I have written this article for information purposes, and I hope you learn something from it. Though I would like to state it is current and up to date, in all candor, I can't. In most cases, the concepts are relatively accurate (except for obviously old and dated materials, primarily related to taxes). You should confer with your own lawyer about issues that affect you and your family.
During the Victorian period, George Outram immortalized the annuity, with his famous poem (which is reprinted at the end of this article, if you want to read it), which I find entertaining and humorous. Today, most people think of annuities as life insurance companies, as alternatives to an investment in Certificates of Deposit. An annuity may also be a means of earning income, but deferring the tax on it, until funds are withdrawn. There is, however, another type of annuity, known as a private annuity, which sometimes lends itself to some creative estate planning.
The easiest way of describing how a private annuity can be used is by example. Let's say that Stan, age 84, transfers a $1,000,000 piece of real estate to his son, George, in exchange for a private annuity. There is no mortgage given to secure the annuity, but George agrees to pay his Dad, Stan, the sum of $213,306 every year that his dad lives. When Stan dies, the annuity will not have any balance due, for it is (on Stan's death) regarded as being paid in full. Thus, if Stan dies within a couple of years after the transfer, George will have paid Stan the sum of $426,612, but George will owe nothing additional for this $1,000,000 piece of real estate, and there will be no estate tax on this property.
Because this transaction is a sale of real estate, the property being transferred is not included Stan's gross estate for estate tax purposes (even though he made the transfer within three years of his death). Stated differently, Stan's gross estate is now $1,000,000 less than it was (except for anything remaining from the payments of $426,612).
From a practitioner's vantage, the difficulty in structuring a private annuity is knowing how much is to be paid to Stan, and what the income tax consequences of the transaction are. To calculate the amounts, you must know what the Section 7520 rate of interest is. If we use the July 1999 Section 7520 rate of interest, which is 7.2%, for purposes of this illustration, and assume a basis in the real estate of $50,000, and also assume that the annuity payment will be made annually at the end of the period, then we can determine the annual payout to be $213,306 per year. Using this amount, we can calculate the income tax consequences to Stan, as follows: $7,246 of the annual annuity payment will not be taxed for income tax purposes, $137,681 will be subject to capital gains tax and $68,378 will taxed as ordinary income. All of these calculations are based on a single life expectancy for an 84 year old, of 7.4 years.
Though I will not use this column to endorse products, I will make an exception this time. Steve Leimberg has written a program (Number Cruncher) to complete all of these calculations (and a number of other useful estate planning computations). More details about this program can be obtained at http://www.leimberg.com. From an estate planner's perspective, the program can be used with your client sitting in front of your computer screen, and you can compute these amounts in a matter of seconds, rather than search though lots of books to determine what is needed.
As an estate planner, the benefit of a private annuity is this: if the owner of the property is in ill health, or might not meet ordinary life expectancy for his or her age, then a private annuity is a good means of eliminating property from the federal taxable estate. Admittedly, the maker of the annuity will have to purchase the property and pay the annuity on an annual basis (or more frequently, if desired). But that might not be a bad alternative, if the estate tax consequences of leaving the property in the estate outweighs the annual cash outlay for the private annuity.
There are certainly other uses for private annuities (e.g., they can be prepared for two lives, rather than a single life), but hopefully this illustration will be of use to you in determining whether highly appreciated property should be sold in exchange for a private annuity.
Above article: ©1999 James H. Beauchamp
As promised, here is the poem:
I gaed to spend a week in Fife –
An unco week it proved to be –
For there I met a waesome wife
Lamentin’ her viduity.
Her grief brak out sae fierce and fell,
I thought her heart wad burst the shell;
And – I was sae left to mysel’ –
I sell’t her an annuity.
The bargain lookit fair eneugh –
She just was turned o’ saxty-three –
I coundna guessed she’d prove sae teugh
By human ingenuity.
But years have come, and years have gane
And there she’s yet as stieve’s a stane –
The limmer’s growin’ young again,
Since she got her annuity.
She’s crined awa’ to bane an’ skin;
But that it seems is naught to me;
She’s like to live – although she’s in
The last stage o’ tenuity.
She munches wi’ her wizened gums,
An’ stumps about on legs o’ thrums,
But comes – as sure as Christmas comes –
To ca’ for her annuity.
She jokes her joke, an’ cracks her crack,
As spunkie as a growin’ flea –
An’ there she sits upon my back,
A livin’ perpetuity.
She hurkles by the ingle side,
An’ toasts an’ tans her wrinkled hide –
Lord kens how lang she yet may bide
To ca’ for her annuity.
I read the tables drawn wi’ care
For an Insurance Company,
Her chance o’ life was stated there,
Wi’ perfect perspicuity.
But tables here or tables there,
She’s lived ten years beyond her share,
An’s like to live a dozen mair,
To ca’ for her annuity.
I got the loon that drew the deed –
We spelled it o’er right carefully; -
In vain he yerked his souple head,
To find an ambiguity;
It’s dated – tested – a’ complete –
The proper stamp – nae word delete –
An diligence, as on decreet,
May pass for her annuity.
Last Yule she had a fearfu’ hoast –
I thought a kink might set me free;
I led her out, ‘mang snaw and frost,
Wi’ constant assiduity.
But Deil ma’ care! – the blast gaed by,
An’ missed the auld anatomy;
It just cost me a tooth, forbye
Discharging her annuity.
I thought the grief might gar her quit –
Her only son was lost at sea –
But aff her wits behuved to flit,
An’ leave her in fatuity!
She threeps, an’ threeps, he’s livin’ yet,
For a’ the tellin’ she can get;
But catch the doited runt forget
To ca’ for her annuity!
If there’s a sough o’ cholera
Or typhus – wha sae gleg as she?
She buys up baths, an’ drugs, an’ a’,
In siccan superfluity!
She doesna need – she’s fever proof –
The pest gaed o’er her very roof;
She tauld me sae – an’ then her loof
Held out for her annuity.
Ae day she fell – her arm she brak, -
A compound fracture as could be;
Nae Leech the cure wad undertak,
Whate’er was the gratuity.
It’s cured! – She handles’t like a flail –
It does as weel in bits as hale;
But I’m a broken man mysel’
Wi’ her and her annuity.
Her broozled flesh an’ broken banes,
Are weel as flesh an’ banes can be.
She beats the taeds that live in stanes,
An’ fatten in vacuity.
They die when they’re exposed to air –
They canna thole the atmosphere;
But her! – expose her onywhere, -
She lives for her annuity.
If mortal means could nick her thread,
Sma’ crime it wad appear to me;
Ca’t murder – or ca’t homicide –
I’d justify’t – an’ do it tae.
But how to fell a wither’d wife
That’s carved out o’ the tree o’ life –
The timmer limmer daurs the knife
To settle her annuity.
I’d try a shot, - But whar’s the mark?-
Her vital parts are hid frae me;
Her backbane wanders through her sark,
In an unkenn’d corkscrewity.
She’s palsified – and shakes her head
Sae fast about, yet scarce can see’t;
It’s past the power o’ steel or lead
To settle her annuity.
She might be drowned; but go she’ll not
Within a mile o’ loch or sea; -
Or hanged – if cord could grip a throat
O’ siccan exiguity.
It’s fitter far to hang the rope –
It draws out like a telescope;
“Twad tak a dreadfu’ length o’ drop
To settle her annuity.
Wil puzion do’t? – It has been tried;
But, be’t in hash or fricassee,
That’s just the dish she can’t abide,
Whatever kind o’ gout it hae.
It’s needless to assail her doubts, -
She gangs by instinct – like the brutes –
An’ only eats and drinks what suits
Hersel’ an’ her annuity.
The Bible says the age o’ man
Threescore an’ ten perchance may be;
She’s ninety-four; - let them wha can
Explain the incongruity.
She should hae lived afore the Flood –
She’s come o’ Patriarchal blood –
She’s some auld Pagan mummified,
Alive for her annuity.
She’s been embalm’d inside and out –
She’s sauted to the last degree –
There’s pickle in her very snout,
Sae caper-like an’ cruety;
Lot’s wife was fresh compared to her;
They’ve Kayanized the useless knir;
She canna decompose – nae mair
Than her accursed annuity.
The water-drap wears out the rock
As this eternal jaud wears me;
I could withstand the single shock,
But no the continuity.
It’s pay me here – an’ pay me there –
An pay me, pay me, evermair;
I’ll gang demented wi’ despair –
I’m charged for her annuity.
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