Author: Bill Jackson
For financial professionals seeking to help clients create a tax-efficient legacy while strengthening long-term planning strategies, annuities inside trusts can offer powerful opportunities — but only when structured correctly.
When trustees are considering using an annuity as an irrevocable trust investment, there are many factors they should consider. With the compressed nature of trust tax brackets, reducing tax on the earnings of trust-held assets are crucial.
Below are common questions trustees have when using an annuity within a trust.
If a trust owns an annuity, will the annuity still retain tax-deferral status?
An annuity will retain its tax-deferral status when owned by a trust, provided all trust beneficiaries are individuals. In other words, the trust beneficiaries must be people rather than entities such as other trusts, charities, or corporations.
If a non-qualified annuity is owned by a trust, and the trust is also the beneficiary, will the life expectancy option (stretch) be an option for the trust beneficiary upon the annuitant's death?
When a trust is named as the beneficiary of a non-qualified annuity, the life expectancy payout option (commonly referred to as the "stretch" option) is generally not available. Instead, the trust is typically limited to either receiving a lump-sum distribution or deferring payment for up to five years.
Is there any way to structure a non-qualified contract so that the trust beneficiaries have the ability to stretch out the proceeds?
Yes, if the trustee structures the contract so that the trust's remainder beneficiaries are named as the beneficiaries of the annuity contract.
For example, suppose a trust was created with the following language: Income to A while A is alive, and at A's death, the trust distributes all trust property to B and C.
One possible structure for this contract:
| Owner | Trust | |
| Annuitant | A | By setting it up this way, at A's death, a death benefit will be paid to the trust, and the trust would only have the option of taking a lump sum or deferring for five years. |
| Beneficiary | Trust |
There is an alternative structure that would allow the beneficiaries of the trust to stretch the proceeds:
| Owner | Trust | |
| Annuitant | A | By setting up the annuity with the actual trust beneficiaries, each beneficiary has the opportunity to determine his or her payout — and one of the options will be to stretch. It's important that the trustee update the beneficiary designation of the annuity contract, should any of the beneficiaries pre-decease the annuitant, to ensure that the payout of the annuity and the trust match. |
| Beneficiary | 50% B; 50% C |
Is it possible for a trust to distribute an annuity contract to a trust beneficiary?
Depending on the terms of the trust, it's possible for a trust to purchase an annuity, and at a future time when the trust terminates, distribute that annuity in-kind to the trust beneficiaries. One of the major benefits of this strategy is avoiding a taxable event at the grantor's death. It also transfers the annuity to the intended beneficiary intact with no stretch or RMD requirement.
For this strategy to be successful, the contract structure should be the following:
| Owner | Trust | |
| Annuitant | Trust Remainder Beneficiary | When the income beneficiary passes away, and the trust assets are to be distributed to the remainder beneficiary, the trustee will have the option of distributing the actual annuity contracts to the beneficiaries. |
| Beneficiary | Trust |
The trustee will change ownership from the trust to the trust remainder beneficiary, who will become the owner. The new registration becomes:
| Owner | Trust Remainder Beneficiary |
| Annuitant | Trust Remainder Beneficiary |
| Beneficiary | May be changed by trust remainder beneficiary to a person of his or her choosing |
Will annuity withdrawals be taxed at the trust's tax rates?
Income inside of a trust will be taxed at the trust's tax rate unless the trust distributes that income in that same year to a trust beneficiary. If a trust distributes its net income to the trust beneficiaries, those trust beneficiaries will pay the income taxes due at their individual tax rates.
What paperwork is required for trust-owned contracts?
In addition to the annuity application, 1035 exchange paperwork (if applicable), and replacement documentation (if applicable), trust-owned contracts generally require submission of a copy of the trust agreement and a trustee certification form. If the trust is a Charitable Remainder Trust (CRT), carriers typically require a Charitable Remainder Trust Waiver form in addition to the standard documentation.
What happens for tax purposes when an annuity owned by a credit shelter trust is transferred to the beneficiary after the trust ends?
According to IRS PLR 199905015, an annuity owned by the credit shelter trust is deemed to be owned by a living person, and when the trust dissolves, the retitling of the annuity contract from the trust as owner to the annuitant as owner doesn't trigger a taxable event.
Annuities can be a valuable tool within a trust structure, offering opportunities for tax deferral, asset preservation, and efficient wealth transfer. By understanding the complexities of trust-owned annuities, financial professionals can help clients support their long-term legacy goals.
For additional guidance on trust-owned annuities and advanced planning strategies, contact your Gallagher Life and Annuity Brokerage consultant.
