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Repositioning non-qualified annuity assets to minimize taxes and maximize your legacy

By July 10, 2018 July 12th, 2018 Life Insurance
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You’ve spent a lifetime building wealth Your hard work and sound financial decisions have not only provided you with a comfortable retirement, but also the means to gift assets you no longer expect to use to loved ones. If your financial goals have changed, it may be time to consider strategies that can help minimize taxes so that more of your legacy dollars pass to future generations.

The Potential Tax Impact of Annuities Non-qualified annuities can be effective tools for saving money and generating income. However, the same features that made an annuity a great choice for you—tax-deferred growth, guaranteed lifetime income and no required minimum distributions at age 70½—can make it an inefficient tool for transferring wealth to your beneficiaries.

Example 1: Annuity Value Transfers to Beneficiaries In this hypothetical scenario, we assume a 70-year-old owns a non-qualified annuity currently valued at $500,000. If the annuities’ value is $900,470 when death occurs at age 85, how much of that will the beneficiaries keep after taxes?

Annuity Value at Death $900,470

Federal Estate & Income Taxes $224,150

Net to Beneficiaries: $676,320

The Result: The beneficiaries receive notably less than the annuity’s original value–just 75%.

Maximizing the Value of Your Annuity Dollars: After careful consideration, you’ve concluded that you have sufficient retirement assets and do not anticipate relying on an annuity for future income needs.

Repositioning those annuity assets inside an irrevocable life insurance trust (ILIT) may be an effective solution for maximizing the assets that transfer to your beneficiaries.

​This scenario assumes a 70-year-old female annuitizes her $500,000 annuity contract. Electing the “life only” option provides annual, pre-tax income of $37,500, which is guaranteed to continue as long as she lives (note: the amount shown is hypothetical and not based on a specific product). Annuity income consists of principal and interest and a portion of each payment will be taxed as ordinary income (assume 32% rate).   

Example 2: Repositioning Non-qualified Annuity Assets Within an Irrevocable Life Insurance Trust In this hypothetical scenario, our 70-year-old begins distributions from the $500,000 annuity by electing life only annuitization. This provides annual, after-tax income of $29,500.5 Leveraging annual gift tax exemptions, the owner uses the after-tax distributions to pay the $29,500 annual premiums on an ILIT-owned universal life insurance policy.

  1. ​The annuity owner establishes an ILIT
  2. The owner begins annual distributions from the annuity providing $29,500.5 after taxes.
  3. ​Each year, the annuity gifts $29,500 to the ILIT, which funds the life insurance premiums.
  4. At death, the policy’s proceeds will bypass probate and pass to the beneficiaries free of federal estate and income taxes.

In this example #2, the beneficiaries will receive a total of $985,366. That is 46% more than if the money was left in the annuity from example #1.

How could you benefit?

​If properly structured, repositioning annuity assets inside an Irrevocable Life Insurance Trust may help you:

​Maximize your legacy. Although taking distributions from your annuity will trigger a taxable event, those dollars can potentially purchase a significant life insurance death benefit for your beneficiaries. Avoid double taxation. Life insurance proceeds typically bypass probate, and in general, transfer to beneficiaries free of both federal estate and income taxes. Transfer assets out of your estate. Making tax-free gifts to an ILIT can potentially reduce the size of your taxable estate.

Currently, individuals may gift up to $15,000 annually (per donee) and married couples may combine their gifts to double the annual amount to $30,000 (per donee). Plus, as long as you stay under the $15,000 limit, these annual gifts do not count against your $11.18 million lifetime cumulative gift tax exemption or your $11.18 million estate-tax exemption. Collect additional retirement income. This strategy may allow you to enjoy the difference between your annuities’ distributions and the life insurance premiums.