Annuities vs. Estate Planning

Annuities (the tax-deferred investment packages, as distinguished from old-fashioned immediate annuities) are selling like hotcakes through bank channels. Investment News reports that just three major banks earned almost $800 million in sales commissions on annuities last year:

Wachovia Corp. earned the most commissions from annuity sales. . . . The Charlotte-based bank collected $483 million in annuity fees, or 0.06% of $782.8 billion in assets. JPMorgan Chase and Co. of New York came in second with $163 million in fees . . . .

Rounding out the top three was Charlotte-based Bank of America Corp., which brought in $152.5 million in annuity fees, 0.01% of $1.7 trillion in assets.

Good news for a bank's bottom line isn't necessarily good news for trust officers and others involved in estate planning. Another Investment News article warns annuities can destroy estate plans.

"Many trusts are drawn to continue beyond the death of the owner," said David F. Sterling, a financial consultant and attorney at Sterling Capital Resources of Sarasota, Fla. "When the trust receives and deposits the annuity profits, they could be subject to an onerous tax rate."

It's not necessarily the annuity purchase that is the problem, but rather how it works in this context, lawyers said.

For example, certain tax-deferred annuity contracts stipulate that an investor can designate a trust as the owner and beneficiary of an annuity as "an agent for a natural person." Since trusts are "non-natural" entities, the investor is still considered the owner of the contract, and the annuity remains tax-deferred.

However, depending on the structure of the trust, a detail in the tax code could force the payout of the annuity in the trust within five years if that investor dies. In this case, the annuity's profits are then taxed at the rates for a trust, as opposed to the rates for an individual.

Last year, for example, a trust needed to earn just $10,450 in order to be subject to the 35% income tax rate — which is higher than the tax rates assessed for individuals. The problem is especially serious for multigenerational trusts, Mr. Sterling said.

What about it, trust officers? Is the trend to investing via annuities threatening to screw up more and more estate plans?