Filed Under:Annuities, Sales Strategies

The benefit of joint and survivor annuities over trusts

Opinion

Trusts are a common method to convey non-spousal IRA assets to adult children and other beneficiaries, but SPIAs can do the same thing with a few advantages.
Trusts are a common method to convey non-spousal IRA assets to adult children and other beneficiaries, but SPIAs can do the same thing with a few advantages.

A recent Forbes post explored the idea of establishing a “conduit trust” for a non-spousal IRA beneficiary, usually an adult child. In the article, an attorney recommended such a trust from a creditor protection standpoint relative to the IRA beneficiary. 

In June of 2014, the Supreme Court ruled a non-spousal inheritance of an IRA isn’t protected as “retirement funds” relative to the non-spousal beneficiary. Therefore, inherited IRA funds may be seized in a bankruptcy action. If adult child creditor protection is a desired IRA benefit, the knee-jerk reaction is to possibly go the trust route. While attorneys are famous for recommending trusts, for many people, a simple joint and survivor immediate annuity (SPIA) will do the trick and any old annuity agent can get this going.

A simple SPIA avoids many of the mechanical issues associated with actually getting the trust in action after the IRA owner dies.

Trusts face many issues, including:

  • Will the IRA have any actual value to be placed in trust at the time of the owner parent’s death?
  • Will the trust be the actual beneficiary when IRA owner parent dies?
  • Can the trustee produce the necessary investment results over many decades to yield the desired income?
  • Will the trustee be able to avoid dissipation events significantly reducing the trust value or bring the balance to zero?
  • What about incapacitation of the trustee? Is there a comparable alternative who can serve? 
  • While inherited property is exempt from marital property claims (see Uniform Marital Property Act 1983), under pressure from the beneficiary’s marriage, trust assets via ad hoc liquidations could be slowly converted over time to marital property.

A SPIA avoids all the above because, the contract is guaranteed by the carrier and the parties are irrevocable. Thus, the mechanics of the contract aren’t subject to all the issues outlined above. In this respect, the carrier acts as the de-facto trustee and the SPIA contract acts as the de-facto trust. So, in addition, there are no trustee proficiency and or continuation issues, and of course no attorney’s fees. The survivor benefit portion of the contract stays securely in the adult child’s separate property estate.

Potential drawbacks

Are there some possible problems with the annuity arrangement? Yes, of course.

If the survivor (adult child) predeceases the IRA owner (not too likely), the IRA owner is stuck with the same income rate. In some cases, this can be modified by an income “pop-up” to the surviving IRA owner. Upon the death of the adult child, annual IRA owner household income will increase to what the IRA owner’s single life annuity rate would have produced on the annuity purchase date but not for the survivor benefit (income) election.

The adult child has to be insurable and there is an initial annual premium cost for this benefit lowering overall household income. However, this premium cost would not be so substantial vs. a traditional life insurance premium because there is a lower likelihood of the adult child predeceasing the IRA owner as well as the IRA owner living a long enough duration to collect the additional monthly income to bring him/her up to the higher singe life annuity rate.

Also, there is no chance to name a new beneficiary to take the deceased adult child’s place. The SPIA pays a set an annual income unless priced and issued with an annual cost of living adjusment benefit.

Some annuity agents are not aware that a properly constructed IRA SPIA meets all the RMD requirements for maximizing the annual SPIA income for both the IRA owner parent and the eventual non-spousal IRA recipient when the IRA owner parent dies.

retirement savings

Advisors who want to work with qualified money SPIA cases should be careful to understand the implications of the DOL's fiducary rule. (Photo: iStock)

So, how much annual income can such a contract produce? It will depend on several factors. SPIA current purchase rates reflect the attained age of both the IRA owner and the adult child, while the IRS age tables consider the IRA owner and the adult child ages on 12/31 in the year of purchase. Per the IRS table for this survivor benefit, the adult child’s maximum survivor benefit ranges from 100 percent to 52 percent (28 possible reductions) of the IRA owner’s benefit.

For example, at current market rates, a $100,000 premium (qualified) for a father, age 80, and a son, age 50, at 12/31 of the SPIA purchase year, using a joint and survivor with a 60 percent benefit (IRS permitted maximum) to the son, produces a monthly income of roughly $510. The father collects this monthly amount as long as he survives and the adult child income rate reduces to $306 ($510 x 60 percent) per month upon the father’s death, payable as long as the adult child survives. In this example, there are no further possible beneficiaries.

Joint & survivor IRS RMD compliance

SPIAs are special and, as such, have a carve-out addressing their RMDs. While I won’t go into all of these, the joint & survivor rules for non-spousal annuitants are set forth by Internal Revenue Bulletin (IRB): 2004-26 Q-2 A-2 (c) addressing the ”incidental benefit” rule.  The survivor annuitant, in this case the adult child, faces an annuity benefit (income) reduction when the IRA owner dies. The SPIA contract is priced on the purchase date to account for this reduction.

It’s is a little bit more complicated because, in some cases, there is a table adjustment. A 100 percebt survivor benefit for the adult child is still possible as it depends on both IRA owner and adult child ages on 12/31 of the SPIA purchase year and if the IRA owner is under age 70 on the purchase date (modified in the final regulations effective 1/1/2006).

Important DOL fiduciary rule IRA practice compliance note

Under the new DOL rules regarding fiduciary conduct, you better really know what you are doing before you take on such a qualified money SPIA case. I know, many agents and home offices discount SPIA issues with attitudes of “well how hard can it be? Really, it’s just a SPIA.” Wrong after April 2017!

What many agents don’t realize is all “street” SPIA quote pricing software, provided by the carriers, only provide quotes that fit within the realm of their current offered structures and that also happen to be compliant. If the IRA owner is seeking the maximum survivor benefit for his adult son and the carrier will only quote reductions of 75 percent, 66 2/3 percent and 50 percent, you could have a big problem.

It could be, as in our example case, that the actual maximum benefit per the IRS table is 60 percent. The carrier can’t issue 75 percent or 66 2/3 percent because both are too high. So, they go to/offer their next default survivor rate of 50 percent. But this isn’t the maximum permitted by the IRS.  

So, you as the agent/distributor will have to know how to calculate the maximum yourself and request (from the home office) a “custom” survivor benefit quote of 60 percent. If the home office can’t or won’t do a custom quote you will have to jettison that carrier. Remember, SPIAs are non-fixable after the issue date. So if you get it wrong, there won’t be second chance, it will be wrong forever. This could result in unhappy clients with happy attorneys.

See also:

Charitable gift annuities vs. commercial SPIAs

Under-annuitized households: A growing epidemic

On immediate annuities and multigenerational tax benefits

 

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Nichole Morford

Nichole Morford
Managing Editor

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