Congress created the “stretch” rules for retirement
accounts and annuities that allow distributions to be taken in small amounts
over the life expectancy of the beneficiary.
However, the rules for stretching an inherited account
are more problematic in the case of a trust as the beneficiary, because a trust
is not a living breathing human being, and therefore doesn’t have a life
expectancy to stretch against!
Accordingly, beneficiaries of inherited annuities
generally have three options for how to take distributions after the death of
the original annuity owner
– If the designated beneficiary
is a surviving spouse, the beneficiary can continue the contract in his/her own
name (known as the “spousal continuation” rule, similar to the spousal rollover
of an IRA);
– If the designated beneficiary
is a non-spouse (i.e., any other living breathing human being besides the
annuity owner’s surviving spouse), the beneficiary can stretch distributions
over his/her life expectancy beginning in the year after death; and,
– If the beneficiary is a
non-designated beneficiary, the annuity must be liquidated within 5 years of
the annuity owner’s death.
In the case of retirement accounts, the IRS and Treasury
have created the “see-through” trust rules that allow post-death required
minimum distributions to occur based on the life expectancy of the underlying
trust beneficiaries.
However, in the case of annuities, no see-through trust
rules exist, compelling trusts to instead liquidate inherited annuities over
the far-less-favorable 5-year rule!
While non-qualified annuities (i.e., those NOT owned in a
retirement account) do not subject their owners to required minimum
distributions (RMDs) while alive, the beneficiary of an inherited annuity is
subject to post-death RMD rules that are very similar to those applicable to
retirement accounts.
In fact, the rules for post-death RMDs from annuities are
virtually identical to those for retirement accounts where the word “annuity”
is simply substituted for the word “retirement account” instead!
On the other hand, when an annuity is held inside a
retirement account, the retirement account rules do apply (as
they would for all retirement accounts, regardless of whether the account owns
an annuity or some other investment asset).
However, annuities have no such regulations defining how
to make a “see-through” trust that can qualify as a designated beneficiary. As
a result, when a trust is named as the beneficiary of an annuity, it is “stuck”
with the 5-year rule as a non-designated beneficiary!
Notably, though, this is
about a trust as the beneficiary of an annuity. The consequences
of having a trust as the owner of an annuity are entirely different.
Explained in another Blog to follow!
Nonetheless,
where the trust is necessary, its benefits must be weighed
against the adverse consequences of the trust. The primary negative impact of
using a trust is losing the tax-deferral opportunity for a “stretch” of the existing
gains embedded inside of the annuity at the death of the original owner.
The situation is exacerbated by the fact that trusts are
subject to compressed trust tax brackets, with the top 39.6% tax bracket and
the 3.8% Medicare surtax that also applies to annuity gains kicking in at just
$12,300 of taxable income.
Contact John
L Mottram CPA LLC, Certified Public Accountants at www.mottramcpas.com for
more details or speak directly with John L Mottram CPA
MBA CGMA at 214-543-1855, text or email
at jlm@mottramcpas.com
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