Using Trusts With Annuities Spurs Questions



Using Trusts With Annuities Spurs Questions

By Norse N. Blazzard and Judith A. Hasenauer

We are frequently asked questions about the use of trusts with annuity contracts. In most instances, the questions relate to having a trust act as the legal owner of an annuity. The basic rules applicable to trust ownership of annuities are contained in Section 1572(u) of the Internal Revenue Code.

This section states that ownership of an annuity by a non-natural person will cause the annuity to lose the tax deferral afforded to annuities in general. Section 1572(u) provides an exemption to the prohibition of ownership by a non-natural person so long as ownership is vested in a "trust or other entity as an agent for a natural person."

The limitations on ownership of annuities by non-natural persons was intended by Congress to make it more difficult to use annuities to fund corporate non-qualified deferred compensation plans.

The Congressional intent was not to prevent the use of trust ownership of annuities in non-corporate situations. Nevertheless, the language in the Internal Revenue Code is broad enough that any ownership of an annuity by a non-natural person must be carefully planned in order to avoid adverse tax consequences.

Use of annuities with revocable living trusts.

General annuity tax law does not make any differentiation among types of trusts.

Any type of trust would presumably qualify for the exemption so long as it is an "agent for" a natural person. To date, there have been no regulations promulgated to interpret or otherwise provide guidance with respect to what activities a trustee can perform that would cause the Internal Revenue Service to determine that the trustee is not merely "an agent for" a natural person.

Likewise, there have been few other interpretations issued by the IRS in the form of Private Letter Rulings or Revenue Rulings that give us any real guidance on the questions raised. The legislative history for Section 1572(u) seems to indicate that Congress intended that a trust, to be eligible for the exemption, must hold the contract as a nominal owner and the beneficial owner must be a natural person.

Unfortunately, there is no bright line that would clearly indicate the elements of "nominal" ownership and what type of trust provisions interfere with such "nominal" ownership if an annuity owned by a trust is to be treated as an annuity for tax purposes. It should be noted that the IRS has indicated it is currently studying this "agency" exemption under Section 1572(u).

Many people use revocable living trusts as substitutes for wills. Obviously, such a person who owns an annuity contract may have an important reason to have such annuity held by the trust.

We believe there is generally nothing inherent in a revocable living trust that would make a trustee more than "an agent for" a natural person--i.e., the beneficiary (ies) of the trust. Thus, if we have a determinable natural person or persons for whom the trust is acting as agent, there is nothing in a living trust that would cause the annuity to fail as an annuity for tax purposes.

Use of annuities with family trusts.

Family trusts have become popular financial planning tools. If an annuity is a significant family asset that the family members would like to have owned by the family trust, there should be no reason why it could not be incorporated in the trust. If we have determinable natural persons for whom the trust acts as agent, the Section 1572(u) exemption should be available.

Structuring an annuity contract to be owned by a trust.

Any annuity contract that is to be owned by a trust should have appropriate ownership designations on the contract data page or similar page of the annuity contract. These ownership provisions should always disclose the trust status and show the natural person(s) for whom the trust is acting.

Distributions on death under a trust-owned annuity.

Our previous articles have discussed the requirements that an annuity contract must contain specified language requiring distribution of contract values on the death of the "holder" of the contract.

The Internal Revenue Code states that if a non-natural person is the owner of an annuity contract, then the annuitant is treated as the "holder" for purposes of the distribution on death rules.

Thus, if the annuitant dies and the annuitant's spouse is the beneficiary of the annuity contract, there should be no reason why the spousal beneficiary rules would not apply. On the other hand, if the trust itself is the beneficiary, then no spousal beneficiary treatment would apply.

The IRS has recognized look-through treatment for spousal beneficiaries in qualified plans but has not done so for trusts as beneficiaries of non-qualified contracts.

If one spouse is the annuitant and the other the beneficiary, then the contract can be continued. If it is the desire to continue ownership of the annuity by the trust, then it is probably best for both spouses to be named as joint annuitants and as joint beneficiaries.

If this is done, then regardless of which one dies first, the spousal beneficiary rules will apply. The spousal beneficiary rules apply only when the spouse is specifically named as a beneficiary. Joint ownership alone is not sufficient!

Obviously, the technical treatment of ownership of annuity contracts is a complex subject--particularly when a trust is used. Nevertheless, such ownership may be important to annuity purchasers and it is important for sales personnel and insurers to understand the proper method to structure such ownership.

Mr. Blazzard and Ms. Hasenauer are principals in the Blazzard, Grodd & Hasenauer, P.C. law firm, based in Westport, Conn. and Hollywood, Fla. Mr. Blazzard is immediate past chair of National Association for Variable Annuities, and Ms. Hasenauer co-chairs NAVA's regulatory affairs committee.

 

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