and as such, the rules generally only apply in situations where annuities are owned directly by individual, living, breathing human beings who may in fact someday retire (known in the tax code as “natural persons”).
Accordingly, whether annuities owned by trusts still enjoy tax-deferred growth depends upon the exact details of the trust.
The rules do allow that when a trust owns an annuity “as an agent for a natural person” the contract can still keep its tax-deferral treatment, such as when it’s owned by a revocable living trust; even if merely all the beneficiaries the trust are natural persons, such as with a bypass trust for the benefit of a surviving spouse and children, favorable treatment is still available.However, if other beneficiaries are involved – even and including charities – a trust-owned annuity may lose its preferential treatment.The scenarios discussed above where a trust may own an annuity and receive tax-deferral treatment are all situations where a trust tax-deferral treatment of an annuity – but instead IRC Section 72(e)(4)(C), which controls whether a transfer itself can be done without triggering the recognition any embedded gain on an annuity, and was created to prevent individuals from shifting the unrealized gains of an annuity to another person through gifting.Under this section of the tax code, if “an individual who holds an annuity contract transfers it without full and adequate consideration” any gains are recognized when the transfer occurs; in other words, the tax code treats it as though the contract was liquidated in a taxable event, and the proceeds were then transferred to purchase a brand new annuity.An even more complex point of intersection between annuities and trusts is when annuity contracts are transferred to/from a trust.
The problem is a key section of the tax code designed to prevent the unrealized gains of annuities from being shifted to another individual through gifting; as a result, if an individual transfers an annuity “without full and adequate consideration” its gains are immediately recognized.
The exception to the 72(u) “natural person rule” is that if an annuity is held “by a trust…
as an agent for a natural person” it will still be eligible for tax-deferral treatment.
For instance, if a grantor trust owns the annuity, it is clearly eligible for tax-deferred growth.
This would appear to be true both given the general treatment of grantor trusts, and with the supporting guidance of PLR 9316018.
(Michael’s Note: It’s important to remember that in the case of annuities owned inside of IRAs or other retirement accounts, the tax rules of retirement rules are controlling, including the tax-deferral treatment for retirement accounts; IRC Section 72 and its associated rules and regulations apply only to so-called “non-qualified” annuities held outside of retirement accounts.) Unfortunately, the tax code itself does not describe what constitutes “an agent for a natural person” and the rules are not entirely clear from the supporting Treasury Regulations, either.