How To Use an Annuity for Generational Wealth Transfer Planning

By Alan Jahde, JD, LLM (taxation)

August 12, 2022
Grandfather with grandson

Oil and water, tinfoil and microwaves, pineapple and pizza (yes, I went there!) – these are just a few examples of things that simply don’t work together.  

In the wealth preservation planning arena, some advisors would add annuities and generational transfer planning to the list I started. It’s an understandable misconception since traditional use cases for annuities are quite narrow. But the reality is this: A private placement variable annuity (PPVA) can be used in a variety of unique ways that support specific planning goals.

One of the use cases for PPVA we’ve been speaking to a lot of advisors about lately is the “stretch annuity.”

When structured correctly, a private placement stretch annuity can optimize across all three U.S. tax systems – income, estate/gift/transfer, and generation skipping transfer (GST) – to stretch tax deferral for multiple generations.  

Stretch Annuity Basic Structure 

Unlike most other annuities, in a stretch annuity structure the premium payor does not have to be the owner, annuitant, or beneficiary.   

Here’s an example: 

Diagram of three generation's roles in the stretch annuity structure

In this scenario, the premium payor is the matriarch or patriarch of an ultra-high-net-worth (UHNW) family. Generation 1buys a PPVA and then gifts the annuity outright or in trust to their child. Generation 1 may use his or her remaining gift tax exemption or, if exhausted, utilize other transfer tax planning techniques to transfer the stretch annuity to Generation 2.  

Annuity withdrawals from the stretch annuity are optional for Generation 2 until age of 98, or upon their death. Therefore, all accumulated growth during Generation 2’s lifetime can be income tax deferred.    

The Generation 3 beneficiary can elect to take payments over their expected lifetime. For Generation 3 grandchildren in their20s, that is currently approximately age 85. Therefore, the income tax can be deferred and stretched over two generations.  

Benefits Over Traditional Retirement Planning

Retirement planning, such as 401(k) plans, IRAs, and Roth IRAs, are great for meeting retirement needs and achieving income tax deferred growth during the lifetime of the account holder. However, as a generational planning tool, special considerations have to be made to accommodate gift and estate taxes.

Table comparing traditional retirement accounts to a stretch annuity
Clock is Ticking on Higher Estate Tax Exemption 

A UHNW family that utilizes an institutionally priced variable annuity in this way could enjoy income tax deferral on all account earnings across multiple generations, as well as avoid transfer and GST taxes as to the account growth. That’s a winner under each tax system, in my view.    

Moreover, a stretch annuity’s wealth planning potential is made more powerful for the next few years. This is due to a tax exemption increase implemented under the 2017 Tax Cuts and Jobs Act (commonly known as the Trump Tax Act), which essentially doubled the transfer tax exemption to around $12 million per person for 2022. Unfortunately, the Trump Tax Act sunsets at the end of 2025, when it will drop back down to around $5.5million.  

Generation 1 can take advantage of the Trump Tax Act, utilizing their unused exemption to purchase a PPVA and then gift the annuity outright or in trust to Generation 2.  

If you’d like to learn more about the planning opportunities available by utilizing stretch annuities, please let us know. We have prepared some materials and case studies that are available upon request.

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