The perceived tax advantages for those who inherit mutual funds has frequently been cited as a major reason for investing in mutual funds rather than variable annuities. However, recent tax law changes indicate that those advantages may be eliminated in the future.
For the past several years, the Internal Revenue Code has provided an unlimited step up in basis to beneficiaries who inherited mutual funds. A similar step up in basis is not available to beneficiaries who receive variable annuity proceeds from a deceased annuity owner. The word "basis" refers to the original cost of a mutual fund or variable annuity together with any upward or downward adjustments in such cost. The following example demonstrates application of the stepped-up basis rule where a mutual fund and variable annuity owner have died.