tax on every dollar until the earnings are exhausted; only then do you start receiving the original investment tax-free.⁴ Many beneficiaries expect the reverse.

If you annuitize the contract instead of taking withdrawals, each payment is split between a taxable and a tax-free portion using an exclusion ratio equal to your investment in the contract divided by the expected return.⁵ The lifetime tax-free amount cannot exceed your total cost basis.

When Pennsylvania Also Taxes the Income

The idea that Pennsylvania simply doesn’t tax annuity income is not accurate. The type of annuity decides.

Distributions from employer-provided retirement plans generally qualify as exempt retirement income under Pennsylvania law, and IRA distributions are treated the same way as long as you don’t owe a federal early withdrawal penalty.⁶

Non-qualified annuities purchased directly from an insurance company are treated differently. The earnings portion of those distributions is taxable as interest income for Pennsylvania purposes.⁶ Inherit a non-qualified annuity with significant gains and you’ll owe both federal income tax and Pennsylvania income tax on those gains.

How You Take the Money Changes the Tax

The distribution choice you make can matter as much as the annuity type. Federal law requires most non-spouse beneficiaries of a retirement annuity to empty the account within 10 years of the original owner’s death, for deaths occurring in 2020 or later.⁷ You have flexibility inside those 10 years, but you cannot stretch payments beyond them.

Some beneficiaries qualify as “eligible designated beneficiaries” and can still take distributions across their own life expectancy: surviving spouses, minor children of the deceased (until they reach the age of majority, when the 10-year clock starts), disabled or chronically ill individuals, and anyone not more than 10 years younger than the deceased.⁷

Within those rules, your three broad choices produce very different bills:

A lump sum gives immediate access but crams the whole taxable gain into one year. For a large annuity that can mean the top federal bracket and, for a non-qualified contract, a substantial Pennsylvania income tax hit at once. This is where beneficiaries most often overpay.

Spreading distributions over several years, up to 10 for most non-spouse beneficiaries, keeps the balance growing tax-deferred while letting you draw amounts that stay in lower brackets. Years of lower income are the right years to take more.

Annuitizing into lifetime payments produces the smallest annual tax hit and, for non-qualified contracts, lets you use the exclusion ratio to recover basis tax-free alongside each payment rather than having all the gains come out first under the LIFO rule.⁵ The trade-off is that you give up access to the principal.

Why Surviving Spouses Fare Best

A surviving spouse who inherits a qualified annuity can roll the account into their own IRA, which resets the distribution timeline and delays required minimum distributions until the spouse’s own retirement age. They can also keep the inherited account and delay distributions until the original owner would have turned 72.⁷ Combined with Pennsylvania’s 0% inheritance tax rate for spouses, that makes the surviving spouse the most tax-efficient beneficiary by a wide margin.

Deadlines and the 5% Early Payment Discount

Pennsylvania gives a 5% discount on inheritance tax paid within three calendar months of the death.⁸ On a $200,000 annuity going to a sibling at 12%, that’s $1,200 saved. The discount applies proportionally to amounts actually paid within the window, so an estimated payment counts even if the final figure isn’t settled. After nine months, unpaid inheritance tax becomes delinquent and starts accruing interest.

The REV-1500 inheritance tax return itself is due nine months from the date of death, with annuities reported on Schedule G.² You’ll need to identify your relationship to the decedent accurately, because that classification sets the rate. Payment goes to the Register of Wills in the county where the decedent lived.

On the federal side, the insurance company or plan administrator issues a Form 1099-R each year showing the total distribution and the taxable amount, which you report on your federal return.⁹ Hold on to documentation of the original owner’s cost basis; you’ll need it to establish the tax-free portion of any non-qualified annuity payments. If Pennsylvania income tax also applies, the earnings portion of a non-qualified annuity is reported as interest income on your state return.⁶ When an inherited annuity straddles qualified and non-qualified treatment, a tax professional familiar with Pennsylvania’s retirement income rules is the safest way to avoid an expensive filing error.

1
Commonwealth of Pennsylvania. Inheritance Tax
2
Pennsylvania Department of Revenue. Where Do I Report the Value of Annuities for Inheritance Tax When Transferred to Named Beneficiaries
3
Internal Revenue Service. Topic No. 410 Pensions and Annuities
4
Internal Revenue Service. Publication 575 Pension and Annuity Income
5
Internal Revenue Service. Publication 939 General Rule for Pensions and Annuities
6
Commonwealth of Pennsylvania. PA Personal Income Tax Guide – Gross Compensation
7
Internal Revenue Service. Retirement Topics – Beneficiary
8
Pennsylvania Department of Revenue. How Do I Qualify for the 5 Percent Discount for Inheritance Tax
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Internal Revenue Service. About Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.