592 / How long does the beneficiary of an annuity have in which to elect to take death proceeds as an annuity, rather than as a lump sum, and thus avoid being in constructive receipt of all contract gain?

There is a widespread (mis-)belief that the beneficiary of a deferred annuity, where the owner died prior to annuity starting date, has one year, not 60 days, in which to make an election to take the death proceeds as an annuity without becoming in constructive receipt of all contract gain. This mis-belief is grounded in the fact that IRC Section 72(s)(2) provides that no contract issued since January 18, 1985 shall be considered “an annuity” (and taxed as an annuity) unless it provides that “any portion of the holder’s interest” that is payable to a designated beneficiary will be distributed “over the life of such designated beneficiary (or over a period not extending beyond the life expectancy of such beneficiary),” and that “such distributions begin not later than one year after the date of the holder’s death or such later date as the Secretary may by regulations prescribe” ( Q 593). That provision, however, states only the provisions that an annuity contract must contain (with respect to distributions made on the death of any holder) to be deemed “an annuity” for tax purposes. It does not speak to how long a beneficiary may wait to exercise an annuity payout option without being in constructive receipt of all contract gain; as noted above, IRC Section 72(h) does speak to this. Moreover, Section 72(s) applies only on the death of the holder of an annuity and not when the annuitant of an annuitant-driven contract dies. Some commentators suggest that Section 72(s) “trumps” Section 72(h) because it is newer. The latter section, however, has not been repealed or amended.