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Question: My business owner client is implementing a defined benefit plan. In conjunction with the plan administrator, they’ve decided to buy a nonqualified annuity as a pension investment. Will the annuity’s inside build-up be subject to the non-natural person tax rules?
Answer: Possibly yes, but it shouldn’t matter.
The inside buildup of the annuity is taxable on an annual basis if the annuity is owned by a non-natural owner, such as a corporation.
Here’s what Section 72 of the Tax Code says about annuity ownership by a non-natural owner:
(u) Treatment of annuity contracts not held by natural persons
(1) In general
If any annuity contract is held by a person who is not a
natural person –
(A) such contract shall not be treated as an annuity contract
for purposes of this subtitle (other than subchapter L), and
(B) the income on the contract for any taxable year of the
policyholder shall be treated as ordinary income received or
accrued by the owner during such taxable year.
For purposes of this paragraph, holding by a trust or other
entity as an agent for a natural person shall not be taken into
A pension trust might be considered an agent for a natural person—the plan participant—under that analysis. The IRS hasn’t said for sure. However, because a pension trust is a non-taxable entity, even if the annuity growth is taxable, the pension trust won’t pay tax.
The pension participant pays tax on amounts received from the pension plan—no matter what the source. That’s when the IRS has its day or reckoning.
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