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Private annuity.

The private annuity has been most effectively used in family situations where it is desired to make a transfer of a business interest, or other asset, from one generation to the next free of estate taxes. Under a typical private annuity transaction, a parent will sell part or all of a business interest, or other asset, to his or her child or children. In return, the children promise to pay the parent an income for life (called a "straight life" annuity). While the annuity obligation cannot be secured, it does represent a contractual obligation that is legally enforceable. Since payments terminate at the parent's death, the annuity has generally been considered to have no value and to escape taxation in the parent's estate.


The amount of the annual payments is determined by using annuity valuation factors. The entire amount of the gain or loss must be recognized at the time of the transaction. Annuity payments are made up of interest income and a nontaxable recovery of basis. If it is desired to provide an ongoing income to both surviving parents, a reduced income can be paid for as long as either parent is alive (called a "joint and survivor" annuity). Although the value of the survivorship benefit is includable in the estate of the first parent to die, it should escape taxation because of the unlimited marital deduction. At the time the annuity is established, the child receives a "temporary basis" equal to the value used in calculating the annuity. After the parent's death, this temporary basis is adjusted to reflect the amount actually paid.

It would be best to avoid stipulating lower annual payments than those calculated under the annuity tables. Such annuity payments result in a gift from the parent to the child (i.e., the child is not paying full value from his or her separate funds). If there is a gift element, then its value is the difference between the fair market value of the asset and the present value of the annuity payments.

Furthermore, if the child does not pay full value, the property transferred for the private annuity could be included in the parent's estate as a gift with a retained life estate.

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Title Annotation:Chapter 17: planning for retirement
Author:Cady, Donald F.
Publication:Field Guide to Financial Planning
Date:Jan 1, 2010
Previous Article:Equity-indexed annuity.
Next Article:Taxation of annuities.

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