The government is standing by to dip into your inherited annuity as you collect. My wife recently inherited an annuity from her mother, who had not yet begun taking payments from the contract. Either way, your wife will owe income taxes on the difference between what her mother invested and the total she receives in payments. But the timing of the tax bill can vary. If she chooses the five-year option, she can take all the money tomorrow, take several withdrawals over the next five years, or wait until the end of the period and withdraw it all at once.
Any money left in the annuity continues to grow tax-deferred.
Under this option, any money your wife receives will be fully taxable until she has withdrawn all of the earnings. After that, all withdrawals would be tax-free. Part of each payout is tax-free, based on the ratio of the amount invested to the amount of earnings. The insurance company has to give you a report each year showing how much is taxable. The first payment must be made no later than the end of the year after the annuity owner died.