Clients who inherit an annuity may now have a few more options, thanks to a recent private letter ruling from the IRS. Rather than being bound by the terms of the decedent's contract, beneficiaries may be able to exchange inherited contracts for newer, higher-paying contracts, according to PLR 201330016. Such an annuity might have lower costs, come from a stronger company, offer better investment options or have more desirable features.
"Advisors with clients in this situation should work with their firm's experts who are knowledgeable about annuities so that all the options can be considered," says Scott Stolz, president of Raymond James Insurance Group, the insurance general agency for Raymond James. Previously, clients would generally either elect to annuitize the contract within 12 months or take all the money out within five years and pay tax on any deferred gains, Stolz says.
In this case, the PLR was written in response to a taxpayer whose mother had died, naming her as the beneficiary of several annuities that had not been annuitized. These annuities were non-qualified, so they were not held in a tax-advantaged retirement account.
The daughter elected to receive the payout over her life expectancy, but she discovered that she could get a new annuity from company C with a higher payout than she'd receive from companies A or B, the issuers of the inherited annuities.
"That's not unusual," Stolz says. "A client who shops around today might find a better income rate than the annuitization rates offered on inherited annuities." Today, with interest rates expected to head higher, waiting for up to 12 months to decide might deliver more cash flow from a replacement annuity.
In this PLR, the daughter arranged for an annuity from company C; the money from the original annuities is to be sent directly to company C by companies A and B. The taxpayer requested that the process would be treated as a tax-free exchange, under Section 1035 of the tax code, the provision commonly used for swaps of annuities and life insurance policies. The IRS consented, provided all the requirements of a 1035 exchange are observed.
A PLR is non-binding and only applies to the taxpayer who made the request, but it also shows how the IRS regards a certain issue. Thus, an exchange for a higher-paying annuity may be a realistic option for beneficiaries.
The challenge may lie in finding an insurance company willing to issue an annuity that will conform to the rules while not imposing steep costs, Stolz explains. The PLR is so recent that it's too early to know how insurers will react. Nevertheless, it's not too soon for advisors to have conversations with clients who inherit annuities to tell them that trading up is now a viable strategy, he says.