Tough jobs make for popular TV viewing these days. TV programs explore offbeat occupations ranging from dirty to disgusting to dangerous.
What’s one daunting job, however, that has yet to be spotlighted? The job of acting as a trustee.
Serving as a trustee is no easy task. Being legally and morally bound to manage trust property in a responsible and productive manner — without any personal conflicts of interest — a trustee must act solely and prudently for the benefit of the trust’s beneficiaries.
When faced with the responsibilities and complexities of trust management, trustees may be increasingly ready to consider putting annuity-oriented strategies to work. Are you ready to discuss those strategies with your clients?
A Trustworthy Alternative
All the traditional advantages of nonqualified annuities, plus added ones provided by today’s new features, are attracting attention from trustees. Decision-makers overseeing various types of trusts are open to exploring the significant tax, spendthrift, diversification and income protection advantages that may accompany nonqualified annuities.
As always, proceed with caution. Different sets of rules, each complex, govern annuities and trusts. Mixing the two can result in unexpected and unintended tax and distribution consequences. Building your knowledge of the basics is essential.
Take a Top-Down Look at Trusts
A trust is a fiduciary relationship. One person holds property for the benefit of another. The grantor creates the trust by executing a trust document and transferring property to the trust. The trustee administers the trust according to the terms of the trust document.
The grantor may create a trust during their lifetime (inter vivos) or by will at death (testamentary). Almost any property can be placed in trust. Examples include a residence, a business, and assets such as stocks, bonds, life insurance, annuities and cash. The trustee receives legal title to the property.
A grantor who retains the right to revoke or modify the trust creates a revocable trust. For income tax purposes, the grantor is treated as the owner of the trust and is taxed on trust income. A revocable trust does not remove the trust assets from the grantor’s estate.
A grantor who relinquishes the right to amend, modify, change or revoke the trust creates an irrevocable trust. Property in a carefully drafted irrevocable trust is removed from the grantor’s estate and placed beyond the reach of creditors and judgments.
Why Consider an Annuity?
Nonqualified annuities may interest trustees for many reasons. The potential tax deferral and ability to control the timing of distributions can be important, especially for trustees who want to accumulate income for later distribution. Undistributed gains inside an annuity are not generally defined as trust income under most state trust laws and do not have to be distributed to current income beneficiaries. This can provide flexibility and allow trustees to request distributions only as needed.
Some trustees may be attracted to the financial strength and stability of highly rated insurers. Others may be interested in the income guarantees offered by the many different riders available today. The absence of underwriting also may appeal to grantors and/or annuitants of older ages or failing health.
Tax Implications to Consider
Section 72(u) of the Internal Revenue Code (IRC) provides that a nonqualified annuity contract owned by a non-natural person (such as a trust) generally will not be treated as an annuity contract. Thus, a valuable tax advantage — income tax deferral — may be lost.
However, an exception is provided when the nonqualified annuity contract is held by a trust as an agent for a natural person. For a trust to qualify as an agent for a natural person, all beneficiaries — both income and remainder as well as current and future — must be natural persons. In such instances, income earned on the nonqualified annuity contract each year is not subject to current income tax or the additional 3.8 percent net investment income tax.
This deferral can be extremely valuable for taxable income retained by irrevocable non-grantor trusts.
Consider this: Taxes on trust income are compressed into only five brackets. The highest rate, 39.6 percent, begins at just $12,501 of income for 2017. In comparison, married couples filing jointly don’t reach that rate until $470,701 of taxable income (for 2017).
Next Steps: Explore the Opportunity
Trusts come in many different types. Their potential benefits vary by type and local laws. Annuities may not be appropriate for all of them. Factors such as the purpose of the trust, the terms of the trust and the controlling state law must guide the decision-making.
Still, for clients tackling the tough job of being a trustee, using annuities in trusts can leverage the benefits of both. Pairing sound investment options and innovative planning strategies, a trust-owned annuity may provide flexibility to help pursue a number of wealth goals, including income and estate objectives.