Continuing Education for CPAs

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1 UFS Making Sense of the Tax Rules Affecting Annuity Contracts L (exp0713)(all states)

2 Metropolitan Life Insurance Company, New York, NY New England Financial is the registered mark for New England Life Insurance Company, 501 Boylston Street, Boston, MA MetLife companies. MetLife Insurance Company is registered with the National Association of State Boards of Accountancy (NASBA), as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State Boards of accountancy have final authority on the acceptance of individual courses for CPE credit. L (exp0713)(all states)

3 Objectives To educate you on the taxation of distributions from a non-qualified annuity contract to better enable you to provide assistance to your client s that own or are considering purchasing an Annuity contract. To identify opportunities that enable the client to meet their planning objectives and comply with the Internal Revenue Code and IRS rulings. Note: For purposes of these slides and discussion, unless otherwise stated, any reference to annuity contract, contract or annuity is intended to apply only to nonqualified annuity contracts.

4 Agenda Types of Non-Qualified Annuity Contracts Distributions from non-qualified annuity contracts Death of Owner Estate Tax Treatment

5 Types of Annuity Contracts Annuitant Driven Owner Driven Suggested Ownership Arrangements

6 Suggested Ownership Arrangement Owner and the Annuitant are the same Owner and Annuitant Driven contracts

7 Taxation of Withdrawals Mary Smith (60 years old) purchased a non-qualified annuity contract in 2000 with an initial payment of $125,000. The contract now has an accumulated value of $195,000 and a surrender value of $191,000. What are the tax consequences if Mary takes a withdrawal of $95,000?

8 Taxation of Withdrawals Peter Paul ( Mary s older brother) purchased a nonqualified deferred annuity contract in 2002 with an initial payment of $85,000. The contract has experienced wide fluctuations in value and now has an accumulated value of $130,000 and a cash surrender value of $115,000. What are the tax consequences if Peter takes a withdrawal of $40,000?

9 Surrender Mary Smith (60 years old) purchased a non-qualified annuity contract in 2000 with an initial payment of $125,000. The contract now has an accumulated value of $195,000 and a surrender value of $191,000. What are the income tax consequences if Mary surrenders the annuity contract?

10 Pledges and Loans Chuck Jones (age 54) owns a non-qualified annuity contract with an accumulated value of $225,000, a surrender value of $200,000, and a basis of $100,000. The First M & A Bank is lending money to Chuck provided he pledges the annuity contract as collateral for the loan. What are the general income tax consequences, if any, of such a pledge?

11 Multiple Contracts Cooper Lybrand (age 62) purchased two non-qualified annuity contracts in 1997 from the same Life Insurance Company. The initial investment in each contract was $65,000 and each contract has an accumulated value of $120,000 (no surrender charges). What are the tax consequences of a $70,000 withdrawal from one contract?

12 Premature Distributions Ten years ago when Billy was 30 years old he purchased an annuitant driven annuity contract and designated himself as the owner, his mother as the annuitant, and his younger brother as the beneficiary. The contract was purchased with a single payment of $50,000 and now has an accumulated value of $105,000 (no surrender charges) when his mother dies suddenly at the age of 60. What, if any, are the tax consequences upon the death of Billy s mother?

13 Premature Distributions - Exceptions On or after the owner reaches Age 59 ½ Death of Owner Disability of Owner (as defined by federal tax law) Immediate Annuity (as defined by federal tax law) Substantially Equal Periodic Payments based on life or life expectancy Effective Date

14 Premature Distributions Special Rule Contracts issued after August 13, 1982 and prior to January 18, 1985 may not be subject to the penalty tax provided the distribution is allocable to an investment in the contract more than 10 years before the date of distribution.

15 Non-Natural Person General Rule Annuity contract held (owned) by a non-natural person shall not be considered an annuity contract for tax purposes and the internal build-up will be taxed each year. Examples of Non-natural persons include: Corporations Partnerships (including FLP) Charity Charitable Remainder Trust Trusts Governmental Entity Exceptions include: Agent for a natural person Immediate annuity The federal tax rules impose certain requirements and limitations on annuity contracts. These rules may differ depending on w hether an annuity contract is owned by an individual or non-natural person (e.g., trust or estate) and may also differ if a designated beneficiary is an individual or non-natural person. When purchasing an annuity contract, your client should fully consider these rules and the impact these requirements and limitations may have on the contract and any living and/or death benefits provided under the contract. If a non-natural person owns a nonqualified annuity contract, changing the annuitant will generally trigger the after-death required distribution requirement. Additionally, if a non-natural person owns a nonqualified annuity contract that satisfies one of the exceptions to the general rule, the taxable portion of any distribution or withdrawal will generally be subject to the 10% federal income tax penalty because most of the exceptions (including the age 59 ½ and substantially equal periodic payments for life exceptions) do not appear to apply.

16 Non-Natural Person - Taxation Taxable income = (net surrender value at the end of the year + all distributions received during the year and all previous years ) (total net premiums + all amounts previously taxed). An annuity owned by a non-natural person still has to meet the after death distributional requirements under section 72(s) of the Internal Revenue Code keying off the death of the primary annuitant. A change in annuitant will generally not be permitted and where permitted will trigger the section 72(s) distributions requirements. If a nonqualified annuity contract issued by a MetLife company is owned by a grantor trust (as defined under federal tax law), the individual treated as owner of the assets of the grantor trust (typically the grantor) must be named the annuitant under the contract.

17 Non-Natural Person - Note Currently MetLife does not generally allow its non-qualified annuities to be sold to non-natural persons outside of charitable remainder trusts, grantor trusts and certain nongrantor trusts; this includes any annuities sold through the EGA.

18 Gift of Annuity Contract Mrs. Paul purchased a non-qualified annuity contract in 1989 with a single payment of $60,000 and it now has an accumulated value of $160,000. She gifts the contract to her 48 year old daughter who immediately takes a $60,000 withdrawal. What are the tax consequences of these transactions?

19 Gift of Annuity Contract Tax Consequences Non-Qualified Contracts issued before April 23, 1987 Contracts issued after April 22, 1987 Transfer to spouse

20 Death of any Owner Before the annuity starting date All within 5 years after the date of death of owner Payments over life (or over a period no longer than remaining life expectancy) of designated beneficiary beginning no later than one year after date of owner s death On or After the annuity starting date At least as rapidly as under method used at date of death

21 Death of Owner Spousal Continuation Mark and Mary Mars would like to jointly own an annuity contract so the survivor could continue the contract upon the death of the first spouse. Upon the death of the survivor, they want the contract to pass to their infant daughter Ruth. How will you title the contract to meet their goals?

22 Tax-Free Exchanges R. E. Place (age 68) purchased an annuity contract in October of 1981 with an initial payment of $25,000. He completed a 1035 exchange in 1988, 1995 and in He never made any additional payments and the contract has an account value (no surrender charges) of $140,000. Mr. Place decides to withdraw $40,000 to purchase a new car. What are the tax implications of the withdrawal? What if he has received $40,000 in cash as part of a 1035 exchange transaction and exchanged the remaining $100,000?

23 Tax-Free Exchanges Exchange requirements Partial exchanges Exchanges to an existing contract

24 Taxation of Annuity Payments Each payment is generally comprised of two components: Return of basis Ordinary income How are these amounts determined?

25 Taxation of Annuity Payments Exclusion Ratio Fixed Annuity Payments - Exclusion Ratio = Investment in contract (adjusted for any refund feature) Expected Return Variable Annuity Payments - Excludable amount determined by dividing investment in the contract (adjusted for any refund feature) by the number of years it is anticipated the annuity will be paid.

26 Taxation of Annuity Payments John has a 20 year life expectancy and elects to receive annual annuity payments of $15,000 for life from his fixed annuity contract. His basis in the contract is $100,000. How much of each annuity payment will be received income tax free?

27 Estate Tax Issues Estate inclusion Possible reduction for estate and income taxes Income in respect of a decedent

28 Circular 230 Notice and Disclosure: Pursuant to IRS Circular 230, MetLife is providing you with the following notification: The information contained in this document is not intended to and cannot be used by anyone to avoid IRS penalties. This document supports the promotion and marketing of insurance products. Clients should seek advice based on their particular circumstances from an independent tax advisor. MetLife, its agents, and representatives may not give legal or tax advice. Any discussion of taxes herein or related to this document is for general information purposes only and does not purport to be complete or cover every situation. Tax law is subject to interpretation and legislation change. Tax results and the appropriateness of any product for any specific taxpayer may vary depending on the facts and circumstances. You should consult with and rely on your own independent legal and tax advisors regarding your particular set of facts and circumstances. Metropolitan Life Insurance Company, 1095 Avenue of the Americas., New York, NY PEANUTS 2011 Peanuts Worldwide L (exp0713)(all states)

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