Trusts may frequently be good prospects for annuity sales. Often with large amounts of liquid assets, trustees may seek the advantages of guarantees, tax deferral or the limited downside risk that annuities and their riders may provide.
Although an annuity may be appropriate purchase for many trusts, questions should be asked before making a purchase. Among them:
? Is the trust permitted to buy annuities? The trust language and state law should be examined.
? What is the trust’s investment objective? Does this objective square with the risks, benefits, costs and limitations associated with the annuity product under consideration? Is upside potential or downside protection desired? Consider whether annuity riders will help meet the investment objectives.
? Is the trust a qualified retirement plan trust under Section 401? If so, then issues respecting plan qualification, discrimination, administration and distribution may be raised. This article is primarily considering non-qualified trusts, but many of the questions referenced here may also apply to qualified plan trusts.
? Who are the trust beneficiaries and what are their beneficial interests? Will an annuity purchase impinge on any beneficiaries’ rights? The rights of both income and remainder beneficiaries must be considered.
? What income distributions does the trust require? For example, must all income be distributed to a surviving spouse? If so, the purchase of a deferred annuity may impair the spouse’s income unless the trustee has the power to withdraw appropriate amounts from the annuity each year. Guaranteed living benefit riders may be helpful in such situations.
? Would the trust qualify as an exception to the non-natural person rule? For example, are any trust beneficiaries (even contingent beneficiaries) not individuals? If they are not individuals for the purpose of the non-natural person rule, any gain in the annuity contract would be taxed as ordinary income to the owner each year.
IRC Section 72(u)(1) provides that if an annuity contract is held by a trust or other entity as an agent for a natural person, then the contract will be treated as an annuity contract and tax deferral will not be lost under ?72(u)(1). If a trust beneficiary is a business or corporation, then this “trust exception” would not apply.
? Is spousal continuation of the annuity desired after the death of the annuitant? If so, trust ownership may not be the best choice. See discussion below.
? Is it expected that the beneficiary will annuitize the annuity death benefit upon the death of the annuitant? If so, trust ownership may not be the best choice.
? Will trust beneficiaries be receiving distributions from the trust before age 59 1/2 ? If so, the 10% federal tax on premature distributions may apply to the portion of these distributions that represent gain in the contract.