Sell Your Annuity and Save on Taxes

Sell Your Annuity and Save on Taxes

Do you currently own an annuity you don’t need or want? There are tax savings opportunities that you may not be aware of. Take for example, Howard, age 65, and receiving $7,500 per month from the buy of a single premium immediate annuity (SPIA). The annuity was purchased 5 years ago for approximately $1 million dollars and is guaranteed to pay Howard or his beneficiary for a period of 20 years. So far, Howard has received 60 of the 240 monthly payments.

Howard’s income needs have decreased and instead would like to leave money to his children. Howard decided to call the insurance company that sold him the annuity and requested to cash out half his annuity payments. Howard was frustrated to learn that once the decision is made to go into into a 20-year-certain income annuity contract, there is no re-do.

Howard met with his financial planner who advised him to sell his annuity payments to an annuity buyer in the secondary market. After weighing his options, Howard decided to sell half of each remaining payment for a lump sum of cash. Doing so allowed Howard to continue receiving $3,750 per month for the remaining 180 months.

Furthermore, Howard was advised that he could buy a life insurance policy with a $1.4 million dollar death assistance with his lump sum cash proceeds.

In a situation like this, the insurance policy would be purchased by an insurance trust and a gift tax return would be filed for the lump sum of cash gifted to the trust. However, in Howard’s case, there would be no gift tax due since the amount is less than the $1 million life-time gift tax exclusion. In fact, since Howard’s cost basis in the annuity payments sold was higher than the proceeds received, there was a loss which would be reported on Howard’s tax return resulting in tax savings.

Now let’s consider what would happen if Howard did not sell any portion of his annuity payments and died before receiving the remaining 180 annuity payments. Beginning in the year 2011 and beyond, the maximum federal tax-free estate move exemption is $1 million dollars. If Howard’s estate is above the $1 million threshold, the remaining annuity payments would have to be valued for estate tax purposes. Using present value calculations, one could origin the present value of the annuity and determine estate taxes due. Using the top estate tax rate of 55%, the beneficiaries of Howard’s estate would owe more than $550,000 assuming the present value of the remaining 180 payments of $7,500 is about $1 million for estate tax purposes.

Unfortunately, the beneficiaries will have to raise money for estate taxes or sell the annuity payments to pay off Uncle Sam.

Now let’s consider what would happen if Howard did in fact sell half of each annuity payment whereby Howard retains 180 monthly payments of $3,750 and sells the rest. If Howard died, estate taxes of approximately $275,000 would be owed. Unlike the example above, his estate would receive a $1.4 million dollar death assistance as a consequence of the life insurance policy Howard purchased with his lump sum cash proceeds.

Because of this, Howard’s heirs could come out ahead by more than $1 million dollars if Howard sells the annuity payments as shown in this example.

If you are considering selling annuity payments, please be sure to review your income tax and estate tax ramifications with your tax advisor.

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