Annuities and the Estate Tax

<div class="Section1">If a donor irrevocably names one person to receive the income for life and irrevocably names another to receive the refund, the value of the refund at the donee-annuitant&rsquo;s death should not be includable in the donee-annuitant&rsquo;s gross estate. IRC Section&nbsp;2039 is not applicable because the donee-annuitant is not the purchaser of the contract ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="620">620</a>).<div class="Section1"><br /> <br /> However, if the refund is payable to the donee or the donee&rsquo;s estate (or the donee can otherwise direct where the refund goes), it will generally be included in the donee&rsquo;s estate for estate tax purposes.<br /> <br /> </div></div><br />

<div class="Section1">A married couple typically purchases a Medicaid compliant annuity if the two spouses are in unequal health positions to ensure that the healthy spouse—known as the “community” spouse—has sufficient income, while allowing the second, less healthy, spouse to qualify for Medicaid assistance in paying for long-term care expenses, typically within a nursing home.</div><br /> <div class="Section1"><br /> <br /> Rather than treating the purchase of the annuity as an impermissible asset transfer effected in order to meet Medicaid’s means-tested eligibility requirements, if the requirements discussed below are satisfied, the federal Deficit Reduction Act (DRA) treats the purchase as a permissible exempt investment, and the annuity payout stream is shielded as the community spouse’s income.<br /> <br /> In order to qualify as a Medicaid compliant annuity under the DRA, the terms of the annuity contract must satisfy certain criteria. The income from the annuity contract must be payable to the community spouse, the contract must be irrevocable, and the payment term must be based on the life expectancy of the community spouse.<br /> <br /> This is because, in a situation where one spouse requires long-term care and the other remains in the community, the assets of the community spouse are counted—up to a certain level—in determining whether the institutionalized spouse qualifies for Medicaid, but the <em>income</em> of that spouse is not counted.<br /> <br /> Further, the state must be named as the remainder beneficiary on the contract, allowing it to receive up to the amount that it has paid for the institutionalized spouse’s long-term care.<br /> <br /> </div>

<div class="Section1">If a decedent was receiving a straight life annuity, there is no property interest remaining at the decedent&rsquo;s death to be included in the decedent&rsquo;s gross estate, as payments terminated at death.<div class="Section1"><br /> <br /> If a contract provides a survivor benefit (as under a refund life annuity, joint and survivor annuity, or installment option), tax results depend on whether the survivor benefit is payable to a decedent&rsquo;s estate or to a named beneficiary and, if payable to a named beneficiary, on who paid for the contract.<br /> <br /> If payable to a decedent&rsquo;s estate, the value of the post-death payment or payments is includable in the decedent&rsquo;s gross estate under IRC Section&nbsp;2033 as a property interest owned by the decedent at the time of his or her death. If payable to a named beneficiary, the provisions of IRC Section&nbsp;2039(a) and IRC Section&nbsp;2039(b) generally apply and inclusion in the gross estate is determined by a premium payment test. Thus, if a decedent purchased the contract (after March&nbsp;3, 1931), the value of the refund or survivor benefit is includable in the decedent&rsquo;s gross estate.<br /> <br /> In the event a decedent furnished only part of the purchase price, the decedent&rsquo;s gross estate includes only a proportional share of this value ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="623">623</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="627">627</a>).<br /> <br /> The foregoing rules do not apply to death proceeds of life insurance on the life of a decedent ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="81">81</a>). In addition, special statutory provisions apply to employee annuities under qualified pension and profit-sharing plans ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3982">3982</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3983">3983</a>), to certain other employee annuities ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="632">632</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="633">633</a>), and to individual retirement plans ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3712">3712</a>).<br /> <br /> </div></div><br />

<div class="Section1">Life insurance or annuity proceeds payable to a surviving spouse qualify for the marital deduction if certain conditions are met ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="191">191</a>). If proceeds used the marital deduction in the first spouse&rsquo;s estate and the contract provides a survivor benefit to the surviving spouse&rsquo;s estate or to a person surviving the surviving spouse, then the proceeds usually are includable in the surviving spouse&rsquo;s estate.<div class="Section1"><br /> <br /> If the surviving spouse receives a straight life annuity, there is no property interest remaining at his or her death to be included in his or her gross estate.<br /> <br /> </div></div><br />

<div class="Section1">If payable to the annuitant’s estate, it is includable in his gross estate under IRC Section 2033, as a property interest owned by him at death.</div><br /> <div class="Section1"><br /> <br /> If payable to a named beneficiary, and the <em>annuitant</em> purchased the contract (after March 3, 1931), it is includable in the annuitant’s gross estate under IRC Section 2039(a). It is immaterial whether the beneficiary designation was revocable or irrevocable.<br /> <br /> If the refund beneficiary is a charitable organization, the value is included in the annuitant’s estate, but the estate is also entitled to a charitable deduction for the value of the transfer to the charitable organization.<a href="#_ftn1" name="_ftnref1">¹</a> However, where a decedent has directed his executor to purchase a refund annuity for a personal beneficiary and to name a charitable organization as a refund beneficiary, the decedent’s estate is not entitled to a charitable deduction for the value of the refund.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 2055.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.     Treas. Reg. § 20.2055-2(b); <em>Choffin’s Est. v. U.S.</em>, 222 F. Supp. 34 (S.D. Fla. 1963).<br /> <br /> </div>

<div class="Section1">In the usual private annuity transaction ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="603">603</a>) where a decedent is the sole annuitant, the annuity payments cease at the decedent&rsquo;s death and nothing is left to be taxed in the estate. If benefits are payable to a survivor under the terms of a private annuity agreement, the value of the benefits is includable in the decedent&rsquo;s estate ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="921">921</a>). Survivor benefits paid to a surviving spouse under a joint and survivor annuity should qualify for the marital deduction, though.<div class="Section1"><br /> <br /> If the transaction resulted in a gift from the annuitant to the obligor ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="586">586</a>), the annuitant&rsquo;s death within three&nbsp;years of the transaction may result in the value of the gift, plus gift tax paid, being included in the deceased annuitant&rsquo;s gross estate ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="827">827</a>). If an annuitant&rsquo;s death does not occur within three years, but the gift was a taxable gift, the gift will be an adjusted taxable gift for purposes of the estate tax computation in the annuitant&rsquo;s estate.<br /> <br /> In the usual private annuity transaction, an annuitant&rsquo;s transfer of property given in exchange for the annuity is complete and absolute. Under such circumstances, no part of the transferred property is includable in the annuitant&rsquo;s estate. If, however, the annuitant retains at death an interest in the property transferred, the value of the property could be includable in the annuitant&rsquo;s gross estate under IRC Sections 2033, 2036, 2037 or 2038 as may be appropriate under the circumstances.<br /> <br /> </div></div><br />

<div class="Section1">Yes.<div class="Section1"><br /> <br /> If an employee was receiving payments under the contract when he or she died, or if the employee would have had the right to receive payments had he or she lived, the value of the death benefit is includable in the employee&rsquo;s gross estate.<a href="#_ftn1" name="_ftnref1">¹</a> It is immaterial whether the employee&rsquo;s rights were forfeitable or nonforfeitable before death.<a href="#_ftn2" name="_ftnref2">²</a> Premiums paid by the employer are considered as having been paid by the employee himself.<a href="#_ftn3" name="_ftnref3">³</a> For tax sheltered annuities purchased for employees of tax-exempt organizations and public schools, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="633">633</a>.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 2039(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 20.2039-1.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 2039(b). <em>All v. McCobb</em>, 321 F.2d 633 (2d Cir. 1963); <em>Estate of Bahen v. Commissioner</em>, 305 F.2d 827 (Ct. Cl. 1962); <em>Estate of Wadewitz v. Commissioner</em>, 39 TC 925 (1962), <em>aff&rsquo;d</em>, 339 F.2d 980 (7th Cir. 1964).<br /> <br /> </div></div><br />

<div class="Section1">In order to avoid the potential tax and financial repercussions that a lump sum transfer can create, many individuals wish to protect their heirs by providing structure to the way assets are inherited. For these taxpayers, annuities, though commonly used as retirement income planning tools, can provide the solution.</div><br /> <div class="Section1"><br /> <br /> A taxpayer may wish to use annuities to structure an inheritance for a variety of reasons. The reasons for using an annuity as a wealth transfer vehicle often mirror those that apply when a taxpayer is planning for retirement—the annuity creates a stream of consistent income over time, guaranteeing that the taxpayer’s beneficiary is provided for far into the future. This strategy can provide protection for heirs who might be otherwise unable to manage a large one-sum payment, or who might have financial problems that could cause them to spend a large sum too quickly.<br /> <br /> Some annuity contracts also offer a feature called a restrictive endorsement that can prevent the heir from selling or assigning his or her rights in the annuity contract, providing further protection for the income stream.<br /> <br /> Further, individuals might wish to include an annuity in their estate planning in order to ensure that specific beneficiaries are provided for outside of the overall estate plan. Purchasing annuity products can provide income security for those specified heirs while allowing the remaining estate assets to be used to accomplish other goals—such as satisfying estate expenses or allowing remaining assets to be invested more aggressively in riskier investments that have the potential to generate more growth.<br /> <br /> Structuring the payments so that they occur over time, as an annuity stream, rather than as a lump sum payment, can help the account beneficiaries avoid a large up front tax liability. This is because, unlike life insurance death proceeds, proceeds received under an annuity contract are not entirely tax-exempt and a lump sum death benefit would trigger income tax on the entire gain in the year of receipt.<br /> <br /> </div>

<div class="Section1"><br /> <br /> Generally, yes.<br /> <br /> The amount payable on death before maturity is not life insurance and, therefore, the estate tax rules for annuities apply.<br /> <br /> If a death benefit is payable to an annuitant&rsquo;s estate, its value is includable in the gross estate under IRC Section&nbsp;2033, and it is considered to be a property interest owned by the annuitant at the time of death.<br /> <br /> If a death benefit is payable to a named beneficiary and an annuitant purchased the contract after March&nbsp;3, 1931, the value of the death benefit generally is includable in the gross estate under IRC Section&nbsp;2039, whether or not the right was reserved to change the beneficiary. If the individual purchased the annuity as a gift for another person, and retained no interest in the annuity payments, incidents of ownership, or refunds, the value of the annuity ordinarily will not be includable in the individual&rsquo;s gross estate ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="628">628</a>).<br /> <br /> The same rules apply to the proceeds of a retirement income endowment if the insured dies after the terminal reserve value equals or exceeds the face value.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> For example, an employer purchases a contract from an insurance company to provide an employee, upon retirement at age 65, with an annuity of $100 per month for life, and continues to pay a similar annuity to his beneficiary upon the employee&rsquo;s death after retirement. The contract provides that if the employee dies before reaching retirement age, a lump sum payment of $20,000 will be paid to his beneficiary instead of the annuity. Assume that the reserve value of the contract at the retirement age is $20,000. If the employee dies after reaching retirement age, the death benefit to the beneficiary would be an annuity, which would be includable in the employee&rsquo;s gross estate under Section 2039 (a) and (b). If, on the other hand, the employee dies before reaching his retirement age, the death benefit to the beneficiary would be insurance under a policy on the life of the decedent since the reserve value would be less than the death benefit.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 20.2039-1(d).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 20.2039-1(d) (Ex.).<br /> <br /> </div></div><br />

<div class="Section1">The value is the amount the same insurance company would charge the survivor for a single life annuity as of the date of the first annuitant’s death.<a href="#_ftn1" name="_ftnref1">¹</a> Where it can be proven that the survivor’s life expectancy is below average, it may be possible to obtain a valuation based on the survivor’s actual life expectancy at the date of the decedent’s death.<a href="#_ftn2" name="_ftnref2">²</a> For example, lower valuation has been obtained on proof that the surviving annuitant’s life expectancy was short because of an incurable disease.<a href="#_ftn3" name="_ftnref3">³</a></div><br /> <div class="Section1"><br /> <br /> Even if an executor elects to value estate assets as of six months after death (alternate valuation), a survivor’s annuity is valued at the date of death. The date of death value is used, despite the election of an alternate valuation, where any change in value after death is due only to lapse of time.<br /> <br /> If a surviving annuitant dies during the six months following the first annuitant’s death, a lower valuation may be obtained by electing alternate valuation. Thus, in one case, where the survivor died before the optional valuation date, the value at the optional valuation date was determined by subtracting the cost of an annuity as of the survivor’s date of death from the cost of an annuity as of the first annuitant’s date of death.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     Treas. Reg. § 20.2031-8(a)(3) (Ex.1); <em>Estate of Mearkle v. Commissioner</em>, 129 F.2d 386 (3d Cir. 1942); <em>Estate of Welliver v. Commissioner</em>, 8 TC 165 (1947);<em> Estate of Pruyn v. Commissioner</em>, 12 TC 754 (1949), <em>rev’d,</em> 184 F.2d 971 (2d Cir. 1950); <em>Christiernin v. Manning</em>, 138 F. Supp. 923 (D.N.J. 1956).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.     <em>Estate of Jennings v. Commissioner</em>, 10 TC 323 (1948).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.     <em>Estate of Halliday by Denbigh v. Commissioner</em>, 7 TC 387 (1946), <em>acq</em>., 1953-1 CB 4; <em>Estate of Hoelzel v. Commissioner</em>, 28 TC 384 (1957), <em>acq</em>., 1957-2 CB 3.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.     <em>Estate of Hance v. Commissioner</em>, 18 TC 499 (1952).<br /> <br /> </div>