The tax man commeth

2. Weigh your client’s “stretch” options. So-called stretch rules allow heirs both spousal and non-spousal who inherit assets (including annuity contracts that haven’t been annuitized) inside a qualified retirement plan to stretch distributions over their lifetimes, meaning they can dodge the heavy tax burden that accompanies a one-time, lump-sum distribution of a death benefit. But what about when the inherited annuity contract resides in a non-qualified retirement account? In those cases, says Vashko, it may be worthwhile to consider a specific type of annuity contract that comes with a non-qualified stretch feature. Such products are available from some, but not all, annuity manufacturers (including Jackson), he notes, so advisors should shop around. When putting such a product on the table for discussion, it’s also wise, he says, for advisors to involve the client’s heirs in the discussion, since the decision about whether to “stretch” distributions from the annuity ultimately will be theirs.

3. Discuss the distinctions between, and the ramifications of, spousal and non-spousal beneficiaries and owners, and act accordingly. In situations where one spouse owns a deferred annuity of which the other spouse is beneficiary, and the owner dies, the surviving spouse can simply elect to continue deferring distributions from the contract. However, the tax code doesn’t provide non-spousal beneficiaries such a luxury, according to Ivers. Transferring the death benefit to them may trigger a taxable event, an important estate planning distinction. Similar rules apply to joint non-spousal ownership of a deferred annuity contract, notes Vashko. “The moral of the story,” he says, “is that in many cases, non-spousal ownership [of an annuity contract] does not make sense.” Permanent life insurance can be a more tax-efficient wealth transfer tool in such cases.

4. Be heady about gifts from the heart. Think twice before giving an annuity contract as a gift to a person or charity, because as well-intentioned as the gift may be, it can trigger a tax double-whammy, says Vashko, where the person giving the gift may be obligated to pay taxes on capital gains within the contract while the recipient is on the hook to pay gift taxes. In the same vein, Vashko recommends against using non-qualified money to buy an annuity contract for the purpose of putting it inside an UTMA or UGMA custodial account to fund the college education of a child or grandchild. Potentially steep penalties for early withdrawals and a lack of control over how the recipient uses the funds once he or she hits age 18 make such an arrangement less appealing than alternatives such as the 529 college savings plan, he says.

5. Help clients dodge unnecessary redundancies. Income tax deferral is an inherent trait of the deferred annuity. Since assets in qualified plans are also afforded tax deferral, “if you’re going to place a deferred annuity inside any tax-exempt or tax-deferred vehicle such as an IRA, you should have some other compelling reason, besides income tax deferral, for doing so,” contends Ivers. Accessing annuity guarantees on lifetime income, death benefit and principal may be considered compelling reasons, he notes.

Similarly, it may be redundant to put a deferred annuity inside a living or irrevocable trust for the purposes of protecting those assets from probate and regulating income distributions to an heir, says Vashko. “Those are things [annuity] contracts can handle without a trust.”