Advanced Underwriting Consultants

Question of the Day – June 13

Ask the Experts!

Here’s the question of the day.

Question:  My client owns a MEC life insurance policy that she wants to exchange for an immediate annuity.  What are the tax consequences of doing so?

Answer:  The exchange of a life contract for an annuity is tax-free under Code Section 1035.  That’s true whether it’s a “regular” life contract being traded for an annuity or a MEC that’s being traded.

If a MEC is traded for a SPIA, there’s no tax recognition at the time of transfer.  Each of the SPIA payments will each be partly a recovery of basis (based on the basis from the MEC life policy) and partly ordinary income.

The ordinary income portion of the payments will also be subject to the 10% penalty tax if the taxpayer is younger than 59 ½ and if the SPIA payout period is for a duration shorter than the taxpayer’s life expectancy.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day. 

Question of the Day – December 19

Ask the Experts!

Here’s the question of the day.

Question: My client wants to make a gift of an income stream to his grandchild.  The client intends to make a $50,000 deposit into a five year certain SPIA, and assign the income stream to the grandchild.  The SPIA payments are about $12,000 per year.  What are the gift tax consequences of the plan?

Answer: Clearly, the client is making a taxable gift to the grandchild.  The only issue is whether it’s a gift of $50,000 in year one, or annual gifts of $12,000 in years one through five

If the client assigns all rights to the SPIA to the beneficiary at the beginning of the SPIA term, the present value of the income stream–$50,000—will be treated as a taxable gift in year one.  Since the gift would be in excess of the annual exclusion amount ($13,000 in 2011 and 2012), the client would need to fill out a federal gift tax return.

If the client instead kept the right to the SPIA payments himself, but after receiving them turned them over to the grandchild, the client would be making annual gifts of $12,000 each year to the grandchild.  If the client made no other gifts to the grandchild, the gifts would qualify for the annual gift tax exclusion.  No gift tax return would be required.

If the client follows the second path, the client will get the income tax result associated with the immediate annuity payments.  If the first path is followed, it’s the grandchild who recognizes taxable income on the annuity payments.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.