Advanced Underwriting Consultants

Ask the Experts – October 15

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

 Question:  A grantor died leaving a trust which, itself, is the beneficiary of an annuity on the grantor’s life. All but one of the trust beneficiaries want to receive their respective share of the annuity in 2013, but my client wants to postpone receiving his part because he anticipates being in a lower tax bracket next year. Can he postpone, and, if so, what are the tax consequences to doing so?

Answer:  There are two authorities that are relevant to this situation: (1) the IRS minimum distribution rules, and (2) the trust’s own rules.

When a trust is the beneficiary of a non-qualified annuity, and the annuity is due to pay by virtue of a death, the annuity must generally be liquidated no later than five years after the death. There’s no restriction on whether the liquidation occurs all at once or in multiple segments—it simply must all be liquidated by the end of five years.

Since the trust is the beneficiary, the trustee decides when to take the annuity distributions. The trustee makes these decisions based on the terms of the trust.

After the trust has received a distribution from the annuity, it is again up to the trustee to decide to whom this money will be transferred. Again, the trustee will be bound by the trust documents.

We would expect the trust to give the trustee the flexibility to decide to distribute to some beneficiaries earlier than others, but the trust document must be consulted for the final answer.

As distributions are taken from inherited non-qualified annuities, taxable gain is recognized first, and then basis is recovered tax-free. The trust would probably provide guidance as to how the tax burden from the non-qualified annuity would be apportioned between the beneficiaries. However, if the trust is silent as to how the tax burden should be apportioned, beneficiaries who receive funds from the annuity first may end up having to pay tax on their distributions, while the beneficiary who waits might get the tax-free return of basis.

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