The bottom line, though, is simply this: while annuities can be owned by trusts in many situations, and transferred into or out of many (but not all) types of trusts, it's important to understand the particular details of the trust and its beneficiaries to determine the tax treatment of the transaction.
In the rulings, the IRS permitted the owner of the grantor trust to be treated as the designated beneficiary of the annuity contract. This allows the grantor of the trust to stretch the benefits over their life or life expectancy.
When a trust is the owner of the nonqualified annuity, the trust is generally the beneficiary of the annuity. After the annuitant dies, the death benefit from the annuity, if any, is then paid to the trust and the terms of the trust document control how the death benefit is managed and distributed.
In the case of a transfer to a revocable grantor trust, the annuity is not treated as being transferred for income, estate or gift tax purposes because there has been no transfer. The ownership of the annuity is the same before and after the transfer.
By using a variable annuity, a trustee can mitigate additional transaction costs and reallocate the assets without triggering a taxable event. 1 Tax deferral offers no additional value if an annuity is used to fund a qualified plan, such as a 401(k) or IRA, and may be found at a lower cost in other investment products.
Holding an Annuity in an Irrevocable Grantor Trust
The trust uses the cash to purchase annuity policies with you as the named annuitant. When those annuities start paying out, the payouts go to the trust, who can distribute funds to beneficiaries.
To avoid taxes on inheritance, you can use a deferred annuity or a life insurance policy. Annuities offer enhanced death benefits that allow beneficiaries to offset taxes or spread the tax burden over time.
Testamentary direction to purchase annuities
You can make provisions in your will that your executor use assets to purchase an annuity for a particular beneficiary. There are a variety of reasons that you may chose to make such a provision.
After an annuitant dies, insurance companies distribute any remaining payments to beneficiaries in a lump sum or stream of payments. It's important to include a beneficiary in the annuity contract terms so that the accumulated assets are not surrendered to a financial institution if the owner dies.
If a trust is the beneficiary of the non-qualified annuity, the trust must receive the balance within 5 years of the death that triggers the payout. It cannot stretch out the distributions over the life expectancy of one or more trust beneficiaries.
With annuities, you can provide income for yourself during your retirement as well as for a beneficiary after your death. The typical annuity account will not go to probate because it has a named beneficiary. Assets with a named beneficiary, such as annuities and life insurance policies, typically bypass probate.
Annuities are taxed as ordinary income when inherited. The proceeds of inheritance are taxable. If a beneficiary opts to receive the money all at once, they must pay taxes immediately.
They do not form part of the assets in a deceased member's estate. Instead, section 37C places a duty on the trustees of the fund to allocate and pay the benefit in a manner that it deems fair and equitable and only in three exceptional circumstances, may the benefit be paid to the estate.
The main drawbacks are the long-term contract, loss of control over your investment, low or no interest earned, and high fees. There are also fewer liquidity options with annuities, and you must wait until age 59.5 to withdraw any money from the annuity without penalty.
The taxable part of your pension or annuity payments is generally subject to federal income tax withholding. You may be able to choose not to have income tax withheld from your pension or annuity payments (unless they're eligible rollover distributions) or may want to specify how much tax is withheld.
In this sense, the taxation of the earnings is similar to taxation of 401(k)s, non-Roth IRAs and other qualified retirement plans. If you inherit a non-qualified annuity, be prepared to pay taxes on the earnings. But, there is no 10% early withdrawal penalty to worry about.
If you inherit an annuity, you'll have to pay income tax on the difference between the principal paid into the annuity and the value of the annuity when the owner dies. For example, if the owner purchased an annuity for $100,000 and earned $20,000 in interest, you (the beneficiary) would pay taxes on that $20,000.
If your contract includes a death benefit, remaining annuity payments are paid out to your beneficiary in either a lump sum or a series of payments. You can choose one person to receive all the available funds or several people to receive a percentage of remaining funds.
A $50,000 annuity would pay you approximately $219 each month for the rest of your life if you purchased the annuity at age 60 and began taking payments immediately.
Don't have sufficient savings to cover premiums.
Buying an annuity could mean laying out $50,000 or more to cover the premium. If purchasing an annuity would drain your liquid savings and put you at risk of having to borrow to pay for unexpected expenses, it may not be worth it.
The new owner of the annuity can start receiving payments, change beneficiaries, and cash out the policy whenever they want. To give the annuity away, you simply contact the insurance company and state that you want to gift the ownership of the annuity policy to someone else or a trust.
Contact your annuity company and let your account manager know you want to change the owner of your contract. The annuity company will send you a change of ownership form. Fill out the change of ownership form for your annuity.
With the right type of annuity and strategy, you can choose to have annuity payments continue to go to his or her child or children for the remainder of their lives, too. While you may never even meet your great-grandchildren, they too can receive a regular gift from you.
Like other investments, most annuities can be passed along to your heirs in the event of your death. However, it's important to remember that annuities are fundamentally a life insurance product, which alters how they're handled for taxation and inheritance purposes.