What is a private annuity?
A private annuity is an estate planning strategy that involves the signing of an agreement between an annuitant, the entity who is the beneficiary of the annuity/pension, and an obligor, also known as the debtor. This agreement includes the transference of the annuitant’s property to the obligor, in return for which an obligor promises regular payments throughout the lifespan of the annuitant. The property transferred is removed from the obligor’s estate, but the payments received in exchange for the property are a part of the estate. The strategy of private annuity works perfectly in a scenario where a person possesses a low basis property.
The condition on which this agreement is signed is that none of the parties involved in annuity selling business, such as an employee of an insurance company. Also, if a person’s life expectancy is less than a year, they cannot be a part of a private annuity.
Benefits of the private annuity:
There are significant benefits of a private annuity, and that is why many people choose to make this a part of their estate plan.
(i) No gift tax:
Estate property is exchanged with a beneficiary in return for an unsecured promise of annual payments. It is termed as private because no commercial party is involved. This exchange of property, if carried out correctly, may be treated as a sale rather than a gift. No gift tax is imposed on this transaction if the sum of total annuities paid equals the property’s present value in the market.
(ii) Non-Income property provides income:
Another benefit of incorporating this strategy into an estate plan is that a non-income property is converted into an income-producing property.
(iii) Continuous source of income:
It also provides a continuous stream of income throughout the lifespan of an obligor. In addition to this, if a person does not live to the expected age, their family will get a significant number of payments.
Risks involved in a private annuity:
Even though this estate planning strategy boasts excellent benefits to the obligor and its family, it also involves some risks that cannot be ignored.
(i) Reverse mortality risk:
Unlike other estate planning strategies, a private annuity has a reverse mortality risk. If the obligor lives for more than the expected years, the payments of an annuity will surpass the property’s market value. As a result of this, it will cause the obligor’s family to overpay for the property that was transferred, increasing the taxable estate’s size.
To cope with this risk, a deferred private annuity must be considered. This leads to a delay in the annuity payments, thus, reducing the reverse mortality risk.
(ii) Annuitant unable to make annuity payments:
The chances of a transferee being unable to make the annuity payments are high. As this agreement is based upon unsecured obligation, there are many possibilities that this might happen. In such a case, the Internal Revenue Service will label this arrangement as a gift, imposing the gift tax on it.
Role of life expectancy:
The role of life expectancy in a private annuity cannot be neglected. It is on this factor the whole agreement depends upon. Even the value of the annuity payments depends upon life expectancy. If a person has a higher life expectancy, the annuity payments will be of a lower value. In comparison, a person with a lower life expectancy will be subjected to higher annuity payments. Also, if a person is extremely ill and the life expectancy is less than a year, they cannot opt for a private annuity! It is best to take legal advice before jumping right into the agreement, as there is much to understand!
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