Some Pitfalls To Avoid In Annuity And IRA Planning

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Careful planning goes a long way toward helping protect financial assets for a client’s heirs. Unfortunately, critical details may be overlooked if the planner is not sensitive to the potential for pitfalls.

The following examples illustrate the failure to maximize the advantages of 2 forms of personal retirement plans nonqualified annuities and individual retirement accounts (IRAs) along with tips on how to avoid them.

Example: Establishing a deferred annuity with joint annuitants may set the stage for the unintended disinheritance of a spouse.

In the case of some deferred annuities, the annuitant is just the individual (or individuals) upon whose life annuity payments are based when they involve a life expectancy. Unfortunately, the term “joint annuitant” can be misunderstood as providing survivorship rights.

The proper approach is to use the beneficiary designation to grant such rights.

To illustrate, assume Mrs. J buys an annuity to accumulate tax-deferred interest on her savings until she retires. The funds represent a significant part of retirement savings for herself and her husband. As owner, she names herself and Mr. J as joint annuitants under the mistaken belief that the proceeds will be available to Mr. J at her death. She designates their son as primary beneficiary, thinking that he will receive any remaining amounts after she and Mr. J are both deceased.

Although Mrs. J’s plan for the future is clear, she would be shocked to see the actual results. Under this arrangement, at Mrs. J’s death, the proceeds of the annuity would go to her son, not her husband. Mr. J effectively would be disinherited.

Planning tip: In circumstances similar to these, name the spouse as the primary beneficiary, and name the child as contingent beneficiary. As primary beneficiary, the surviving spouse automatically becomes the new owner of the annuity, and any gain in the account can remain income tax-deferred. There is no need to name a joint annuitant under a deferred annuity. Such an arrangement generally is not made until annuity income payments begin (annuitization).

Example: Joint ownership of a deferred annuity also has no influence on the disposition of the contract in event of death.

Under some deferred annuities currently being sold, the death of a joint owner is treated as the death of the owner, and proceeds are payable to the beneficiary, not the surviving joint owner.

Joint ownership may be appropriate in certain situations, of course. For example, where 2 individuals have contributed to purchase the deferred annuity, it may be important to require both signatures whenever a withdrawal, change of beneficiary, or other transaction is to be made. Joint ownership may thus serve to help safeguard the annuity from reckless spending. In such cases, the primary beneficiary designation should be the survivor of the joint owners (e.g., “the survivor of Mr. J and Mrs. J”).

Planning tip: Use the beneficiary provision to pass on a deferred annuity. Here’s a simple way to satisfy the client’s needs in the prior example. The proceeds under this arrangement go to the children only after both spouses are deceased.

Owner and annuitant Mrs. J

Primary beneficiary Mr. J

o Contingent beneficiary their son

A flaw in an otherwise suitable plan can thwart a client’s intentions.

Example: In the following case, providing too much discretion to the trustee cut short the period in which an IRA could have remained in effect for the benefit of the owner’s heirs.

Prior to her death, Grandma A designated a trust as the primary beneficiary of her IRA. The trust provided that distributions to the owner’s 2 grandchildren, who were minors, would be made at the discretion of the trustee for their support, health and maintenance until age 30, at which time each one could withdraw his or her entire share. The trustee was not expressly required to make required minimum distributions (RMDs) even though the trust began to receive such amounts from the IRA 1 year after the owner’s death. Grandma A named her Aunt B as contingent beneficiary of the trust, in case the grandchildren did not live to age 30.

According to IRS regulations, beneficiaries whose entitlement to proceeds is contingent on any event other than the death of a prior beneficiary, must be considered for purposes of determining which beneficiary has the shortest life expectancy and, as such, who is the designated beneficiary for RMD purposes. In this case, unfortunately, the IRS ruled that RMD calculations must be based on Aunt B’s life expectancy. Aunt B was 67 years old; her life expectancy was 19.4 years.

The defect in this plan was that the trust language did not expressly require the payment of RMDs to the grandchildren each year; therefore, the trust language did not preclude the trustee’s accumulating the distributions for the ultimate benefit of the contingent beneficiary. Using Aunt B’s life expectancy, the IRA would be paid out in a relatively short time, compared to the grandchildren’s life expectancies of 66 years or longer.

The potential financial loss is substantial. If we assume a 4% yearly return on $100,000 of proceeds (the actual amount was not revealed in the IRS ruling), the difference in minimum distributions over the 2 time periods adds up to more than $300,000.

Planning tip: When designating it as beneficiary of an IRA, make sure a trust is drafted properly. In most situations, it may not be necessary to designate a trust as the beneficiary of an IRA. Of course, there are situations that may warrant its use. (See chart.)

In the prior examples, we’ve discussed situations that provide convincing evidence of the pitfalls in establishing ownership and beneficiary designations. The majority of client needs can be satisfied with simple solutions. Nevertheless, careful attention to detail is necessary to help assure that the client’s wishes may be fulfilled when the plan actually takes effect.

, CLU, APA, is an advanced sales consultant at Union Central Life Insurance Company, Cincinnati, Ohio. His e-mail address is fburkey@unioncentral.com.


Reproduced from National Underwriter Edition, June 11, 2004. Copyright 2004 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.