Non-qualified annuities—that is, annuities that are not part of an IRA or other tax-qualified retirement plan—can serve as a valuable component of your financial and estate plan. However, there are some potential snags that you may encounter along the way. It’s imperative to understand and make accommodations for these prospective issues well before they arise.
One key stumbling block that many investors encounter surrounds taxes, which can eat up a sizeable portion of the inheritance you hoped to designate for your loved ones or other beneficiaries. However, there are many non-qualified annuity beneficiary options that can minimize your tax liability. If you have concerns about managing your non-qualified annuities, there are strategies that can be implemented with the help of your income and annuity planning advisor.
Take the case of one of my clients who had secured an annuity for a sum of $400,000 a number of years ago. Over time, that annuity matured and grew, reaching a value of more than $4 million. This represents a very sizable taxable gain that, if paid out in a lump sum, would lose an extremely large portion of the payout in taxes. Fortunately, my firm was able to recommend effective methods that served to minimize the tax burden on the client’s beneficiaries, maximizing the wealth that was transferred to the next generation. Below, let’s explore potential tax options for non-qualified annuity beneficiary distribution.
Non-Qualified Annuity Beneficiary Options: Stretch Provisions
A stretch provision is perhaps the single most effective option for minimizing tax liability when the time comes to distribute the funds of your non-qualified annuity to your beneficiaries. The Internal Revenue Service (IRS) has established a number of tax codes—such as 72T and 72S—that allow for what’s known as a stretch provision. This provision is focused on the gradual distribution of funds in place of a lump sum distribution. The result is a reduction in the amount of money lost to taxes.
In the case of a stretch provision, the distribution timeframe is typically determined by the beneficiary’s life expectancy, which, in effect, lessens tax liability as the recipient enters a lower tax bracket as they move into their retirement years. Additionally, this course of action will also provide the undistributed funds with an opportunity to continue to grow over time. The end result, then, is a beneficiary who receives a steady stream of income at a much lower tax burden.
The end result, then, is a beneficiary who receives a steady stream of income at a much lower tax burden.
It’s important to note that stretch provisions are not available for every annuity. Therefore, investors must understand their options before acquiring a new annuity by working with an experienced financial professional who fully understands the many options and configurations available.
Considering the Beneficiary of Your Annuity: Spouses and Non-spouses
Your relationship to the beneficiary matters when it comes to annuity payments and taxation, so this is a key consideration—particularly if you get married or divorced after buying an annuity. The key difference is between spouses and non-spouses. Many annuities are configured to carry over to a surviving spouse, which is ideal in many situations, particularly those cases where an investor is leveraging a stretch provision. This allows your spouse to continue receiving money, while the undistributed funds continue to grow—even after you’ve passed.
A spouse can also see reduced tax liability in some situations thanks to marriage credits and joint filings, so it’s prudent to explore this potential benefit with an annuity specialist, as well as your tax advisor.
Annuity Maximization: Strategies Beyond Non-Qualified Annuities to Maximize Wealth and Minimize Taxes
There are a number of estate planning and annuity strategies that can be leveraged to maximize the wealth that you pass along to future generations and causes or organizations that are important to you. This includes the use of alternatives to traditional investments, such as life insurance policies.
From a tax perspective, life insurance premiums are returned tax-free and, in many cases, if properly structured, the death benefit is estate tax free as well.
Some individuals may prefer to avoid the use of a stretch provision, instead favoring a lump sum or deferred payouts. In these cases, it’s possible to take the taxable distributions from an annuity and use those funds to secure a multi-million dollar life insurance policy. From a tax perspective, life insurance premiums are returned tax-free and, in many cases, if properly structured, the death benefit is estate tax free as well. These annuity maximization strategies can preserve annuity principal and create millions that can more than offset any future tax liabilities associated with the annuity proceeds.These concepts apply to both qualified and non-qualified annuities.
The options associated with annuities and life insurance are many and the best choice will vary depending on your unique situation, your personal preferences, and your goals for the future. An experienced advisor specializing in annuities and life insurance can provide you with insight into the many options that are available as you navigate the estate planning process.
For over 55 years, the professionals of Howard Kaye Insurance have been providing clients with insights and advice on a wide variety of insurance and financial solutions, such as annuities and life insurance. Our team of experts has developed some very effective strategies that will allow you to maximize wealth transfer, while minimizing taxes, so that your loved ones can enjoy the wealth that you worked so hard to achieve. Our advisors are ready to discuss your objectives, so we invite you to reach out to our trusted advisors by calling 1-800-DIE-RICH.
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