Gifting To An Annuity: A New Strategy For Estate Planning

Young adults today know that their retirement may not be like the retirement enjoyed by their parents.
With fewer employers providing defined benefit pension plans, coupled with concerns about the future viability of Social Security, most young adults must build their retirement savings via contributions to an employer-sponsored 401(k) plan and their own personal savings. This increase in personal responsibility for retirement security has forced many to look for alternative options to supplement those savings.
As a result, parents or grandparents of younger adults are often called upon to assist them with saving for retirement. While a cash gift to an adult child or grandchild can help boost their personal savings, it may not be the best plan in every situation, especially for those family members who struggle to handle finances appropriately.

When your clients are in the process of estate planning and considering gifting as part of their strategy, there are a few things they should be aware of:
• They could give each child (or grandchild) $13,000 per year in 2011 and 2012 without paying any federal gift taxes by utilizing the annual gift tax exclusion. The gift could be $26,000 per year per child if both they and their spouse join in the gift.
• They can make additional gifts of up to $5 million for gifts made in 2011 or up to $5.12 million for gifts in 2012, without incurring federal gift taxes, through the use of the federal gift tax exemption.
• They can gift to their grandchild as well. The exemption from generation skipping transfer taxes is also $5 million in 2011 or $5.12 million in 2012.
• Their gifts made in 2011 or 2012 might be subject to a “clawback” and estate taxes if they (as donor) die in 2013 or later, and the federal estate tax exemption in the year of death is lower than the prior gift tax exemption.
As mentioned earlier, your clients’ outright gifts of cash can be a simple and attractive way to assist their children with retirement savings programs. However, the potential problem with these gifts is that the adult child will be able to control these funds and have access to the cash whenever they want to use it. Having access to the cash may not always be the best option.

Gifting to an Annuity Owned by an Adult Child An alternative for your clients to consider when making gifts to their children is to make the cash gifts as a premium payment to a nonqualified deferred annuity contract owned by the adult child (or adult grandchild). The child would have the benefit of income tax deferral on the accumulation in the annuity until he receives distributions from it for retirement.
Any distribution from the annuity to the child would be subject to ordinary income taxes up to the amount of gain in the contract. If the child is under age 591/2, there would be a 10 percent income tax penalty on the distribution up to the amount of the interest accrued (unless an exception applies). A surrender charge might also be incurred depending on the annuity contract purchased.
This ordinary income taxation, potential IRS tax penalty and annuity contract surrender charges could deter the child from accessing the cash in the annuity until after age 591/2 and after the surrender charge period has expired. In that way, the annuity is a forced retirement savings vehicle for the child.
One important word of caution: If your client currently owns a nonqualified annuity and is considering giving the annuity to an adult child or grandchild, or to a trust, keep in mind that the gift of a nonqualified annuity triggers taxable income to your client if there is any increase in value in the contract. Some exemptions apply for gifts to a spouse. You should urge your clients to discuss the tax issues of gifting an existing annuity with their professional tax advisor. 

Using a Trust to Own the Annuity for an Adult Child If the concern is that an adult child may still take cash out of the annuity in spite of the taxes, potential tax penalty and surrender charges, your clients should consider making their gifts to an annuity owned by an irrevocable trust. If all of the beneficiaries of the trust are individuals, the trust would be acting as agent for a natural person, which is required for the increase in value in the annuity contract to be income tax-deferred. An attorney would need to be consulted to make sure such a trust qualifies for income tax deferral.
Access to cash in the annuity would be controlled by a trustee, subject to the terms of the trust. When the trust is established, your client’s attorney could draft it so an adult child is not able to control the annuity and cannot withdraw cash from it until after age 591/2 or an older age selected by your client.
Though an annuity owned by an irrevocable trust has advantages, your clients should also keep in mind the following points:
• Attorney’s fees would be incurred for the drafting of the trust to implement this strategy.
• A professional trustee or a competent individual needs to be appointed to enforce the trust provisions. A professional trustee would incur trustee fees.
• Once the trust is established, it cannot be changed nor will there be access to the annuity values once it is established. The trust would be named owner and beneficiary of the annuity, with the adult child named the annuitant. If the trust is established for multiple children, a separate trust established for each child may be advisable.
A nonqualified deferred annuity provides features and benefits that can assist your client’s family members in preparing for their retirement. The potential ownership of the annuity by an irrevocable trust can provide more controls over the use of the annuity and ensure that it is utilized for the purpose they intended.
Developing a sound plan for retirement is increasing in complexity, so it stands to reason that more parents and grandparents will want to help their children achieve better retirement security. Talk to your clients about the possibility of gifting to help with retirement planning for future generations and consider how a nonqualified deferred annuity can assist their family members with their retirement planning strategies. This material is designed to provide general information on the subjects covered. Pursuant to IRS Circular 230, it is not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market or recommend any tax plan or arrangement.

December 2011 issue of Broker World Magazine. Author’s Bio Debra  Repya, JD, CLU, ChFC JD, CLU, ChFC, is vice president of advanced markets for Allianz Life.


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