“I just do not need the income.”
As a financial advisor, you probably don’t hear that statement very often. However, if your client is a widow or widower who is the beneficiary of an existing credit shelter trust, this sentiment is fairly common. In order to not pay the taxes at the trust level, all income from a CST must be paid out to the surviving spouse.
While some surviving spouses may welcome the income, all too frequently this income only increases the tax liability for the surviving spouse. This potentially unexpected tax liability may leave your clients wondering what options are available to them.
To avoid these taxable distributions, advisors often suggest the client purchase life insurance inside the credit shelter trust. In this scenario, the CST purchases life insurance on the life of the surviving spouse. If a cash value policy is used, the cash value grows tax-deferred; and ultimately the death benefit distribution is paid to the trust beneficiaries, income tax and estate tax-free.
Unfortunately, in many CST situations, the surviving spouse may be unable to purchase a life insurance policy due to advanced age or poor health. In this case, a tax-deferred investment may be an attractive option–hence the concept of purchasing an annuity contract within the CST.
When a non-natural owner purchases an annuity contract, the annuity generally no longer receives the benefit of tax deferral. One exception to this rule is the agent exception. Essentially, if an annuity contract is owned by a non-natural person for the benefit of, or as an agent for, a natural person, the benefit of tax deferral is not lost.