Annuities are the opposite of life insurance because they are estate-liquidating financial products. While life insurance seeks to create an estate, annuities generally seek to use part of your estate to create an income stream. Therefore, an annuity is not vital to estate planning in the sense of building your estate. However, it has an impact on your estate in various ways.
You can use an annuity as a tool to manage your estate, create tax-exempt income or liquidate part of your estate to qualify for estate-tax exemptions. Annuities are critical to estate planning because they can affect the value of your estate and the tax treatment of your estate when you depart the earth.
Estate liquidation
Until an annuity reaches its payout phase, a portion of the accumulated value can be included as part of your estate. However, at the payout phase, the insurer converts the total cash value into a series of payouts based on an annuitization rate. This is the estate-liquidating aspect of annuities. Therefore, when using annuities as part of your financial planning, you must consider their estate-liquidating function, which can work either for or against you.
Using annuities to reduce the value of your estate
Many countries or states have estate-value thresholds. Beyond the stipulated threshold, an estate's value is subject to tax. You must check with the relevant tax authorities to determine what this threshold is. You can purchase annuities- particularly immediate annuities- to reduce the value of your estate so that it is below the threshold level.
When you purchase an immediate annuity, for example, you can benefit by having income from part of your estate by relinquishing ownership of a lump sum. Upon your death, that portion of your estate that you sold to the insurer would not constitute part of your estate and your beneficiary may be able to receive tax-exempt income from the annuity. If you wish to retain the value of your estate for beneficiaries, certain annuities are not advisable. In several cases, the estate-liquidating feature of annuities can redound to your benefit.
Estate taxes on annuities
The tax treatment of annuities in the accumulation phase (before maturity) may differ significantly among states and countries at any point in time. In some cases, the cash value at death (for deferred annuities) is subject to tax. You must be aware of the treatment of the proceeds of a deferred annuity if your death occurs before it matures. Usually the 'death tax' rate is not significantly higher than the income tax rate but it can increase the tax burden of your estate.
Survivor options with annuities
When an annuity matures, insurers or annuity providers require annuitants to declare the 'survivor' options. This option is really a transfer mechanism for annuity income. While it reduces the value of your annuity payout, it provides a seamless transition from the annuitant to a designated beneficiary. The annuity income is usually tax-free and can be useful if you have a spouse who is dependent on your annuity income as well.
Annuities may not appear to have a link to estate planning, particularly as it does not help to build or maintain your estate. However, an annuity is a tool that you can utilize to assist with the planning and managing your estate. Knowing how to use annuities in planning your estate is better for you and your beneficiaries.