Non-qualified annuity stretch payments Irrevocable Trust

[fuller7378]

I have a client whose mother passed away earlier this year. She had a non-qualified annuity whose beneficiary was her revocable trust. Can an irrevocable trust(after mother passed) stretch the payments out to the beneficiary(daughter) over her lifetime? If so, would I need to file 1041's each year as those payments are made from the irrevocable trust to the daughter? Is there a way to pass the annuity payments directly to the beneficiary(daughter) without having to do 1041's and basically closing out the trust? I am not getting much help from the insurance company and can't seem to locate anything on the IRS website.

[Roland Slugg]

Welcome to this discussion board, fuller7378. I see this is your first post here ... and you have posed a very tough opening question. I'll give it my best shot.

The rules governing the taxation of annuities are covered in Code §72, and sub-section 72(u) is probably the most relevant one here. Good luck trying to understand it! My take is that the usual "annuity exclusion rule" will not apply to your situation, because the new annuity holder is not a natural person. It's a trust. I further believe that the annuity's annual taxable income, taxable to the trust, will be the excess of the annuity's year-end FMV ... i.e. redemption value ... in excess of the remaining basis. The latter being the premium(s) paid less the tax-free portion of all distributions, if any, made prior to the original owner's death. What this will amount to each year is the total of: (1) the income earned by the annuity's investments, plus (2) the decrease in the surrender charge.

Regarding your question about maintaining the trust, if the trust continues to own the annuity, then a F-1041 tax return will have to be filed each year as long as it does. However, it is probably possible for the annuity to be transferred to the trust's beneficiary(ies), thus terminating the trust. Your client should probably consult with an attorney about that possibility.

Your post serves to point out that naming an estate or trust as the beneficiary of an annuity is not a very good idea. Whenever possible beneficiaries of annuities, IRAs and employer plans should be named individuals.

[fuller7378]

Reply to Roland

Thanks for your insight. As I was perusing old posts yesterday, I came across a similar discussion regarding annuities. At least I feel a direction to go now with Section 72. I will do some further research and see what I come up with.

[Burke]

The insurance company will pay the proceeds to the trust. Then they are done with it. They have no say-so or any interest in what happens after that, with the exception of issuing a 1099-R at year-end. As always, a copy of the trust document must be reviewed. What was the intention of the trust? Were all assets to be distributed after last expenses paid? Were they intended to be kept in the trust for the benes? When does it terminate? Are minors involved? All these things will affect what the trustee can do with the proceeds of the annuity once they have been paid into the trust.