Tax Planning for Retirees

Personally Purchased Annuities

Partial Annuitization of a Personally Purchased Annuity Contract. – If an annuity contract permits, a retiree may divide the contract into two contracts and take an annuity from one of the separated contracts but not from the other. The annuity must be for a term of more than 10 years, or for one or more lives. The investment in the original contract is allocated pro rata between the separated contracts. Different annuity starting dates may apply to each of the separated contracts. (Small Business Jobs Act of 2010, Pub. L. No. 111-240, § 2113.) See
Chapter 16 of the treatise for a more complete discussion of the taxation of personally purchased annuties.

Personally Purchased Annuities Not Held by Natural Persons. – The Code generally taxes annuity contracts not held by natural persons as if they were not annuity contracts. Exceptions are provided for annuities held by tax-favored retirement plans and for “immediate annuities.” An immediate annuity is an annuity (a) purchased with a single premium, (b) providing for substantially equal annuity payments, and (c) with an annuity starting date no later than one year after purchase.

Also excepted are annuity contracts held by trusts or other entities as agents for natural persons in a non-employment context. For example, a testamentary trust purchased and held separate annuities on the lives of several individuals who were the ultimate residuary beneficiaries of the trust. The IRS treated the annuities as held by natural persons since all the beneficial interests were owned by individuals in a non-employment context. (I.R.C. § 72(u)(1); Ltr. Rul. 201124008.) See Chapter 16.

Non-Spouse’s Minimum Distribution Election Under Personally Purchased Annuity. – The tax law requires that a non-spouse beneficiary receive minimum distributions under a personally purchased annuity contract. However, the IRS has ruled that those minimum distribution requirements may be satisfied if a non-spouse beneficiary merely elects to be treated for tax purposes as if he or she had received the entire value of the annuity contract as of
the retiree’s death. (Ltr. Rul. 201302015.) See Chapter 16 of the treatise for a discussion of personally purchased annuities.

Applicability of Early Distribution Penalty to Annuities Held in Trust. – The IRS has ruled that, if a retiree uses a grantor trust to purchase an annuity for a beneficiary, the early distribution penalty will not apply to annuity distributions to the beneficiary after the retiree (the grantor) reaches age 59½ or becomes disabled. Further, the life or life expectancy of the grantor must be used to qualify for the substantially equal payments exception to the penalty. If instead a nongrantor trust is established and purchases the annuity for a beneficiary, the retiree is not the owner of the trust and thus the age 59½, disability, and substantially equal payment exceptions do not apply. However, for both a grantor trust and a nongrantor trust, it is the death of the primary beneficiary (and not the death of the grantor) that will also allow annuity payments without penalty. (I.R.C. § 72(u)(1), 72(s)(6)(B), 72(q)(2)(A), (B), (C), (D); Priv. Ltr. Rul. 202031008.) See Chapter 16 of the treatise for a more complete discussion of the taxation of personally purchased annuities.