Blog

In my practice of advising elder law attorneys regarding their clients' Medicaid and VA needs, if a case involves a trust and the need to accumulate income - no annual distributions, I typically recommend using a non-qualified fixed annuity as the investment vehicle.

The primary reasons why I make such a recommendation are that a fixed annuity offers safety of principal, a guaranteed return over a guaranteed period, and income tax deferral.  Unlike a variable annuity which is subject to market risk and can lose principal very quickly, a fixed annuity will never be worth less than the original investment amount, except in the case of an early surrender.  At the same time, a fixed annuity can offer a multi-year guaranteed rate of return which ensures growth.  Finally, in that the income tax rates associated to trusts that retain income are excessive in light of the same rates for individuals, the growth within an annuity accumulates on an income tax-deferred basis until the trustee either takes a distribution, annuitizes, or surrenders the contracts.

With the first two reasons being very clear, it is the last reason of "tax-deferral" which causes the bulk of the confusion when an annuity purchase is being contemplated within a trust.  Under IRC Section 72(u), if an annuity contract is held by an entity which is not a "natural person," the contract shall not be treated as an annuity contract for income tax purposes and shall lose its tax-deferral status.  However, under IRC Section 72(u)(3), if an annuity contract is held by a trust or other entity as an agent for a natural person, the contract shall not lose its annuity contract status and shall be entitled to receive continuing tax-deferred status.

As for non-natural persons, since IRC Section 72(u) was enacted to deny tax-deferral for corporate owned deferred annuities, it has been stated that partnerships, S corporations, family limited partnerships, and limited liability companies would be qualified as such.  So why and how is a trust different than one of the aforementioned entities?  The difference relates to the fact that the entities have independent business purposes and do not simply hold title like a trust.  Thus, any trust - whether revocable or irrevocable, grantor or non-grantor, which owns an annuity and only benefits natural persons shall be entitled to maintain tax-deferred status for the investment vehicle.

Krause Financial Services offers such a product that I have outlined above, with rates that are typically better than comparable certificates of deposit.  For more information on the product and the current rates, just click here.