Private Annuity

What Is a Private Annuity?

A private annuity is a special agreement in which an individual (annuitant) transfers property to an obligor. The obligor agrees to make payments to the annuitant according to an agreed-upon schedule in exchange for the property transfer.

Private annuities are not an industry standard necessarily but may be used in various scenarios often involving inheritance planning, business succession, or asset protection. Agreement contract provisions are created and agreed to by both parties. For the agreement to be classified as a private annuity, neither party can be in the business of selling annuities — that is, neither party can be an insurance company. The agreement may or may not include provisions for beneficiaries.

Glossary

Obligor: Also known as a promisor, a person who is contractually or legally committed or obliged, to provide something to another party (called the obligee).

Understanding Private Annuity

Private annuities require careful consideration and agreement by both parties. They are most often utilized within a private annuity trust scenario. In October 2006, the Internal Revenue Service (IRS) proposed and effected regulations that ultimately annulled the major tax advantages of this type of arrangement.

Oftentimes, a private annuity is used to transfer assets to a family member where a normal transfer could be subject to gift or estate taxes. The property transferred to the obligor may include a family business interest, real estate, securities, or a variety of other assets. The transaction provides the annuitant, or a beneficiary, with regular payments that are generally only taxable as income.  

The value of the transferred assets along with the Internal Revenue Service’s life expectancy table and IRS Section 7520 Interest Rates are usually used to calculate the amount of the annuity payments. Once the rate and payment levels are set, they usually cannot be changed. If the annuitant or annuitant beneficiary dies early, the obligor(s) may receive a windfall.

This type of annuity will often be held in a trust, often known as a private annuity trust. Generally, trusts can be structured as their own business entity for operational and tax purposes. There are some limitations for grantor trusts.

The IRS’s 2006 changes required that the sale of the asset must be charged with a capital gain at the time of the exchange. This generally eliminates a non-taxable sale. It also makes the use of a private annuity trust more common for bequeathing assets to beneficiaries.

Private Annuity Advantages

The absence of tax payments from the asset transfer was the major advantage of this type of annuity agreement prior to 2006. After 2006, the transfer of the property must be considered a sale, requiring the recognition of a capital gain, if one exists, at the time of the transfer.

With the transfer of the property, the property's value and all future appreciation are thereby removed from the annuitant's taxable estate and owned by the obligor (usually in a trust). The private annuity effectively takes possession of the property.

If a private annuity trust is used for the purpose of bequeathing assets, the beneficiaries will receive annuity payments as directed. Assets obtained through inheritance are not taxable. The benefit in this scenario could be the sale of assets to the trust for simplifying an inheritance plan, leaving the trustee to manage operational payouts to the beneficiary or beneficiaries.