The concept of wealth transfer is taking on more importance in personal finance as baby boomers look to pass on the wealth that they have created. At the same time, the assets that many will inherit from their parents will both increase their taxable assets and complicate their own estate planning efforts. In fact, by some calculations, the largest wealth transfer in history will occur between now and 2041, when an estimated $41 trillion changes hands.
What all agents must understand, however, is the need to consider the adverse tax impact of annuities in that wealth transfer.
Annuities, a useful but fundamentally illiquid financial asset typically purchased to finance a long retirement, can pose complex personal finance issues for beneficiaries. The children and grandchildren of many annuity holders may find themselves inheriting an asset that is structured to meet the income needs of people in retirement, is highly illiquid, and is subject to tricky (and often unpleasant) tax treatment.
When clients are considering transferring wealth, annuities may complicate estate planning. Now, it’s important to keep in mind that agents should always coordinate their clients’ estate planning strategies with estate planning attorneys to ensure their clients are aware of the options when considering a transfer of wealth.
Some of the broader tax implications of simply leaving annuities to heirs as an inherited asset include:
• Income from an inherited policy is not tax-free; it will be taxed to the heir just as it was taxed to the original owner. There is no step-up in cost basis as there is with stocks, bonds, and mutual funds.
• Heirs are taxed on the income from an annuity at their ordinary income tax rate, not at the lower capital gains rate.
• Taxes are due on the funds when paid out.
• As a result, inheriting an annuity can potentially cost heirs up to 50 percent or more of the total value of the policy.
Some estate planning done in advance can blunt the tax impact. Tax efficiency can be optimized to a certain degree, and because we are talking about a lifetime of wealth accumulation, this optimization can be meaningful.
Annuities can be complex; there may be all manner of bells and whistles on them that can preclude an easy sale and a certain level of tax savings. But with proper use, they can be handy estate planning tools that provide your clients’ beneficiaries with needed income.
John Dougherty is a senior sales representative for J.G. Wentworth. He can be reached at 866-386-3102 or jdougherty@jgwentworth.com. 