In a previous LifeHealthPro article I discussed the potential benefits of using variable annuities (VAs) in trusts.

This article provides additional details on structuring such an arrangement.

Scenarios

In its presentation, “Advanced Techniques: Using Trusts with Annuities,” Jefferson National points to four trusts that can benefit from VAs’ tax-optimization. 

As noted in the presentation: “In most states, the undistributed gains inside of an annuity are not defined as trust income, and therefore do not have to be distributed currently to the income beneficiaries.”

Specifically, here are the four trusts from the presentation:

Credit shelter trust
Net income with makeup charitable remainder trust (NIMCRUT)
Revocable trust
Special needs trust/Supplemental needs trust/Bubble gum trust
 

The details of each trust’s purpose and setup are beyond the scope of this article.

Regardless of the trust type, however, a key reason for a VA investment is to increase control over the timing of trust income and taxation.

 

Mechanics

The VA contract requires an owner, annuitant and death beneficiary. In many cases, the trust can be both the contract’s owner and beneficiary in each of the trusts listed above.

The logic behind having the trust as beneficiary is that it is the trust document that directs how the assets should be used, says Kevin Sullivan, chief of sales at Jefferson National in Louisville, Kentucky.

“By naming the trust as beneficiary you ensure that the assets, even upon distribution, will be given back to the trust and they will be then aligned and distributed out according to the trust documents,” he says.

“If you were to pass those out to the beneficiary you’re removing those assets outside of the trust…It’s not something that you have to do, but it’s a way to retain that same level of control that you were trying to obtain when you created the trust document.”

Distribution Downside

When a trust is the death beneficiary, annuities are subject to distribution rules that differ from the rules for individual beneficiaries.

Specifically, a trust named as beneficiary is restricted to taking a lump sum distribution or a five-year payout and cannot receive income for life. 

One possible planning response to the five-year required distribution rule is to name an annuitant who is considerably younger than the trust grantor.

Sullivan gives the example of a grantor setting up a trust for one of her children and naming the child as the annuitant.

That approach increases the likely span of tax deferred growth for the VA. “One of the benefits is that tax deferral and the best way to maximize that is to elongate the period that you’re deferring those taxes,” he says.

“So you just need to think about that at the beginning when you set it up so that you’re not having a trigger that’s going to happen within the next year or two.”

Another planning option to manage taxation of trust distributions, which some annuities my offer, is for the trust agreement to allow distribution of the annuity contract in-kind while the annuitant is still alive. 

Additional resources 

Obviously, the decision to use a VA in a trust involves multiple considerations when designing the contract and trust to meet clients’ goals.

If you’re interested in learning more about the regulations and technical details, Michael Kitces has written several informative articles on VAs in trusts that are posted on www.kitces.com.