Q. How long have Private Annuities been used?

A. Private Annuities were first used in the 1960s for Estate Planning; however, it really wasn't
until the last several years that they have become a popular tool used by Estate Planners.

Q. Why have I never heard of Private Annuity Trusts?

A. Due to their relative complexity Private Annuities have not been extensively used in the sale of assets. Chances are most Estate Planning attorneys and accountants have heard of Private Annuities but do not specialize in this area primarily due to the complexities and niche market use of PATs.

Q. What type of assets cannot be exchanged into a Private Annuity Trust?

A. IRAs, 401s or any type of qualified retirement plans cannot be sold through a Private Annuity without losing their tax-exempt status. 

Q. If I own more than one property, can I add them to the Private Annuity Trust at a later date?

A. Yes. A Private Annuity Trust may cover more than one property. It is recommended that you set up the initial trust with provisions set aside for the other properties to be included at a later date.  However, if the provisions are not set up prior to the sale of the remaining properties, an additional annuity contract must be created for the new property or properties.  Each annuity contract will be a separate entity and the deferral periods may be different. Certain corporate entities, depending on structure, may not qualify.

Q. Can a Private Annuity Trust be used to transfer a Family Limited Partnership or a Limited Liability Company?

A. Yes. If a Private Annuity Trust is structured properly to comply with IRS regulations, it may be used as a tool to transfer shares of an FLP or an LLC.

Q. When the IRS examines a Private Annuity Trust what factors does it look at?

A. (1) Does the Transferor (Annuitant) have at least a 50% chance of living 18 months?
         (Rev. Ruling 96-3 replacing Rev. Ruling 80-80)

     (2) Does the income from the annuity contract differ significantly from the income producing
          asset that was transferred?

     (3) The Annuity Agreement should state the liability towards the Transferee and 
          specify that the payments are made without regard to the income from the assets.

     (4) The Annuity payments are not limited only to the income from assets transferred
          into the Private Annuity. Thus, the trust should not give a “note” for the annuity payment.

     (5) The Transferor (Annuitant) must relinquish complete ownership over the assets transerred
          into the trust. The transferor and the transferor's spouse must keep "an arms length
          agreement" from the assets inside the Private Annuity Trust.

     (6) The Transferor (Annuitant) must never receive any excess capital from the Private Annuity
          Trust’s assets, other than what the government determines to be his/her annuity income
          payments, fixed for the remainder of his/her life.

     (7) The Trust or Transferee should have resources in excess of the assets that were transferred
          into the Private Annuity Trust. (Rev. Ruling 68-183) This reserve requirement assures that
          the Private Annuity Trust has a greater asset value than the value that makes up the
          Private Annuity Contract.

Q. How is the interest rate determined on the unpaid balance?

A. The IRS will use the ‘Annual Federal Mid-Term Rate’ (AFMR) to determine what interest rate will be used on the unpaid balance in the Private Annuity Trust. The AFMR rate moves up and down monthly based on credit market fluctuations. Your Annuity contract will use the current AFMR rate for the month in which it was established. This rate will “lock in” and become a fixed rate for the life of your annuity payments.

Q. How can I know what amount my income payments will be?

A. Income payments can be calculated by (1) the Annuitant'(s) age/life expectancy, (2) the selling price of assets minus any loans fees, or commissions that must be paid off, (3) the Federal Mid-Term Rate in effect at the time and (4) the deferral length, if any, before income payments begin.

Q. How long can I defer monthly income payments if I do not need it?

A. You can defer monthly income payments and associated taxes as long as you wish, up to age
70 ½. At that time you must start receiving the required minimum payments.

Q. After the annuity contract is set up can I change the deferral period?

A. The income payments are locked into a fixed amount, so once you begin receiving payments you cannot change the deferral period to a later date, however, there has been relevant speculation through the courts as to whether or not you can amend the contract to receive income payments at an earlier date.

 Q. What if I need to receive more money in addition to my fixed monthly income payments? Can there be any type of variability as to receiving more money before retirement, if needed?

A. Yes.

(1) The Annuitant may also receive a loan from a bank or other lender in the amount needed.

(2) If the Annuitant knows that he/she may need more money before retirement and prior to setting up the Private Annuity, then two annuity contracts could be set up in the Trust. One for the amount of income the Annuitant needs presently and the second for the amount which would be deferred until retirement. Calculations would be based on the balance of the value of the asset in the Private Annuity Trust.

Q. Can I sell my assets first and then put them into the Private Annuity Trust?

A. No. In order for the Private Annuity Trust to comply with IRS regulations, it is imperative that the assets be placed into the trust first and then the trust would sell the asset.

Q. What if I need cash from the sale, may I keep some?

A. Yes. You may allocate a partial Private Annuity Trust. In this case the annuitant will be immediately responsible for the proportionate share of capital gains taxes on the cash he/she received.  This taxable amount will not be eligible for deferral like the rest of the proceeds.

Q. Is there any rule as to how much of the assets need to be invested?

A. Yes. The value of the Private Annuity Contract is recommended to be less than the fair market value of the asset.  This will provide the Trust will some excess or reserve capital so that it meets the IRS regulations of having additional assets aside from the assets transferred into the Private Annuity Trust (Rev. Ruling 68-183).  It is generally recommended that the reserve capital should be at least 5-10% of the trust's value.

Q.  What happens if I outlive or die prior to my estimated life expectancy?

A. Income payments are received until the annuitant’s (or in joint annuities, the surviving spouse's) death. Life expectancy is just the number used to determine the payment amount.  If the annuitant(s) outlives his/her projected life expectancy, he/she will still receive monthly income payments until death.

Q. What happens to the Private Annuity Trust at the Annuitant’s death?

A. At the death of the Annuitant the income payments are passed to the surviving spouse (this only occurs in joint annuities).  At the death of the 2^nd spouse, annuity payments cease and are voided. The remains of the assets in the Trust will pass to the heirs/beneficiaries according to the provisions of the Trust. The beneficiaries may be paid out immediately, or may receive payments over a pre-specified period of time. The trust may be responsible for any unpaid taxes that remain.  Because the assets in a Private Annuity Trust are considered "outside your estate", the Trust's proceeds pass to the heirs/beneficiaries, free from Estate Tax.

Q. How are there no Estate and Gift taxes incurred through a Private Annuity Trust?

A. The assets are completely removed from the Annuitant's taxable estate once transferred into and “sold” through the Private Annuity Trust. Because the transaction is considered a “sale” and not a “gift”, there are no gift taxes incurred.

Q. What happens if the trust runs out of money before the death of the Annuitant?

A. If not invested properly, it is possible that the Trust could run out of money. The Annuitant would have the right to sue the Trust for breach of the annuity contract. However, if the assets no longer exist in the Trust, there would be no advantage to taking legal action.  Should this scenario occur, the IRS would be unable to receive its tax money considering no assets remain in the Trust.

Q. Who should be the trustee in a Private Annuity Trust?

A. Usually, the trustee is one of the Annuitant’s adult children. The adult child can be the trustee as well as the beneficiary. However, if the Annuitant does not have any children (or does not wish to use his/her children as the trustee), he/she may choose a relative, family friend or any type of professional trustee such as an attorney, accountant or financial planner to serve as the trustee. Neither the Annuitant nor his/her spouse can be the trustee of the trust. If the Annuitant would like the comfort of extra security, he/she may assign a co-trustee which may be a combination of family members or professionals, for example.  No matter whom the Annuitant chooses as the trustee or co-trustee, the beneficiary has the ultimate decision whether to replace an individual(s) as trustee.

Q. Can the Private Annuity Trust be set up for both my spouse and I to receive income payments?

A. Yes. A joint annuity, or second-to-die entitlement, would be set up in the Private Annuity Trust.  In this case your spouse would not serve as a co-owner or joint Annuitant; however, he/she would receive the income payments at your death. These payments would continue until his/her death (or until the death of the second spouse).

Q. How am I not responsible for any taxes when I sell my assets to the Private Annuity Trust?

A. When you sell your assets to the Private Annuity Trust you are receiving an annuity contract from the trust as payment.  Since there is no exact determination of how many income payments you may receive in your lifetime, the IRS mandates that you make portions of the remaining tax payments as they are received by your income payments.

Q. Is the Private Annuity Trust a “secured obligation”?

A. No. The Private Annuity Trust must be an unsecured obligation. The IRS does not allow this type of tax strategy if the annuity is secured. In essence, the trust cannot be secured by the underlying assets as a guarantee to the annuitant. 

Q. Who bears the risk of making the annuity payments and what kind of guarantee do I have that payments will be made?

A. The trustee bears the risk of ensuring that the Annuitant receives his/her earnings from the assets sold through the Private Annuity Trust. The Private Annuity Trust is as secure as the investments used to fund the trust. For example, if the investments are made up of stocks, then the annuity payments are vulnerable to market fluctuations. Thus, the trustee is responsible for making prudent investment decisions for the Trust.

Q. Can the Annuitant manage the investments in the Private Annuity Trust?

A. No. The trustee is the person responsible for making the investment decisions of the Trust. While the Annuitant may make investment recommendations, it is ultimately the responsibility of the trustee to make prudent investment decisions regarding the Trust.  The trustee should also take special precautions as to managing the asset portfolio in regards to tax efficiency. There is a possibility that the tax liability of the Trust will exceed the annuity payments that the Annuitant is to receive.

Q. Are the Annuity Payments from the Private Annuity Trust tax deductible?

A. No. The annuity payments are considered purchase price payments with an “Annuity” amount.  Therefore, for tax purposes, the Trust’s payments are not tax deductible as interest.

Q. My attorney or tax advisor has never heard of a Private Annuity Trust or has heard of it and doesn't think it is legal. How can they be assured that it is a legitimate Estate Planning strategy?

A. Many attorneys and tax advisors have not heard of Private Annuity Trusts, or perhaps they may have heard of them but choose not to make them part of their everyday practice, primarily due to their relative complexities and niche market use. The only true way for an attorney or tax advisor to understand the legality of a Private Annuity Trust is for him/her to become familiar with the IRS Revenue Rulings. These rulings include IRS Revenue Rulings 55-119 and 69-74, Revenue Ruling 80-80, the IRS’ GCM39503 (5/19/1986) and Treasury Decision TD-8754 (1998), also the Ninth Circuit U.S. Court of Appeals decision “LaFargue v. Commissioner, 689 F.2d 845 (1982)”.  These court decisions and rulings are posted on the "Tax Codes & Court Rulings" page of the website and are also available by mail upon request.

Q. I am interested in implementing a Private Annuity Trust, what is the next step?

A. The next step is to contact NAPAT directly. NAPAT will then meet with you and your tax advisor and answer any questions that you may have.  We will provide you with a detailed illustration of what your annuity payments might look like, and then go through and assist you in filling out an application and information form. Once the application is complete NAPAT will refer you to up to 3 attorneys who specialize in drafting PATs. Finally, upon completion of the documents, NAPAT or one of its associated members will assist you, your financial planner, and tax advisor with the final implementations of the Private Annuity Trust.