ADVANCED TECHNIQUES USING TRUSTS WITH ANNUITIES JNL201409-A133 FOR FINANCIAL PROFESSIONAL USE ONLY. NOT FOR PUBLIC USE.

ADVANCED TECHNIQUES USING TRUSTS WITH ANNUITIES JNL201409-A133 FOR FINANCIAL PROFESSIONAL USE ONLY. NOT FOR PUBLIC USE.

TABLE OF CONTENTS Table of Contents Introduction Regulation of Annuity Ownership in Trusts Why Use an Annuity? Types of Trusts that Can Utilize Annuities Tips for Effective Implementation

Landscape Magnitude Population of High Net Worth Individuals ended 2013 at 4M up from 2.9M in 2009** Assets of HNWI ended 2013 at $13.9T up from $9.9T in 2009** About 6.1M millionaire households are spread across the U.S. = 1 in 20 households ***Wall Street journal The top cited goals of HNW Estate Planning are: * Minimizing taxes Two-thirds (66%) do not feel well-informed about the impact of tax law changes on investment returns Most (69%) HNW investors aren t changing investment strategy to seek tax-efficient investments or minimize taxes Legacy Planning - Nearly six in 10 wealthy people thought it was important to leave a financial legacy to the next generation but efforts don t align 72% do not have a comprehensive estate plan, 66% have not implemented a revocable trust and 80% do not have a irrevocable trust * Source: 2013 U.S. Trust, Insights on Wealth and Worth ** Source : Cap Gemini Financial Services Analyses 2014 *** Source: Wall Street Journal JEFFERSON NATIONAL PAGE 3

Regulation of Annuity Ownership by Trusts Section 72(u) of the Internal Revenue Code If any annuity contract is held by a person who is not a natural person : Such contract shall not be treated as an annuity contract The income on the contract for any taxable year of the policyholder shall be treated as ordinary income received or accrued by the owner during such taxable year Exception: Section 72(u)(1)(B) provides an exception for annuities that are nominally owned by a non-natural person but beneficially owned by an individual = a trust or other entity as an agent for a natural person JEFFERSON NATIONAL PAGE 4

Regulation of Annuity Ownership by Trusts Limitations on non-natural persons were part of the Tax Reform Act of 1986 Intended by Congress to curb perceived abuses, primarily by corporations, of the income tax-free treatment of the interest accumulating in an annuity contract Congressional intent was not to prevent the use of trust ownership of annuities in non-corporate situations JEFFERSON NATIONAL PAGE 5

Regulation of Annuity Ownership by Trusts Private Ruling Letters Provide Confirmation PLRs 9120024, 9204014, 9322011, 9639057, 9752035, 199905015, 199933033, and 200449017, 200449011, 200018046 all reviewed situations where various types of trusts would own an annuity and all the beneficiaries of the trust were natural persons PLRs 9204010 & 9204014 trust had discretion to pay income and corpus to beneficiary until age 40 at which time the entire trust would be distributed to beneficiary PLRs 200449011, 200449013, 200449014, 200449015, 200449016 and 200449017 trust purchased an annuity contract for the sole benefit of the grantor s grandchild PLR 9316018 when a grantor trust owns an annuity, the contract retains tax-deferral status by virtue of the grantor trust treatment alone PLR199933033 irrevocable trust where grantors contribution is used to buy an annuity JEFFERSON NATIONAL PAGE 6

Regulation of Annuity Ownership by Trusts Charitable Remainder Trusts (CRTs) Another Exception A Charitable Remainder Trust is established for the benefit of a charity not for a natural person. But The IRS has ruled this an exception as follows: In PLR 9009047, the IRS ruled that a charitable remainder trust (CRT) was a non-natural person for purposes of Section 72(u), but could hold an annuity without affecting its qualification as a charitable remainder unitrust under section 664(d)(2) of the Internal Revenue Code and the applicable regulations. Since a CRT is already Tax exempt, 72(u) is irrelevant and continuing qualification under IRC 664(d)(2) is the important factor. TAM 9825001 - IRS issued a technical advice memorandum in which it held that an annuity purchase by a NIMCRUT was not an act of self-dealing nor would it affect the trust's status as a CRT A CRT already has tax deferral, so why use an annuity? A CRT may consider an annuity for reasons related to guarantees, rider benefits, and especially income accounting rules. JEFFERSON NATIONAL PAGE 7

Income Accounting Rules An annuity can often be used to control when a trust generates taxable income and when gains can instead accumulate tax-deferred: Internal Revenue Code section 643(b) specifies that the amount of income of the estate or trust for the taxable year is determined under the terms of the governing instrument and applicable local law. In most states, the undistributed gains inside of an annuity are not defined as trust income, and therefore do not have to be distributed currently to the income beneficiary. For trust accounting income purposes, income may not be recognized until the trustee makes withdrawals from the annuity. States adopting the Uniform Principal and Income Act, the Revised Uniform Principal and Income Act, or the Uniform Principal and Income Act (1997) permit settlors to write their own principal and income definitions and allocation rules, even if they conflict with the default statutory rules. In states that either have not enacted a principal and income act or have a version with altered language, trustors typically can look to case and common law for the grant of discretion to include special trust provisions. JEFFERSON NATIONAL PAGE 8

Why Use an Annuity to Tax-Optimize Trusts? Tax rates on income retained by trusts are relatively high and have low thresholds. So the benefit of tax deferral may be great: If trust taxable income is: The trust tax is: Over $12,150 $3,140.50 plus 39.6% of the excess over $12,150 NOTE: An individual does not reach 39.6% until $457,600 of taxable income In many cases, if a trust owns an annuity, it can qualify for income tax deferral until the trustee takes a distribution. Benefits of deferring gains inside an annuity: Minimize, delay or eliminate income that must be paid to the income beneficiary Control timing of and possibly reduce beneficiaries tax burden Increase accumulations for later distribution to the remainder beneficiaries charity, kids, grandkids Retain all of the benefits intended when trust was created JEFFERSON NATIONAL PAGE 9

Trusts that Can Use an Annuity for Tax-Optimization Using annuities with trusts can be beneficial in certain scenarios Net Income with Makeup Charitable Remainder Unitrust (NIMCRUT) Revocable Trust Credit Shelter Trust / Bypass Trust/ Family Trust Special Needs Trust / Supplemental Needs Trust/ Bubble Gum Trust These four scenarios will be discussed in greater detail JEFFERSON NATIONAL PAGE 10

Net Income with Makeup Charitable Remainder Unitrust (NIMCRUT) Allows for the ability to reduce the taxable estate and time income: Reduce taxable estate and defer gains by transferring appreciated property to NIMCRUT and investing gains in an annuity. Uniform Principal and Income Act states this type of a trust does not have income from an annuity until the trustee takes a distribution from the annuity. Avoid income by simply not taking a distribution from the annuity. If the NIMCRUT has no income, then the trust does not have to make payments to the Grantor. Make-up payments - the trust can take distributions from the annuity in excess of the promised percentage to pay the Grantor in later years. Sample Contract Structure: Owner: Mary K. Watkins Charitable Remainder Unitrust Annuitant: Mary K. Watkins Death beneficiary: Mary K. Watkins Charitable Remainder Unitrust *Don t name the charity as the death beneficiary because the Trustee should collect the death benefit and send the check and the K-1 to the charity. JEFFERSON NATIONAL PAGE 11

Revocable Trust Valuable for a grantor in a high tax bracket: Investor who wants to avoid investment income during working years, and would like the option to defer investment income. If a revocable trust owns an annuity, it can get income tax deferral until the trustee takes a distribution. A grantor of a revocable trust can revoke the terms and take back all the assets at any time, therefore a revocable trust is an agent for a natural person and qualifies for income tax deferral when using an annuity. The annuity does not offer an extra benefit of probate avoidance, since assets inside the trust already avoid probate. Sample Contract Structure: Owner: JEFFERSON NATIONAL PAGE 12 Jason B Watkins Revocable trust Annuitant: Jason B. Watkins Death beneficiary: Joel B. Watkins Revocable Trust [or whatever person or trust the trust assets pass to when Jason dies. * Note that if a trust is the death beneficiary of a nonqualified annuity, at Jason s death the trust will only have the option of a lump sum or five year deferral payout, not income for life.

Credit Shelter Trust / Bypass Trust/ Family Trust A vehicle to keep current trust income to a minimum and save more funds for the next generation: Under the state Uniform Principal and Income Act, a trustee can usually define the amount of income in the trust. The trust can define that it does not have income from an annuity until the trustee takes a distribution from the annuity. If the trustee is supposed to pay all income from the trust to the spouse, but the spouse has plenty of resources for current needs, putting assets into an annuity is a way to keep trust income to a minimum and save more funds for the children. Put another way, the annuity can prevent the trust from leaking out income to a spouse who doesn t need it. For income tax purposes, the trust should be able to get income tax deferral under 72(u) since it is likely that all the trust beneficiaries are people. Sample Contract Structure: JEFFERSON NATIONAL PAGE 13 Owner: Watkins Family Trust Annuitant: Mary K. Watkins Death beneficiary: Watkins Family Trust. *Note that at Mary s death a trust beneficiary will only have the option of a lump sum or five year deferral, not income for life.

Special Needs Trust / Supplemental Needs Trust/ Bubble Gum Trust The trustee has total discretion whether to give or not give assets to the child: It s this control that makes the assets the trust s assets, not the child s, preserving Supplemental Security Income and Medicaid benefits. Since all the trust beneficiaries are children (the special needs child and the other children after death) the trust should be an agent for a natural person and eligible for income tax deferral. Premature distributions will be measured using the annuitant. Since the annuitant is likely disabled, there should be an exception to the 10% penalty. Sample Contract Structure: Owner: Missy Watkins Special Needs Trust [Missy is the special needs child] Annuitant: Missy Watkins Death beneficiary: Missy Watkins Special Needs Trust [or whatever person or trust the trust assets pass to when Missy dies. *Note that at Missy s death a trust beneficiary will only have the option of a lump sum or five year deferral, not income for life. This may not be a problem since the trust will likely distribute all assets to other children at Missy s death.] JEFFERSON NATIONAL PAGE 14

Tips for Effective Implementation Generally the trust should be the owner and beneficiary of the annuity contract. If the grantor of the trust is named the annuitant, his or her death will likely trigger a complete and taxable liquidation of the contract within five years. If the annuitant were to die while the annuity contract was still held in trust, the contract will likely need to be liquidated in five years. Thus, consideration should be given to distributing the annuity contract to the beneficiary-annuitant before his or her death. By doing so, the beneficiary-annuitant, as the new owner, will continue to enjoy all of the contract's benefits and guarantees, and can name a new designated beneficiary. The trust agreement should specifically allow distribution of the annuity contract in-kind to avoid adverse income tax consequences. If separate contracts are established for each trust beneficiary, with each beneficiary named as the annuitant for his or her respective contract, the in-kind distribution of the contract to the beneficiary-annuitant should be a non-taxable event. The named annuitant should never be changed. Otherwise, the contract must be liquidated within 5 years. JEFFERSON NATIONAL PAGE 15

Disclosure Variable annuities are subject to market fluctuation and risk. Principal value and investment returns will fluctuate and you may have a gain or loss when money is withdrawn. Variable annuities are long-term investments to help you meet retirement and other long-range goals. Withdrawals of tax-deferred accumulations are subject to ordinary income tax. Withdrawals made prior to age 59½ may incur a 10% IRS tax penalty. Monument Advisor is issued by Jefferson National Life Insurance Company (Dallas, TX) and distributed by Jefferson National Securities Corporation, FINRA member. Policy series JNL-2300-1, JNL-2300-2, JNL-2300-3. JEFFERSON NATIONAL PAGE 16

Contact Info Advisor Support Desk (866) 667-0564 www.jeffnat.com JEFFERSON NATIONAL PAGE 17