Annuities seem complicated enough, but the tax complexities get even messier after death, warned industry blogger Michael Kitces during the AICPA Engage conference Monday in Las Vegas.
A complicating factor with annuities is that much of the tax treatment is not covered by formal Treasury regulations or even a revenue ruling from the IRS, said Kitces, director of wealth management at Pinnacle Advisory Group. “The only guidance we have on a lot of these key areas are private letter rulings.”
As a result, insurers each handle tax issues differently, and these interpretations often come into play after death of the owner, Kitces said.
One of the first complications after death can be in valuing an annuity for estate tax purposes. Be sure to include any death benefit a contract may pay out in addition to the cash value, Kitces told advisors at the conference. Ask for a “'date-of-death death benefit valuation'” to get an accurate value.
A surviving spouse may continue a contract as an original owner, but they must be named as the beneficiary, Kitces said. Many couples intend for the surviving spouse to get the annuity by setting the contract up with joint ownership, a spouse as annuitant and the kids as beneficiaries. But this common mistake bypasses the surviving spouse in favor of the kids.
Like IRAs, inherited annuities are subject to required distributions, but the rules are a bit different.
The same standard five-year rule for taking withdrawals applies, except that with annuities you have a hard-and-fast five years to take it out, not until the end of the fifth year as with IRA distributions, Kitces said.
And similar to inherited IRAs, annuity heirs might be able to stretch out payments based on their life expectancies.
But some insurers require that a “stretch” be done by annuitizing the contract. This means heirs lose control of the asset, so most heirs take withdrawals instead, Kitces said.
Other issuers allow IRA-like withdrawals. “You have to call the annuity company and ask if you can take stretches as withdrawals,” Kitces said.