The Devil is in the Details – Understanding Annuities

Meme used for blog on by Attorney Matt Schwartz

What is an Annuity?

Recently, I was consulting with a client who owned several nonqualified annuities. A nonqualified annuity is an investment where an individual invests after-tax dollars with an annuity company in exchange for lifetime income guarantees and deferred taxes on any growth earned during the time that the assets are owned by the annuity. Usually, the costs of these annuities to individual investors are the significant commissions to the people who sell these annuities. Despite these commissions, nonqualified annuities are a common way for investors to save additional taxes when they have already maxed out the opportunities to save taxes through qualified plans and Roth IRAs.

Ownership of an Annuity by a Trust

What was unusual about this client’s situation was that the annuity was owned by the spouse’s Revocable Living Trust rather than by the annuitant. I believe the reason this form of ownership was recommended to them at the time they purchased the annuity was to have the proceeds of the annuity paid to the spouse’s Revocable Living Trust so that the proceeds would avoid probate at the surviving spouse’s death. If the annuity is owned by a Trust, then the proceeds will be paid to the Trust.

Although this ownership arrangement accomplishes the goal of avoiding probate on these assets at both spouse’s death, it took away a very important opportunity for the surviving spouse. Not only did the surviving spouse lose the opportunity to take advantage of the spousal continuation benefit to continue the tax deferral on the growth in the annuity until advanced age (90 under most policies) or death, but more importantly the annuity had to be fully liquidated within five years as a lump sum distribution (one distribution) meaning that the spouse had to recognize all of the deferred income from the annuity at one time. Since these annuities had several hundred thousand dollars of deferred income, the immediate taxation to a surviving spouse would have been significant (would have likely be over $100,000 in this particular case) which would have substantially reduced the initial benefit of deferring the taxes.

Ownership of an Annuity by an Individual

A better alternative is to have these policies owned by the annuitant and name the spouse as the primary beneficiary and a trust, if appropriate, as a successor beneficiary. Naming the spouse as the primary beneficiary allows the spouse in most cases to continue the tax deferral of the annuity which is normally advantageous. If the spouse chooses not to continue the annuity, he or she can choose to put the proceeds in their Revocable Trust (if they created one) or name a beneficiary on the account where they invest the proceeds (not what we normally recommend because of limited distribution options). Although we would likely recommend that the spouse continue the annuity in many circumstances, it is good for the surviving spouse to have options.

Should the Beneficiary of an Annuity be a Trust or an Individual?

The more interesting question is the successor beneficiary of the annuity. Some companies will permit a Revocable Trust to be a beneficiary and allow the individual beneficiaries of the trust to stretch out the proceeds over their lifetimes. However, most annuities require a five-year payout of the annuity to the trust (many of these distributions must be one-time distributions of the entire annuity within five years). For a trust with a subtrust for a spendthrift or special needs beneficiary, this immediate taxation can add insult to injury by forcing much of this taxation to be at the 37% maximum federal income tax rate.

In certain situations, liquidation of an annuity as a lump sum distribution may need to be considered by a beneficiary if the distribution options are limited to life income options which involve the risk of a loss of principal if the beneficiary does not live to his or her life expectancy.


It is crucial to have the right owner and beneficiary of a nonqualified annuity. To know the optimal owner and beneficiary, it is important to ask the right questions about the annuity. The attorneys at Lange Legal Group, LLC are trained to analyze these annuities and ask the right questions on your behalf. Please do not hesitate to reach out to Matt Schwartz, Esq., if you have questions about the ownership and beneficiary options of these annuities or other estate planning questions.

Contact Matt Schwartz, Attorney at the Lange Financial Group for Estate Planning needs including Wills.

The Hazards of Naming Different Beneficiaries for Different Accounts

It is quite common in my practice for clients to say they want one particular account to go to one beneficiary and a different account to another beneficiary. The accounts might reflect the relative proportionate value that the client wants each of the different beneficiaries to receive, but I think this can turn into a nightmare.

• You will have a terrible time trying to keep track of the different
distribution schedules.

• As the different investments go up or down, the amount going to the different heirs would also go up and down, which is probably not the intent.

• A beneficiary designation may say, “ I leave my Vanguard account to beneficiary B and my Schwab account to beneficiary A. ” If during your lifetime you switch or transfer money from Vanguard to Schwab, you have, in effect, changed who is going to get what, and that may not be your intention.

In general, I prefer one master beneficiary designation for all IRAs, retirement plans, 403(b)s, 401(k)s, and the like. In it I describe distributions as I would in a will or irrevocable or revocable trust. That way, we can avoid mistakes and simplify estate administration after the retirement plan owner dies.

I recognize that, for investment purposes, people use different accounts for different beneficiaries. For example, you might treat the investments of a grandchild beneficiary differently from those of a child or spouse. Under those circumstances I would be willing to bend and accept different beneficiaries for different accounts.

The one area where it might make sense to direct certain money to particular beneficiaries is FDIC insured deposits. At press time, the amount that the FDIC would insure rose from $ 100,000 to $ 250,000 through 2009. Assuming the money is outside the IRA (there are different protections for IRAs) one way to get more FDIC insurance is to have different beneficiaries with different paid on death designations. If you are a parent with four kids and you have four $ 250,000 CDs, you can do a pod account for each child and have the entire amount federally guaranteed. If the money was in an IRA, you are also insured up to $ 250,000 but you can ’ t get additional coverage by naming additional beneficiaries.

Retire Secure! Pay Taxes Later – The Key to Making Your Money Last, 2nd Edition, James Lange, page. 271-272