Non qualified annuity- trust beneficiary-tax rate?
I have a client who recently passed who had a NQ deferred annuity in which she named her revocable trust as the beneficiary. Presuming the beneficiaries want to take the lump sum distribution, how will the interest earned during the deferal period be taxed? The insurance company rep told me that the lump sum payout would be paid to the trust and would be taxed at the trust tax rate. I question the accuracy of this if the payment is distrubuted to the beneficiaries right away. Is there a way to flow the payments to the beneficiaries and have the interest taxed at their individual tax rate rather than at the trust tax rate? If so, what needs to take place for this to occur? The rep also suggested the ability to take a 5 year payout. She said the first payment would have to go to the trust, but then the trust could be disolved and the remaining 4 payments would go to the beneficiaries individually. The first payment would be taxed at the trust rate, but the subsequent payments paid to the individuals would be taxed at their respective rates. I would like to know the options in both instances.
Thank you kindly,
Permalink Submitted by Alan Spross on Wed, 2009-09-09 22:47
The trust provisions determine whether the trust can be terminated and when, and also what income can be distributed to the trust beneficiaries. IF the trust income can be distributed to the beneficiaries, then the tax liability is passed to the beneficiaries on a K1 and is reported by the beneficiaries. However, if the trust is written to retain distributions and income, then the trust will have to pay the taxes at the higher compressed rates that apply to estates and trusts.
Mere payment to the trust does NOT mean that the trust will have to pay the taxes, but it does mean that the trust will have to report the income on Form 1041, but then pass it through to the beneficiaries if trust provisons so state. The rep does not seem to be making this distinction.
It may also be possible to terminate the trust before ANY payment from the annuity is required, but again that depends on the trust. It is very possible for the first payment to be made to the trust, and the trust could pass this income through. After the trust in allowed to terminate, the remaining assets in the annuity can be assigned directly to the trust beneficiaries. It may even be possible for some beneficiaries to select different payout options from the others.