Estate Planning and Private Annuities

As we remind our clients, tax concerns are a major part of a comprehensive estate planning strategy. Anticipating the potential tax consequences related to your estate as well as those that might arise prior to, during, or after the disposition of your assets is an integral part of making sure your loved ones don’t inherit a significant tax burden that limits the amount of assets you pass to them. For some individuals, private annuities may offer a way to avoid the high costs of estate taxes, gift taxes, and other taxes related to estate planning.

The Benefits of Private Annuities

Basically, private annuities can be used to help reduce your potential estate tax liability while avoiding the gift tax and securing a steady stream of income for the grantor. They are termed “private” because they are privately structured rather than created by some commercial entity. A private annuity allows the individual to essentially transfer that asset to the heir in exchange for lifetime payments for the property. As the person receiving the property will be paying the grantor for it, private annuities typically count as a sale instead of as a gift of property.

Let’s say an individual owns property that they eventually wish to distribute to an heir. When considering and subsequently creating a private annuity, you will need to determine the fair market value of the property to be transferred. Once the value has been established, the annuity payment will be calculated based on the property’s value as well as an interest rate established by the IRS. Payments are to be spread out over your life expectancy. This type of arrangement effectively removes the property from your taxable estate and, if you fail to fulfill your life expectancy then the recipient of the property will inherit the property free of any estate or gift taxes.

Potential Drawbacks to Private Annuities

As with many tools in estate planning, private annuities are not right for everyone. Even for individuals for whom a private annuity might be a good fit, there are potential drawbacks. One of the most common issues that arises with a poorly structured private annuity is that the individual that grants the property in exchange for payments outlives their life expectancy. In such cases, the annuity payments made to you could potentially surpass the fair market value of the property in question. This could count as additional enrichment and has the potential to increase the overall value of your taxable estate. There are ways to potentially avoid this issue, specifically by utilizing a deferred private annuity.

Another potential downside to private annuities is that even individuals that agree to make private annuity payments may eventually be unwilling or unable to continue doing so. In these cases, it is possible that the IRS will challenge the annuity as having been a gift in disguise. In these situations, the grantor or the recipient may be liable for additional gift and other related taxes imposed by the IRS. An experienced estate planning attorney can help you understand these and other potential pitfalls related to private annuities as well as other aspects of your estate planning strategy.

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