Inherited annuities: Helping to stretch generational wealth

Baby boomers are set to pass $68 trillion in wealth to their children. A significant portion of that wealth may be transferred through annuities. As a result, some beneficiaries could face an unwelcome tax burden.

A new study shows that using structured annuities with income benefits on the portfolio’s efficient frontier substantially increases the likelihood that clients will have assets left at age 100. 

How can advisors educate clients about this challenge and help them identify smarter planning solutions? At a recent webinar held by the National Association for Fixed Annuities, Dan Kozlowski, regional vice president at MassMutual Ascend, presented insights on ways inherited contracts may provide a way to spread out tax liability, while allowing an inheritance to continue growing.

A nonspousal beneficiary of an annuity or an individual retirement account may have the option of transferring the death benefit into an inherited annuity contract. This approach can help spread out the beneficiary’s tax liability while allowing the inherited assets to keep growing.

“An important thing I always like to mention is that nonqualified or inherited nonqualified annuities were not part of the SECURE Act,” Kozlowski said.  “A nonqualified stretch does not have to be liquidated in 10 years like a qualified or inherited IRA does.”

Inherited annuity contracts provide the following benefits to nonspousal beneficiaries:

• Continue the annuity’s growth. Assets may continue to grow, which can provide a significant boost to an inheritance over time.

• Spread income-tax impact over time. Money will not be taxed until a distribution is taken.

• Designate specific beneficiaries. One day, your client can pass their loved one’s generosity on to future generations.

The nonqualified stretch

A nonqualified stretch annuity is not subject to restrictions under the SECURE Act, Kozlowski said. It provides an opportunity for a nonspousal beneficiary to stretch the annuity, while limiting their tax liability.

“The ideal situation for this would be, let’s say my dad purchased an annuity 20 years ago, it grew to $1 million and he took out $100,000 before he died. I want to avoid adding $900,000 to my adjusted gross income this year. That is a tax-inefficient distribution.” 

Instead, a nonqualified stretch would enable a nonspousal beneficiary to stretch the nonqualified annuity over their life expectancy instead of taking a lump-sum death benefit.

Leaving a legacy

Kozlowski provided an example of how a stretch concept can provide a legacy to future generations.

In this example, at age 65, John purchases a nonqualified annuity with a $100,000 purchase payment. For this example, a 4% interest rate on the annuity is assumed.

John died in year 11 of the annuity contract at the age of 75 and did not take any distributions from the annuity. John’s widow, Jane, inherited the entire account value of $153,945. Jane died in year 21 of the contract at age 80, leaving a remaining account value of $227,877. 

John and Jane’s daughter, Alison, inherits that remaining account value. She could choose to take it in a lump sum, but instead, she chooses to stretch the payments and begins receiving them based on her life expectancy.

Alison dies at age 75, having taken $306,126 in distributions. Her daughter, Mary, inherits the remaining account value of $190,899. Mary can either take the remaining account value in a lump sum or receive distributions totalling $239,983 over the remaining 11 years in her expected lifetime. 

Kozlowski compared this approach to that of using a spousal IRA as a stretch IRA. In the example he provided, John purchased an IRA for $100,000 at age 65. He began taking the required minimum distributions at age 72 and took $20,361 in total distributions before dying at age 75. John’s widow, Jane, inherited the entire account value of $132,371. She elected to treat the IRA as her own, taking RMDs when she reached age 72. Jane died at age 80, having taken $52,652 in total distributions.

John and Jane took a total of $73,032 from the IRA before their deaths. They left a remaining account value of $134,614, which their 48-year-old daughter, Alison, inherited.

Alison could take the entire amount in a lump sum payout but chose to stretch the IRA payments and begin receiving them based on her life expectancy. The final payment must be made within 10 years of Jane’s death. Alison received $191,405 in distributions over 10 years.

If Alison died within the 10-year period, any remaining payments can continue for her sole beneficiary, her daughter, Mary. 

“Seeing the tax liability spread out over three generations gives you a unique opportunity,” Kozlowski said. “Think of some of your older clients who have nonqualified annuities, and bring their beneficiaries into this discussion as far as what might be available to them from an inherited standpoint.”

Susan Rupe is editor in chief, magazine, for InsuranceNewsNet. She formerly served as communications director for an insurance agents' association and was an award-winning newspaper reporter and editor. Contact her at [email protected].