Disposition Of An Annuity Contract

<div class="Section1">Yes.<div class="Section1"><br /> <br /> The payee, however, generally may elect not to have anything withheld, which is commonly chosen. In addition, only the amount that is reasonable to believe is includable in income is subject to withholding, not any return of principal payments.<br /> <br /> If withholding occurs from periodic payments (i.e., an annuitized contract), the amounts are to be withheld at the same rate as wages. Payments are periodic, even if they are variable, if they are payable over a period of more than one year.<br /> <br /> If payments are not periodic, 10&nbsp;percent of the includable amount is withheld. Payments made to the beneficiary of a deceased payee are subject to withholding under the same rules.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> An election out of withholding generally will be ineffective if a payee does not furnish his or her taxpayer identification number (&ldquo;TIN,&rdquo; usually the payee&rsquo;s Social Security number) to the payor or furnishes an incorrect TIN to the payor and the payor is so notified by the IRS.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Payments under qualified pension, profit sharing, and stock bonus plans are discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3972">3972</a>; payments under IRC Section&nbsp;403(b) tax sheltered annuities are discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4083">4083</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4085">4085</a>; and private annuities are discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="603">603</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;&sect; 3405(a), 3405(b); Temp. Treas. Reg. &sect; 35.3405-1T (A-9, A-10, A-12, A-17, F-19 through 24).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 3405(e)(12).<br /> <br /> </div></div><br />

<div class="Section1">Yes.<div class="Section1"><br /> <br /> These contributions generally qualify for the marital deduction, however, and do not require the filing of a gift tax return. There should be no question that an individual&rsquo;s contributions to a spousal IRA would qualify for the marital deduction, so long as the donee spouse is the one who names a beneficiary to receive account proceeds remaining at that spouse&rsquo;s death.<br /> <br /> If the donor spouse (i.e., the contributing individual) designates a beneficiary, the donee spouse&rsquo;s interest in the IRA would be a nondeductible terminable interest and the marital deduction would not be allowed, except in the case of certain joint and survivor annuities ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="619">619</a>).<br /> <br /> </div></div><br />

<div class="Section1">If an employee&rsquo;s interest in a qualified plan is community property ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3984">3984</a>) and the employee gratuitously and effectively designates someone other than his or her spouse to receive a survivor benefit, the value of the benefit conveyed comes equally from the employee&rsquo;s community half and the employee&rsquo;s spouse&rsquo;s community half. The effect of the transaction is to create a gift from the employee&rsquo;s spouse of one-half the value of the benefit conveyed when the conveyance is complete.<a href="#_ftn1" name="_ftnref1">¹</a> The gift is considered by the IRS to be subject to gift tax.<div class="Section1"><br /> <br /> It should be noted that community property law varies from state to state with respect to the power of a spouse to make a gift of community property without the express consent of the other spouse.<br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> If a participant designates the spouse as the beneficiary of a benefit payable under a qualified plan, the participant also should provide for a contingent disposition in case the spousal beneficiary disclaims the benefit or dies first, and in such case, could provide that on death, the spousal beneficiary&rsquo;s interest would pass to that spouse&rsquo;s estate, and the participant&rsquo;s interest would pass to a credit shelter trust that would pay the income interest. In this manner, the participant can take advantage of the unified credit and avoid a gift as to the spouse&rsquo;s interest.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <hr><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; 2513. Prior to TRA &rsquo;86, IRC Section&nbsp;2517 contained an exemption from gift tax for this kind of gift.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; BNA, Estate and Gift Tax Issues for Employee Benefits, Portfolio 378, Detailed Analysis, I.C. (3d ed.).<br /> <br /> </div></div><br />

<div class="Section1">Yes, subject to the limits on deductions for gifts to charities ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="739">739</a>). This does not necessarily mean, however, that gain at the time of gift is avoided.<div class="Section1"><br /> <br /> If a policyholder gives an annuity contract that was issued after April&nbsp;22, 1987, whether in the year it matures or in a year prior to maturity, the policyholder is treated as if he or she received, at that time, the excess of the cash surrender value at the time of the transfer over the policyholder&rsquo;s investment in the contract.<a href="#_ftn1" name="_ftnref1">¹</a> Thus, the policyholder must recognize gain on the contract in the year of the gift. Given that gain is recognized, though, the policyholder&rsquo;s charitable deduction is equal to the full fair market value of the annuity, due to the fact that any embedded gain was recognized at the time of transfer (as otherwise the charitable gift rules limit the deductibility of ordinary income property with embedded gains).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Where an endowment contract (or annuity contract) issued before April&nbsp;23, 1987, is contributed before the year the contract matures, Revenue Ruling 69-102 requires that the donor include in his or her income, in the year the contract is surrendered by the donee (or matures), the excess of the cash surrender value at the time of the gift over the donor&rsquo;s basis. Because gain is not recognized at the time of gift, though, the IRC limits the donor&rsquo;s charitable deduction to the donor&rsquo;s cost basis.<a href="#_ftn3" name="_ftnref3">³</a> (The ruling concerned a gift in the year immediately before the contract matured but may not be limited to that year.)<br /> <br /> For a gift to a charity in connection with purchase of an annuity from the charitable organization, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="607">607</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; 72(e)(4)(C).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 1.170A-4(a).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 170(e)(1)(A).<br /> <br /> </div></div><br />

<div class="Section1">A waiver of the right to receive a qualified joint and survivor annuity or a qualified pre-retirement survivor annuity ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3881">3881</a>) by a nonparticipant spouse is not treated as a taxable transfer by the nonparticipant spouse if the waiver is made before the death of the participant spouse.<a href="#_ftn1" name="_ftnref1">¹</a><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; 2503(f).<br /> <br /> </div></div><br />

<div class="Section1">An irrevocable beneficiary designation would appear to be a gift falling under the broad sweep of IRC Section&nbsp;2511, applying the gift tax &ldquo;whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.&rdquo;<a href="#_ftn1" name="_ftnref1">¹</a> The IRS has ruled, for example, that a retiring federal employee who receives a reduced annuity to provide a survivor annuity for the beneficiary makes a gift subject to gift tax of the value of the survivor annuity by the mere act of retiring.<a href="#_ftn2" name="_ftnref2">²</a><div class="Section1"><br /> <br /> If the beneficiary designation does trigger a gift, it will clearly be one of a future interest, which means it will not qualify for the gift tax annual exclusion.<a href="#_ftn3" name="_ftnref3">³</a> If the beneficiary of the survivor annuity is the employee&rsquo;s spouse, however, the gift generally will qualify for the marital deduction ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="619">619</a>).<a href="#_ftn4" name="_ftnref4">⁴</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; 2511(a); Treas. Reg. &sect; 25.2511-1(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Let. Ruls. 8715010, 8715035, 8811017.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 25.2503-3(c) (Ex. 2).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 2523(f)(6).<br /> <br /> </div></div><br />

<div class="Section1">There is no gift if the purchase of an annuity is a bona fide ordinary business transaction.<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> Where closely related parties are involved, however, a gift is made to the promisor of the amount by which the fair market value of the property exchanged for the annuity exceeds the present value of the annuity.<a href="#_ftn2" name="_ftnref2">²</a> Likewise, a gift can be deemed made to the purchaser of the amount by which the present value of the annuity exceeds the fair market value of the property transferred. There will be no gift even in an intra-family transaction, however, if substantially equal values are exchanged and there is no donative intent found.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> Before May&nbsp;1, 2009, the present value of the annuity generally was determined by use of the current estate and gift tax valuation tables ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="921">921</a>).<a href="#_ftn4" name="_ftnref4">⁴</a> After May&nbsp;1, 2009, the present value is determined under Section&nbsp;7520&rsquo;s actuarial factors.<a href="#_ftn5" name="_ftnref5">⁵</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; Rev. Rul. 69-74, 1969-1 CB 43, Treas. Reg. &sect;&sect; 25.2511-1(g)(1), 25.2512-8.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Rev. Rul. 69-74, supra; <em>Estate of Bell v. Commissioner</em>, 60 TC 469 (1973); <em>Fehrs v. U.S.</em>, 79-2 USTC &para; 13,324 (Ct. Cl. 1979); <em>La Fargue v. Commissioner</em>, 800 F.2d 936 (9th Cir. 1986).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; <em>Ellis Sarasota Bank &amp; Trust Co. v. U.S.</em>, 77-2 USTC &para; 13,204 (M.D. Fla. 1977). <em><em>See also</em></em> Rev. Rul. 76-491, 1976-2 CB 301.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp; Notice 89-60, 1989-1 CB 700; Treas. Reg. &sect;&sect; 20.2031-1, 25.2512-1; <em>Estate of Cullison v. Commissioner</em>, 221 F.3d 1347, 2000-1 USTC &para; 60,376 (9th Cir. 2000).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 25.2512-5(d).<br /> <br /> </div></div><br />

<div class="Section1">Ordinarily, a cash basis taxpayer is treated as having constructively received an amount of cash when it first becomes available to the taxpayer without substantial limitations or restrictions. The taxpayer must report this amount as taxable income even if he or she has not actually received it.<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> When an endowment contract matures, a death benefit becomes payable, or when any type of contract is surrendered, a lump sum payment generally becomes available to the policyholder unless, before the maturity or surrender date, the policyholder has elected to postpone receipt of the proceeds under a settlement option.<br /> <br /> However, a lump sum will not be considered constructively received in the year of maturity or surrender if, within 60 days after the lump sum becomes available and before receiving any payment in cash, the policyholder exercises an option or agrees with the insurer to take the proceeds as an annuity.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> The 60-day extension is allowed only for the election of a life income or other installment-type settlement (those considered annuities ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="495">495</a>)). It does not apply to an election to leave the proceeds on deposit at interest; if a taxpayer wishes to make an election to leave proceeds on deposit at interest and still defer taxation, such an election must be made before maturity or surrender (if available under the contract) to avoid constructive receipt ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="21">21</a>).<br /> <br /> If there is a gain on the contract but the proceeds are not constructively received and instead are received as a life income or installment-type settlement as an annuity, the policyholder is not taxed on the gain in the year of maturity or surrender. Instead, the amounts are taxed as &ldquo;amounts received as an annuity&rdquo; when payments are made, under the standard rules applicable to such payments.<br /> <br /> If there is a gain on the contract and the proceeds are constructively received (as where the election is made after the 60-day period), the full gain is taxable to the policyholder in the year of constructive receipt as if he or she actually had received a one sum cash payment ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="51">51</a>). Because gain <em>has</em> been recognized, if the contract is subsequently annuitized the investment in the contract (cost) would not be premium cost but would be the entire lump sum applied under the settlement option (as though the contract had simply been surrendered with the proceeds reinvested into a new contract as a separate transaction). Although the larger cost would result in a larger excludable portion for the annuity payments, it usually is advisable for the policyholder to avoid being taxed on the entire gain in one year in the first place.<br /> <br /> Even where the cash surrender value is less than net premium cost, it appears that net premiums may be used as &ldquo;cost&rdquo; in determining the exclusion ratio for the annuity payments, provided the cash surrender value is not constructively received in the year of surrender.<a href="#_ftn3" name="_ftnref3">³</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; Treas. Reg. &sect; 1.451-2.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 72(h); Treas. Reg. &sect; 1.72-12.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 72(c)(1); Treas. Reg. &sect; 1.72-6(a)(1).<br /> <br /> </div></div><br />

<div class="Section1">Taxpayers who purchased&nbsp;variable&nbsp;annuities with a view toward generating retirement income may be facing buyout offers from an issuing insurance company, notices that their investment choices are being limited to those that are very conservative, or may simply find themselves facing changed circumstances so that the product no longer makes sense.<div class="Section1"><br /> <br /> For example, a taxpayer who has recently been diagnosed with a disease that is likely to shorten his or her life expectancy may find that surrendering the&nbsp;annuity&nbsp;in exchange for a lump sum payout may better serve his or her reduced need for lifetime income. Other taxpayers may be facing unanticipated expenses and see the buyout as a way to meet those expenses.<br /> <br /> Taxpayers facing the need for an immediate lump sum of cash should also be aware that it may be possible for them to withdraw a portion of the&nbsp;annuity&rsquo;s assets, keeping only a small part of the initial investment in the&nbsp;annuity&nbsp;to maintain the contract&rsquo;s death benefit. Taxpayers who are simply unhappy with the annuity&rsquo;s investment performance may also find this strategy appealing, as they can then invest in another income-producing product while preserving some value in the original&nbsp;annuity.<br /> <br /> For taxpayers who are still attracted to the income-producing feature of a&nbsp;variable&nbsp;annuity, however, it might be best to hold on to the product in the face of a buyout offer, especially if the product offers guaranteed returns that may be unavailable in a replacement product.<br /> <br /> After a taxpayer has determined that his or her best interests will be served by surrendering the product, the surrender charges associated with the&nbsp;annuity&nbsp;still must be taken into account. If the taxpayer has a buyout offer on the table, it is likely that the insurance company has already offered to waive any surrender charges. If the taxpayer has independently decided to surrender, however, he or she may be able to negotiate a waiver, especially if the taxpayer agrees to reinvest the recovered&nbsp;annuity&nbsp;funds with the same carrier that issued the surrendered product.<br /> <br /> It is important that taxpayers realize they will owe taxes upon any gain realized at the time of surrender. If the taxpayer has only held the&nbsp;annuity&nbsp;product for a few years, this gain might not be substantial&mdash;in fact, many&nbsp;variable&nbsp;annuity&nbsp;products that were issued just before the economic downturn in 2008 took&nbsp;years to return owners to the break-even point. Still, for taxpayers who have owned the&nbsp;variable&nbsp;annuity&nbsp;for many years, the tax liability can be substantial&mdash;especially when the new 3.8&nbsp;percent investment income tax for high earning taxpayers (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8647">8647</a>) is taken into account.<br /> <br /> For taxpayers who purchased the annuity product within an IRA, the funds can be transferred in a trustee-to-trustee type rollover transaction, which allows the taxpayer to defer taxation until the funds are withdrawn from the IRA. Taxation can also be deferred if the taxpayer exchanges the undesirable&nbsp;annuity&nbsp;for another&nbsp;annuity product in a tax-free exchange under IRC Section&nbsp;1035.<br /> <br /> </div></div><br />

<div class="Section1">Where an annuity is purchased by a donor on his or her own life and immediately given to another, or when an annuity is purchased by one person for another on the latter&rsquo;s life, the value of the gift is the premium paid for the contract.<a href="#_ftn1" name="_ftnref1">¹</a> If a person purchases an annuity and gives the contract to another person at a later date after the annuity starting date (i.e., once annuity payments have begun), the gift tax value is the single premium the company would charge for an annuity providing payments of the same amount on the life of a person who is the annuitant&rsquo;s age at the time of the gift.<a href="#_ftn2" name="_ftnref2">²</a>&nbsp;The value of a deferred premium-paying annuity is the terminal reserve, adjusted to the date of the gift, plus the unearned portion of the last premium payment ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="119">119</a>).<a href="#_ftn3" name="_ftnref3">³</a><div class="Section1"><br /> <p style="text-align: center;"><strong>Joint and Survivor Annuity</strong></p><br /> Where a donor purchases a joint and survivor annuity for the benefit of the donor and another, the gift tax value is the cost of the annuity less the cost of a single life annuity for the donor.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <blockquote><em>Example</em>. A donor purchases from a life insurance company for $15,198 a joint and survivor annuity contract that provides for the payment of $60 a month to the donor during the donor&rsquo;s lifetime, and then to the donor&rsquo;s sibling for such time as the sibling may survive the donor. The premium that would have been charged by the company for an annuity of $60 monthly payable during the life of the donor alone is $10,690. The value of the gift is $4,508 ($15,198 less $10,690).<a href="#_ftn5" name="_ftnref5">⁵</a></blockquote><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; Treas. Reg. &sect; 25.2512-6(a) (Ex.1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 25.2512-6(a) (Ex. 2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; <em>Commissioner v. Edwards</em>, 135 F.2d 574 (5th Cir. 1942).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 25.2512-6(a).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect; 25.2512-6(a) (Ex. 5).<br /> <br /> </div></div><br />