Estate Planning with Annuities
Every client is unique, with different goals and changing circumstances. To develop a strategy for leaving a lasting legacy, advisors and their clients may benefit from consulting with an estate-planning or tax-planning expert. This is especially true for your high-net-worth clients.
While estate planning will likely involve many investment vehicles, advisors do not always consider using variable annuities to help meet their goals. It’s possible that VAs have been ignored because of their high asset-based insurance fees and a limited selection of investment options, complex structure, surrender fees and steep commissions.
But simple, transparent, no-commission products that cut costs and offer more investment options can add great value for your client’s estate. Whether your clients want to accumulate more, avoid probate, reduce the size of their taxable estate or control the income and deferred asset growth inside a trust, a VA may help them accomplish these goals. Here, I will review the issues around using VAs with trusts; in an earlier articleI discussed matters related to the tax-treatment of VAs. (Note that VAs are not the only tool for estate planning and, in some cases, life insurance may be a better vehicle for the transfer of wealth.)
Whether saving for retirement or setting aside funds for a legacy, accumulation is a big issue — even for clients who are high wage earners. In the face of retirements that can span 30 years or more, it is imperative that clients understand that the more they accumulate, the more they can leave to their estate.
In order to maximize long-term accumulation, experts agree that few things beat the power of tax deferral. When clients stockpile investments for years or decades — compounding growth without stripping away 15-35 percent in taxes each year during the accumulation period — they can save more.
Likewise, for tax-inefficient assets, including bond funds, REITs, alternative investments and actively managed investments, currently taxed at ordinary income rates as high as 35 percent, tax deferral delivers a powerful advantage. New research shows that tax deferral can potentially increase returns by as much as 100 basis points — without any subsequent increase in risk — simply by locating assets based on their tax treatment between taxable and tax-deferred vehicles.
Once employer-sponsored plans and IRAs are maxed out, VAs are a powerful alternative for long-term tax-deferred investing. Earnings inside the annuity grow tax-deferred, and the account isn’t subject to annual contribution limits like other tax-deferred qualified investment vehicles, making them a great fit for your high-net-worth clients.
A matter of trusts
Many advisors warn against placing a VA in the ownership of a trust. First, an annuity will already avoid probate if it has a named beneficiary, so no trust is required for this purpose. In addition, the IRS could in many cases argue that the premature withdrawal penalty of 10 percent will apply if a trust owns the annuity, since the trust is a “non-natural” person and can never attain age 59 1/2 . Also, depending on the type of trust used, the annuity owner could be subject to a gift tax.
However, a credit shelter trust can be structured successfully using deferred variable annuities. A CST (also known as an A/B trust) is typically used to minimize the combined estate taxes payable by spouses. In the IRS Private Letter Ruling 199905015, it was ruled that (1) the annuity owned by the CST is deemed to be owned by a natural person for purposes of Section 72(u) and, (2) upon dissolution of the trust, the re-titling of the annuity contracts to the named beneficiaries is not a taxable event. This approach is often referred to as a “pass-in-kind” strategy.
Charitable remainder trusts are another structure where variable annuities can be used successfully. These irrevocable structures are established by a donor to provide an income stream to a beneficiary, while a designated public charity or private foundation receives the remainder value of the principal when the trust terminates. These “split interest” trusts are defined in ?664 of the Internal Revenue Code of 1986 as amended, and are normally tax-exempt.
While a full explanation of these strategies is beyond the scope of this article, it is worth noting that a CST or CRT may provide a valuable estate planning strategy that enables advisors to help their clients pass assets free of estate taxes and to allow the beneficiaries to benefit from tax-deferred accumulation.
An enduring estate plan
While it is important to assist clients in developing an estate plan as early as possible, it is even more critical that you review this plan regularly, especially after milestones such as the birth of a child or the sale or purchase of a business. Being proactive is the best way to help ensure that your clients’ goals are met.
FROM THE AGENT’S SALES JOURNAL OCTOBER 01, 2011 ISSUE
Laurence P. Greenberg is president of Jefferson National.