A longtime client comes to you one afternoon with a predicament — they have owned an apartment building for 10 years and are getting ready to retire. They don’t, however, want to deal with the headaches involved with managing a property, yet they also don’t want to be stuck with a bill for capital gains taxes. What they are looking for, essentially, is:

  • The ability to defer their capital gains tax
  • A safe and secure income stream
  • A low to no-maintenance solution

In the past, a financial advisor or agent would probably direct them toward a 1031 exchange or installment sale, or advise them to simply pay the tax. While these strategies are all valid, though, they could not help this client reach their goals and often to not net commissions once these older strategies are enacted.

In 2005, however, an alternative solution appeared on the marketplace: a structured sale annuity, which allows clients who are selling appreciated assets to safely defer their capital gains taxes while providing them with a guaranteed income stream.

How does a structured sale annuity work?
While these annuities have been used for 30-plus years in the structured settlement industry, they are just now coming into the realm of appreciated assets.

In essence, structured annuities are:

  • Traditionally fixed single premium annuities.
  • Usually owned with a third-party company, partially owned by the annuity issuer, and 100 percent guaranteed by the issuer (the ownership by a third party is necessary to avoid a constructive receipt for the beneficiary.
  • Products where the beneficiary is not taxed on the funds until payments are received – and in some cases, they are exempt from state and federal income taxes.

Generally, the structured sale annuity allows the seller of highly appreciated assets (such as closely held businesses or homes) to defer their capital gains taxes over whatever timeframe they select and receive a guaranteed stream of income backed by the financial strength of the issuer. Buyers who implement this strategy are not at risk of defaulting, either, as they are with traditional installment sales.

Commissions on annuities can reach as high as 4 percent of the annuity premium.

Potential drawbacks
Just as with any capital gains deferral strategy, there are some drawbacks. For instance:

  • The annuity is very flexible in the type of payment stream that can be created; however, once the annuity contract is issued, it is locked in per the terms of the contract and cannot be changed.
  • Because of the guaranteed nature of the product, the returns are relatively conservative. The average pre-tax return is between 4 and 5 percent, with the maximum return currently reaching close to 5.5 percent.
  • Most advisors have still not yet heard of this annuity strategy, so it often requires education on the part of any CPA partners or other advisors helping your client.

Succeeding as an agent often requires a search for hidden opportunities in your current business and a bit of outside-the-box thinking. New annuities – or those with newer applications – can be worth exploring in order to help expand your market and aid any clients in a situation such as that described above.

Trevor Mauch is vice president of Settlement Professionals Inc. He can be reached at 800-666-5854.