Inheritance Tax Money

Annuities buyers should be cognizant of the annuity inheritance tax.

"A ruling by a Louisiana appeals court recently stated that the entire death benefit from a single premium annuity plan paid to the beneficiary named in that plan was subject to inheritance tax because it was part of the deceased annuity owner's estate," says annuities specialist Steven Hart. "Since individuals may purchase annuity plans to avoid such taxes, it's important for investors to learn as much as they can about the potential annuity inheritance tax."

In the Lousiana case, a woman's son was the sole heir of her estate. He had also been named as beneficiary for the nonqualified, tax-deferred, single premium annuity plan his mother purchased over her lifetime. The tax collector said the entire death benefit should be subject to the inheritance tax but the son disagreed, insisting that the annuity was equal to a life insurance policy and as a result should not be subjected taxes. The earnings part of the annuity, he said, classified both as "income" earnings and "inheritance" to the beneficiary, created double taxation, which is unconstitutional. The court disagreed and the Appeals Court ruled that proceeds are not like life insurance proceeds and therefore are subject to inheritance tax.

"One of the significant features of a deferred variable annuity plan is that payouts are treated as ordinary income," says Hart. "If the owner of the plan dies before the annuity's beginning date, all of the interest has to be distributed within five years of the individual's death, except when certain conditions apply.

"If a designated beneficiary is the spouse of the annuity owner, at the owner's death, the spouse becomes the owner of the annuity, and no distributions have been made. Therefore, the spouse keeps the deferred status of the plan. If an annuity owner dies during the accumulation phase of the plan, its cash value can be included in the deceased estate if its payable to that estate. If the annuity owner dies after payouts have started, the remained of the annuity contract must be distributed as quickly as the in-force distribution method allows.

"Death benefits from a deferred annuity are considered ordinary income to the beneficiary of that annuity, just as the amounts would have been to the owner of the annuity if he or she had lived. If a lump sum benefit is involved, taxes can be deferred on that amount if the beneficiary chooses to receive a lifetime payout within sixty days of the owner's death."