Vernoia, Enterline + Brewer, CPA LLC

Annuities have moved to the forefront of retirement planning lately as traditional pension plans have been replaced by 401(k) plans, individual retirement accounts (IRA), and other “defined contribution plans” for which there is no guarantee that the balance will last a lifetime.  While the concept of an annuity may be simple – payment of an amount in return for a guarantee of a certain annual or monthly amount for the life of the annuitant, the types of annuities now on the market, as well as the ways in which they may be held, has made for a certain amount of confusion.

Generally, annuity payments include income and are taxable to the annuitant. The income earned on the contract is not taxable until payments are made. However, income on an annuity contract is taxable as it is earned if the annuity is not held by a natural person.  Furthermore, an individual who transfers an annuity contract without full and adequate consideration is taxable on the transfer.

Transfers in trust

A taxpayer recently wanted to transfer an annuity that he owned into a trust for wealth planning purposes, but justifiably was concerned that such a transfer might trigger a “taxable event” that would accelerate the tax liability that would otherwise be spread out over future annuity payments.  Here are the details that necessarily are a bit complicated because of the estate planning goals that were to be achieved:

Husband established a grantor trust for his Wife and six beneficiaries who are their descendants. On Husband’s death, the Wife became sole trustee. The trust was divided into sub-trusts: Trust A for the Wife, and Trust B for all other property. Wife may also use Trust B for her benefit or the beneficiaries. When Wife dies, Trust B will be divided and distributed to the beneficiaries.

Wife intends to purchase flexible premium deferred annuity contracts, naming each beneficiary as the annuitant on one contract, in proportion to the beneficiary’s residuary share in the trust. The contracts are substantially the same except for the annuity dates. The trust will be the owner and beneficiary of the contracts but does not expect to take any distributions from them.

Upon final trust distribution, an annuity contract will be distributed to the beneficiary/annuitant. The trust will not receive any consideration for the contracts. Husband established a grantor trust for his Wife and six beneficiaries who are their descendants. On Husband’s death, the Wife became sole trustee. The trust was divided into sub-trusts: Trust A for the Wife, and Trust B for all other property. Wife may also use Trust B for her benefit or the beneficiaries. When Wife dies, Trust B will be divided and distributed to the beneficiaries.

Favorable IRS rulings

The first issue before the IRS was whether a trust could be considered a “natural person.”  The IRS determined that the contracts will be treated as owned by natural persons because the beneficial interests are owned by natural persons in a non-employment context.  As a result, the tax on the income built in within the annuity could be deferred.

Second, would the transfer to the trust itself be considered a a taxable event.  Again, the IRS ruled favorably.  The transfer of the contracts to the beneficiaries was not an assignment without full and adequate consideration and does not accelerate taxation, the IRS determined.

LTR 201124008

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