Transferring an annuity often has significant tax implications. By Iyandra Smith, Esq., TEP Any income received by the trust is treated as your income (this will include taxable pension distributions). Under these circumstances the government acknowledges you have divested yourself of enough power to grant the beneficiaries of the trust certain benefits. (Although note that state estate tax limits can be much lower than federal.) This can be a good way to shift some of the tax burden out of your estate if youre in good health and want to provide ongoing funding for beneficiaries. These instructions may lead to adverse income tax results or to an unplanned party controlling the contract. The trust uses the cash to purchase annuity policies with you as the named annuitant. A common type of grantor trust is a living trust used for estate planning purposes. While they offer more freedom, revocable trusts only offer limited creditor protection, minimal estate tax savings, and you may not qualify to receive any government program benefits, because the assets held within a revocable trust are counted against resource limits for Medicaid and other programs. However, if you were to sell the annuity outright to a company that buys annuities, that would not be considered a transfer and the three-year rule wouldnt apply. As the word "irrevocable" implies, the terms and features of the trust can't be changedand that includes the named beneficiaries. As a general rule, a taxable event occurs when assets are transferred into an irrevocable trust. With some living trusts, you can name someone to . IAR CE is only available if your organization contracts with Kitces.com for the credit. An even more complex point of intersection between annuities and trusts is when annuity contracts are transferred to/from a trust. Step 2 Talk about creating wealth! This can be expressed as a fixed dollar amount or a fixed percentage of the trusts total assets. So the real question is not whether or not you want an irrevocable trust, but which irrevocable trust would you want now knowing that it may not be the one you want in the future. Although your state may impose mandatory withdrawal rules for your nonqualified annuity, the IRS does not. Thats why we recommend consulting with a true annuity professional before proceeding, they can help you decide the strategy that will work best for you, when transferring annuities to reduce taxes. Being open with your daughters about your own financial planning and focusing on the areas of financial literacy, budgeting and investing can help her become a financially secure woman. Future US, Inc. Full 7th Floor, 130 West 42nd Street, Examples of qualified retirement plans include IRAs and 401(k) plans. . I believe it IS a taxable event for the growth in the contract. A non-qualified annuity is one purchased with after-tax funds and isnt necessarily a retirement vehicle, but it can be. Helping Those with Disabilities Qualify for Government Benefits: Disabled beneficiaries on Medicaid and Supplemental Security Income have stringent income and asset limitations if they own or receive too much money they can lose these government benefits. That person now has the power to withdraw funds, begin payments or change beneficiary. The trust must . Similar IRS rules apply to funds held in an employer-sponsored qualified retirement plan, which are solely for the exclusive benefit of the individual employees or their beneficiaries. In a conventional revocable trust plan, a client may be advised to transfer all assets, other than IRAs or qualified plans, to his revocable trust or to designate the trust as the beneficiary of the non-qualified annuities. Therefore, understanding the tax implications is critically importantwhich is why we focus on irrevocable trusts in the discussion below. The Bottom Line. Usually made to transfer wealth, protect assets, or reduce taxes. If you have cash assets in an irrevocable trust, you should invest in an annuity in that trust. For more information on this topic or to further discuss your estate planning. Hope youre on good terms with them: You are not the trustee, and he or she is the person who gets to decide what happens to trust property. A grantor trust for income tax purposes could be either. The person who is creating the trust is referred to as a settler and the one who manages the trust is known as a trustee. Separately, funds representing "contingent interests" are insured up to $250,000 in the aggregate. As an example, we recently met with a couple, ages 70 and 69, who will be taking their after-tax annuity proceeds of $80,000 annually to purchase a $5 million survivorship policy that would be equivalent to $10 million given the net worth and tax status of that couple. You can transfer ownership over to a trust as well. This is a relatively seamless process that will require you and the individual receiving the annuity to agree to the transfer. Nonetheless, to the extent that a revocable living trust does own an annuity, it can do so on a tax-deferred basis. This is why, when it comes to placing an annuity in a trust, you'll need to be extremely careful or else risk losing the annuity's preferential tax treatment. Boca Raton, FL 33431, Call: 800-DIE-RICH Irrevocable trusts usually have to pay an accountant to file a separate income tax return for the trust. Each week, Zack's e-newsletter will address topics such as retirement, savings, loans, mortgages, tax and investment strategies, and more. It can either take the annuity out as a lump sum or take it in a series of payments over five years. If none of these situations applies, you should not have an irrevocable trust. In the case of a transfer to a revocable living trust, this is not an issue, as the annuity is not treated as transferred for income or estate or gift tax purposes, and accordingly there has been no "transfer" to which a full-and-adequate-consideration exchange can be considered. If you sense there is little chance of you being sued, or that the person you would name as trustee is less responsible than you, asset protection trusts may not be a good option. The "standard" tax treatment for deferred annuity is that they are tax-deferred (note: the reason they're called "deferred" annuities is notbecause they're tax-deferred, but because they date of annuitization is deferred to the future; i.e., they have not yet been "annuitized"). In the original guidance from the Senate Report from the Tax Reform Act of 1986 (which created this code section,see page 567), Congress indicated that the point of the rule was that if the nominal owner was not a natural person but the beneficial owner was a natural person, the annuity would still qualify, such as where a corporation technically holds title to a group annuity for the pure benefit of the (natural person) employee participants. In addition to the benefits of a revocable living trust, transferring an annuity to a trust carries many additional advantages, including avoiding probate. Once you pass away, the annuity contract will need to be dissolved, and your trust is going to take a tax hit. In addition, some of the newer stretch provisions that allow your beneficiaries to distribute annuity income over their lifetime are unavailable with trust owned annuities. And you dont need an irrevocable trust to protect your beneficiaries from their creditors, since a carefully drafted revocable trust protects every beneficiary except you and your spouse (and even then, in certain circumstances your spouse may be protected by a revocable trust). Usually, an irrevocable trust retains the asset in its owners name. The transfer of assets to an irrevocable trust can have tax benefits. By Thomas Ruggie, ChFC, CFP By contrast, in PLR 9009047, the trust's remainder beneficiary was a charitable organization and not a natural person, so the tax-deferral treatment was lost; similarly, in PLR 199944020 found that a partnership holding an annuity would not be eligible for tax-deferral treatment, as a partnership is a business entity unto itself and not merely the nominal owner for a natural person beneficiary. By Evan T. Beach, CFP, AWMA That would defeat the purpose of the retirement account. Distribution of assets takes place according to the instructions in the trust. Usually made as part of a will - for example, a child . Plus, you are usually limited to receiving income from Medicaid trusts and cannot withdraw principal, so if you do not end up receiving Medicaid your principal is nonetheless locked up. These trusts would lower the couple's countable assets for Medicaid purposes by $20,000 - $30,000. This is where those who use this tactic run into problems. The monthly income generated from the MCA belongs to the community spouse. Yes, you can retain some powers that give you limited control over the trust and the trustee, and third parties can take some actions to modify irrevocable trusts. Using an annuity within a trust is not usually necessary. Depending on the type of trust involved, annuity transfers into or out of a trust may be taxable. Tax rules differ for retirement accounts depending on whether the account is part of a qualified or nonqualified plan. The growth in the annuity isnt taxable until you withdraw it, and some annuities offer guarantees on your principal and returns. The favorable rules are generally intended to support the use of annuities as a vehicle for retirement savings and/or retirement income and as such, the rules generally only apply in situations where annuities are owned directly by individual, living, breathing human beings who may in fact someday retire (known in the tax code as "natural persons"). A trust created during the life of the grantor, but that takes effect at the grantor's death. Purchase your pass by March 3 and receive a Kitces-Blue Goodies Mystery Box, Quantifying the Value of Financial Planning Advice, The 5 Languages of Appreciation in the Workplace: Empowering Organizations by Encouraging People, Top 10 Influential Blog for Financial Advisors, #1 Favorite Financial Blog for Advisors. On the other hand, since annuities already pass directly to beneficiaries by operation of contract, they avoid probate without any need for ownership by a revocable living trust, raising the question ofwhyindividuals would choose to transfer an annuity into such a trust in the first place, unless for management in the event of disability. Copyright 2023 Zacks Investment Research. In the first step, the owner of the annuity must designate the trust as the owner and the beneficiaries of the trust. However, you should make sure that you partner with the right trust. The assets within the annuity are asset protected to varying degrees in most states regardless of whether or not the annuity is held in a trust. For more information on this topic or to further discuss your estate planning, contact us at 800-DIE-RICH. The problem is a key section of the tax code designed to prevent the unrealized gains of annuities from being shifted to another individual through gifting; as a result, if an individual transfers an annuity "without full and adequate consideration" its gains are immediately recognized. Got Cash on Hand? The process of transferring an annuity to an irrevocable living trust is complicated. If you are not wealthy, there is no good reason to fund an irrevocable trust with life insurance, create charitable remainder trusts, or gift substantial property to avoid estate taxes prior to your death. Most states require that funds be owned by the trust for one or two years prior to their being protected, so assets placed in an asset protection trust may not qualify for protection from recent accidents. Irrevocable trusts can shelter income and assets, so these limits are not exceeded.