Using annuities for estate planning
Annuities are an effective estate-planning tool for several reasons. First, they can provide guaranteed income and most are insulated from stock market risk. They also grow tax-deferred and offer a number of payout options. In addition, annuity owners must name a beneficiary and/or beneficiaries to receive all or a portion of the annuity, and those assets can pass through without formal probate proceedings.
Here are just a few ways you can use an annuity for legacy planning, wealth transfer or estate preservation.
Charitable Gift Annuity
A charitable gift annuity is an arrangement made with a charitable organization. You make a donation to a charity, and in return the charity agrees to make regular fixed payments to the donor, or an individual he or she designates. You can receive the income immediately or you can defer it to a later date at your choosing. The amount of income you receive from your gift is expressed as a payout percentage. If you donate $100,000 and you’re payout percentage is 4 percent annually, you will receive $4,000 a year in income until you pass away.
The initial donation entitles the donor to an immediate tax deduction, just as any charitable gift would. The deduction is equal to the excess of the net fair market value of the donation over the annuity’s present value. This is referred to as the present value of remainder interest. A portion of the annuity payments, the portion considered a return of the principal you gave to the charity, will not be taxable. The remainder of the payments will be taxed as ordinary income.
Credit Shelter Trust
A credit shelter trust is a method for married couples with sizable combined estates to reduce the estate tax liability to beneficiaries after the death of the second spouse.
When the first spouse dies, all assets pass to the surviving spouse with no tax obligation. However, if the combined estate is valued at more than the estate tax exempt amount, then the estate will be taxed when it’s passed to beneficiaries following the death of the second spouse.
A credit shelter trust can be established to move some of those assets after the first death, essentially sheltering them from being part of the surviving spouse’s estate.
What some people do to maximize the value of the assets inside the trust for the benefit of their beneficiaries is to purchase a deferred annuity. Using a deferred annuity allows the investment to potentially grow on a tax-deferred basis. Further, the beneficiaries can continue to defer income taxes on the death benefit by choosing from a number of different distribution options.
Special Needs Trusts
Many children with special needs will continue to need expensive care after the death of their parents. Leaving money and other assets directly to that child will likely disqualify them from receiving state or federal government aid because those benefits require recipients to use their own money first before getting financial help. Leaving the money to siblings or other loved ones in the hope they use it to care for the special needs child could be risky.
One way to better ensure there are funds to provide for the child’s care without disqualifying him or her from government benefits is to use a special needs trust. The parents can purchase an annuity and name the trust as the beneficiary while naming their child as the annuitant. That means the payouts will be calculated using the child’s life expectancy. Also, because the annuity is owned by a trust and not directly by the child, it won’t disqualify him or her from receiving government aid for care. And the trust can be set up so that its assets are required to be used for the child’s ongoing care.
Some insurance companies offer a “stretch” annuity or legacy annuity option, which provide multi-generational payouts and is designed to benefit the beneficiaries of the annuity once the owner passes away. It provides tax-deferred allowances and allows the beneficiary(s) more flexibility and control over maintaining the contract. Stretching the annuity can provide lifetime income to the owner’s beneficiary.
Providing income to long-time employee
Some individuals, typically those of considerable wealth, may want to provide for a long-time household employee after their death. One way they can do that is purchasing an annuity and naming the employee as the annuitant. The employee can then receive income for his or her life or for a certain guarantee period following the death of the employer.
These planning techniques can be complex and costly if not executed properly. Therefore it is recommended you work with an advisor and/or attorney knowledgeable in estate planning concepts and tax laws.