We have all read numerous articles and attended many seminars on estate planning changes resulting from the “phase-out” of the federal estate tax.

But confusion remains regarding proper handling of annuities during the transition period and thereafter.

During the past 15 years, the annuity industry has enjoyed unprecedented sales growth in annuities, both fixed and variable. And today, large numbers of variable annuity contract owners have very large contract values, due to their premiums plus the growth in investment yield over the years.

These very large values, when combined with other client assets, may now be creating a situation where the clients need some careful estate planning–to avoid unnecessary estate taxes, or at least to have sufficient liquidity to pay those taxes with funds that are available on an other-than-emergency basis.

One of our estate planning lawyer partners likes to say: “Tell me when you plan to die, and I can tell you how to plan your estate.”

Realistically, very few of us have any inkling when our deaths will occur. Therefore, we have to plan for the worst case–and hope our representatives in Congress and the White House will not feel the need to make additional changes before everyone has digested the changes that have already been made. (If they do make changes, at least we have done everything possible to avoid unnecessary taxes.)

Consider the “non-qualified” annuity. As you know, the increase in value of such annuities is taxed at ordinary income rates, whether distribution occurs in the form of withdrawals, loans, pledges, annuity payments or death proceeds. Hence, the beneficiary stands to pay what could be substantial federal income taxes on receipt of the death proceeds from the contract.

Yes, there are supposed to be continuing reductions in the marginal federal income tax rates. However, receipt of lump sum proceeds from an annuity that will be taxable at ordinary income rates could cause payment of substantially more tax than would be the case if the proceeds were paid out over a lengthy period of time.

In addition, in most cases the contract owner will die with the death benefits includable in her gross estate. Thus, they will be subject to federal estate taxes, unless proper estate planning has been done. The combination of federal income taxes and federal estate taxes could well eat up the majority of funds distributed from the annuity upon death.

The time to do this planning is before a problem occurs. The checklist on this page may help to ameliorate problems.

Many annuity owners made their purchase in anticipation of a particular goal they wanted to accomplish. This goal might have been to provide for retirement that could not be outlived, or to provide for loved ones on death.

Whatever the reason, failure to do proper planning can keep the goal from being achieved in event of the unanticipated death of the contract owner. Proper planning can help ensure that the goals of the purchaser have the best chance of being accomplished.

The next 10 years will challenge the financial services industry. Many consumers, particularly as they age, will be bewildered by the increased complexity of the estate planning process.

With continuing uncertainty over what the rules will be and how long theyll last, it is essential that the industry help annuity owners to plan for the worst–so they wont be caught unsuspecting when, in fact, it takes place.

Norse N. Blazzard, JD, CLU, and Judith A. Hasenauer, JD, CLU, are principals in the Westport, Conn. and Ft. Lauderdale, Fla. law firm of Blazzard, Grodd & Hasenauer, P.C. E-mail them at Norse.Blazzard@BGHPC.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, April 29, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.