Who's your beneficiary? The role of annuities and life insurance in estate planning

By Paul Cross

Annuity National Brokerage Co.


Who are your beneficiaries? Are they your family members and loved ones or are they the probate courts and your Uncle Sam? The choices are yours to make. You have the liberty to make your own decisions. In absence of legally expressing your authority with designated beneficiary forms, wills and trusts, Uncle Sam has an alternate plan for you.

The most powerful of all documents are designated beneficiary forms for company retirement plans, individual retirement plans including IRAs, Roth IRAs, annuities and life insurance. The designated beneficiary forms trump all other legal documents and have been upheld all the way to the Supreme Court.

Generally, individually owned annuities and life insurance policies should be owned and held outside of trusts. The primary purpose of most individually owned trusts is to avoid the cost and time delays of probate courts. With designated beneficiaries, annuities and life insurance proceeds avoid the cost and time delays of probate courts; nonetheless many people have included their annuities and life insurance in the trust.

Reasons to hold annuities outside the trust include:
  • The proceeds are paid directly to named beneficiaries outside the probate court, saving court battles, time delays, court costs and legal fees.

  • The named beneficiaries may be changed any time at the discretion of the owner without costs or legal fees.

  • The owner of annuities may designate the manner in which the proceeds are to be paid, and the payout distribution is made directly to the beneficiaries in lump sums, income streams, or a combination thereof without the necessity of a trustee and administrative costs.

A big advantage of annuities that is often overlooked

Annuities grow and compound tax deferred. Said another way, the annuity develops an automatic re-investment cash flow of tax dollars that also grow and compound tax deferred.

When the distribution is made to the beneficiary the cost basis is income tax free and the gain or accumulated interest is taxable in the tax year received.

The big advantage

The owner may elect to have the beneficiary distribution paid out over the life expectancy of the beneficiary, thereby converting big tax balloon payments into streams of income. Each year, a portion of the income is considered cost basis and a portion is taxable gain. The balance in the annuity continues to earn tax-deferred interest.

The annuity company, at no cost, administers the payout from the annuity to the beneficiary or beneficiaries, thereby saving administrative costs and trustee fees.
A couple of disadvantages to the trust

  • The full taxable gain is reported to the IRS in the year the payout is made to the trustee, circumventing the ability to convert big tax balloon payments into streams of income.

  • The only way to change beneficiaries in an irrevocable trust is via the will, providing the trust contains and authorizes beneficiary changes; thereby, again, not only adding legal fees, the enforcement of the will by the probate court will incur time delays and court costs.

Who’s your beneficiary?

It is wise, money smart, to make periodic reviews of primary and contingent beneficiary designations and the advantages of distribution methods. So often, there are changes within the family including, weddings, new births, and unfortunately, divorces and death, among other factors.

There are many types of trusts and many reasons to utilize trusts in estate planning, however, all assets are not required to be held inside or owned by the trust and all aspects should be reviewed and studied carefully.

To make sure your remainder goes to the people within the payment method of your choosing, make annual reviews of values, beneficiary designations and methods of payout options.