Titling considerations for non-qualified annuity contracts

Titling Considerations for Non-Qualified Annuity Contracts

Proper titling of an annuity contract is critical to ensure intended financial objectives are met. Titling designates the names of the owner, annuitant, and beneficiary. These designations define legal rights over the annuity including what happens and who receives what payments or proceeds in the case of death of one of the parties. Proper titling may help avoid probate and expedite payments to beneficiaries.

THREE PARTIES TO AN OWNER DRIVEN ANNUITY

1. OWNER: Holds legal title of the contract and is responsible for all tax obligations related to the annuity. The owner holds all legal rights over the annuity, including the power to request withdrawals, elect optional benefits, name the beneficiary, and make changes to the account. The owner may be up to two individuals (natural owners) or a non-natural owner (like a trust or business).

   For a natural owner (i.e., a person) the death of the owner triggers the death benefit payout

   Non-natural owners who are holding the contract for the benefit of a natural person do not receive tax deferral on gains. Under IRC section 72 (u) the annual gains are considered taxable income even if they are not distributed.

2. ANNUITANT: Income payments are based on the annuitant’s life. The annuitant holds no legal rights over the annuity and cannot make changes to it.

   During the accumulation phase, death of the annuitant with a natural owner does not trigger a death benefit —the owner can name a new annuitant. For a non-natural owner (e.g., trust), the death of the annuitant triggers the death benefit.

3. BENEFICIARY: Receives the death benefit payment upon the death of the owner. Beneficiaries are prioritized as follows.
   1. Primary beneficiary¹

      Note: Joint owners should be designated as the primary beneficiary(ies) to ensure they will inherit annuity proceeds before any contingent beneficiary. Naming an alternate primary beneficiary could result in the unintended payout of the death benefit.

   2. Contingent beneficiary

WHAT CHANGES CAN BE MADE TO THE PARTIES POST CONTRACT ISSUE²

Can the owner be changed? Yes, however depending on the status of the new owner, the change may result in a taxable event.

• Non-taxable ownership changes: a change in ownership to the owner’s grantor trust, to a spouse or to the spouse’s grantor trust does not result in immediate tax consequences. The spouse or trust assumes all rules and rights of the initial contract. The original owner’s cost basis carriers over to the new owner and they can collect all remaining payments and choose a new beneficiary.
• Taxable ownership changes: when ownership of a deferred annuity is changed to a person or entity other than described above, the transferred amount (account value) is treated as a distribution for tax purposes. The original owner is taxed on any previously tax-deferred gain and may be subject to an IRS 10% penalty for premature distributions. The new owner’s beginning cost basis is equal to the account value.

Can the annuitant be changed? Yes, the annuitant may be changed on a contract with a natural owner that has not been annuitized.

Changes to owners and annuitants may be subject to the insurance company’s underwriting rules and may impact the benefits of existing contract riders. An ownership change may change the death benefit amount, as well as modify the existing death benefits. Consult a financial professional and tax/legal professional prior to requesting any contract changes.

Can the beneficiary(ies) be changed? Subject to the rights of any irrevocable beneficiary, if any, changes can be made to the primary and/or contingent beneficiaries prior to the owner’s death.

OPTIONS FOR DEATH BENEFIT PROCEEDS

Upon the death of a natural owner, the beneficiary of the contract (or joint owner if one is named) generally has the following options.

A. Lump sum: Receive a lump sum of the remaining value of the annuity. If a lump sum is selected, the beneficiary will pay taxes on all accrued gains in the inherited annuity in the year of the distribution.

B. Annuitize: Receive regular income within 12 months of the date of death. The income cannot extend beyond the life expectancy of the beneficiary. Annuitization options may include period certain, life with period certain, and life only. If the owner of an annuity annuitized for a period certain prior to death, the beneficiary is entitled to receive those annuity payments for the remaining years under that period certain.

C. Spousal continuation: If the beneficiary is the surviving spouse, he or she can become the new owner of the annuity and continue the contract under its existing terms.

D. Five-year rule: Receive a distribution of the total value of the contract within five years of the date of the owner’s death. If this option is selected proceeds can be taken out at any time during the five-year period. No distribution is required for any year before that fifth year.

E. Non-qualified stretch: This option permits beneficiaries to receive a death benefit in the form of a systematic withdrawal over a period not to exceed their life expectancy. Non-qualified stretch requires the beneficiary to take a minimum amount each year to satisfy IRS requirements. Additional amounts can be withdrawn at any time and may be subject to withdrawal charges. Non-qualified stretch distributions must begin within one year of the death of the decedent.

F. Post-death 1035 exchange: With the issuing of Private Letter Ruling 201330016, the IRS allows an annuity to be transferred from one annuity carrier to another via post-death 1035 exchange. Insurance companies are not required to send or receive post-death 1035 exchanges so check with the sending and receiving annuity carriers to ensure they will send/receive a nonqualified post-death 1035.

If no beneficiary is named, the death benefit defaults to the estate and the five-year rule will be applied.

If a non-grantor trust or other non-natural beneficiary is listed as the beneficiary of a deferred annuity contract the death benefit options are a lump sum or 5-year rule.

Assigning a beneficiary may help heirs avoid probate and legal delays and may help them access the death benefits proceeds faster. For help understanding proper titling of non-qualified annuities, talk to your Global Atlantic wholesaler as well as a tax and/or legal advisor.