Annuity Maximization

How Does It Work

1. A withdrawal is made from the annuity. The withdrawal is taxed as current income thus reducing the amount subject to taxation at death

2. The after tax withdrawal amount is gifted to an irrevocable life insurance
trust. In case there is a gift tax, it may be reduced by using up any availible unified credit or annual exclusion amounts.

3. The ILIT buys life insurance to replace the value of the annuity.
The trustee of the ILIT uses the gifts to purchase life insurance on the annuity holder or the annuity holder and spouse

4. Upon death of the insured, life insurance proceeds pass income and estate tax free to the ILIT. The remaining annuity death benefit proceeds passes to heirs after payment of any income and estate taxes

Summary

An annuity is double taxed at death and could erode by as much as 80%.
More of the annuity will pass to the goverment than your loved ones.
By following Annuity Maximization approach, you can ensure that heirs will
be well provided, while reducing tax liability.

The Situation

Deferred annuities have traditionally been a preferred vehicle for accumulating wealth for retirement. Because they grow on a tax deferred basis the wealth accumulation happens faster than comparable vehicles that are taxable on an annual basis. However over time, the client’s planning objectives may change from wealth accumulation to preserving the estate.
Often the annuity ends up being left in the estate to be passed on
to the next generation.
This is not a good idea. An annuity does not receive a stepped up basis upon death. Consequently the annuity beneficiaries will pay income taxes on the annuity when they take distributions. Also an annuity is subject to estate taxes at death. Estate taxes are close to 50% when the estate exceeds a certain threshold. Therefore, when you add estate and income taxes, the annuity could loose as much as 80% of its value at death.
A better way to use the annuity is to leverage it to fund a life
insurance policy inside of a trust. This is also known as annuity
maximization.

The Strategy
Annuity Maximization is a simple technique, in which a deferred annuity is converted to a single premium premium immediate annuity (SPIA) and after tax distributions are used to fund a life insurance policy inside of an irrevocable life insurance trust (ILIT).
Annuity Max also works by taking withdrawals from the deferred annuity and using the withdrawals to fund the life insurance policy.
Technically the after tax distributions and withdrawals would be gifted to the irrevocable life insurance trust. Using life insurance in the trust can increase the wealth transferred to heirs and provide an income and estate tax free source of liquidity to pay
estate costs.

Another common technique is to use the life time income option of a (SPIA). Example of a SPIA could be distributions from a pension plan. This option will deliver a higher payout (higher monthly income) compared to a period certain option.
The difference in income between the lifetime and the period certain option would be used to fund a life insurance policy. This often provides the survivor with higher benefits (income) compared to if the period certain option was used.

So for individuals who do not plan on using the annuity while alive, annuity maximization can:

> Remove future appreciation from both income and estate taxes
> Potentially increases the wealth transferred to heirs
> Replace the amount of the annuity death benefit proceeds
   that would be lost due to income and estate taxes.