Funding Credit Shelter Trusts With Annuities

For example, in private letter ruling (PLR) 200018046, the Internal Revenue Service determined that a trust owning a group annuity for the benefit of an individual retains the benefit of tax deferral. Furthermore, there have been several other PLRs, including PLR 199905015, in which an annuity owned by an irrevocable trust also continued to receive the benefit of tax deferral.

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One option is for the credit shelter trust to purchase an annuity on the life of the surviving spouse. During the life of the surviving spouse, the annuity remains tax deferred. Should the surviving spouse need any of the cash value, the trustee can request a distribution from the annuity contract. Upon the spouse’s death, the death benefit is paid to the trust and distributed according to the underlying trust document. Unfortunately, these distribution options are limited.

As an alternative, the CST could purchase an annuity on the life or lives of the child or children, with the trust being both the owner and beneficiary. Consider the following example: A family with two children establishes a credit shelter trust with $1.2 million dollars. The trustee purchases two annuity contracts worth $600,000 dollars each, one on the life of each child, with each child being the annuitant on their own contract.

During the lifetime of the surviving parent, the trust will own the contract. Upon the death of the surviving spouse, the trust could distribute each contract to each annuitant in a tax-free exchange. The end result is that each child becomes the owner of his or her annuity contract based on his or her own life, with no requirement of immediate distribution. As the owner of the contract, the child can make his or her own investment choices. Furthermore, additional distribution options are available upon death, including spousal continuation.

One disadvantage of this technique is the issue of income taxation. Should the surviving spouse need access to the cash value while the annuitant is under the age of 59 1/2 , a 10% federal tax penalty could apply because of the premature distribution. Likewise, even after the death of the surviving spouse, should the new owner/annuitant need to withdraw any of the cash value, the penalty for premature distributions would be an issue if the owner were under age 59 1/2 .

Finally, many investment options are available when working with an irrevocable trust. In fact, depending on the client, almost anything could be used. However, if income tax liability and underlying investment freedom are concerns, a life insurance policy or an annuity contract could provide income tax deferral and a tax-efficient means of trust asset distribution.

Sonja Hayes is a director for the Retirement & Wealth Strategies Group at Jackson National Life Distributors LLC. Headquartered in Denver, Colorado, the company is the sales and marketing arm of Jackson National Life Insurance Company, Lansing, Mich. She can be reached at .