Estate planning is a critical component of financial management that is sometimes overlooked or misunderstood. It entails deciding how your assets will be allocated after you die, ensuring that your loved ones are cared for and your desires are followed out. Variable annuities, on the other hand, is a method that allows you to turn a portion of your retirement assets into a source of income that fluctuates in response to market performance.

While these two concepts appear unrelated at first look, they do cross in key ways when it comes to estate planning.

Estate planning encompasses a wide range of considerations, including creating a will, establishing trusts, designating beneficiaries, and minimizing estate taxes. It involves taking stock of all your assets, such as real estate, investments, bank accounts, and personal belongings, and determining how you want them to be distributed upon your passing. By engaging in estate planning, you can ensure that your assets are transferred smoothly and efficiently to your chosen beneficiaries while minimizing potential conflicts or legal challenges.

Variable annuities can play a significant role in estate planning by providing a steady income stream for both yourself and your beneficiaries. When you purchase a variable annuity, you invest a lump sum with an insurance company in exchange for regular payments over time. These payments can be fixed or variable depending on the performance of the underlying investment options within the annuity. By incorporating variable annuitization into your estate plan, you can create a reliable source of income for your loved ones even after you’re gone.

Variable annuities offer flexibility and control over how your assets are distributed. You can choose the frequency and duration of payments, as well as designate multiple beneficiaries or contingent beneficiaries. This allows you to tailor the annuity to meet the specific needs of your estate plan, ensuring that your wishes are carried out precisely as intended.

To illustrate the potential benefits of incorporating variable annuitization into estate planning, consider a retiree named Sarah who wants to leave a legacy for her children while also ensuring

Basics of Estate Planning

Estate planning is an essential component of financial management that is frequently overlooked or postponed. It entails deciding how your assets will be managed and dispersed following your death, ensuring that your loved ones are cared for and your desires are followed out. While it may appear difficult at first, learning the fundamentals of estate planning is critical for everyone, regardless of age or income.

1. Define your goals: The first step in estate planning is to clearly define your goals and objectives. What do you want to achieve with your estate plan? Do you want to minimize taxes, protect your assets, provide for your family’s financial security, or support charitable causes? By identifying your goals, you can tailor your estate plan to meet your specific needs.

For example, let’s say you have a blended family with children from previous marriages. Your goal might be to ensure that both your current spouse and children from previous relationships are provided for in the event of your death. In this case, you may need to consider setting up a trust or establishing specific provisions in your will to address these concerns.

2. Take inventory of your assets: To effectively plan for the distribution of your assets, it is important to take inventory of everything you own. This includes real estate, investments, retirement accounts, life insurance policies, business interests, and personal belongings. Knowing what you have will help you determine how best to distribute these assets according to your wishes.

For instance, if you own multiple properties across different states or countries, it is crucial to consider the legal implications and tax consequences associated with each jurisdiction. By taking inventory of all your assets, you can ensure that nothing is overlooked during the estate planning process.

3. Choose beneficiaries and executors: One of the key decisions in estate planning is selecting beneficiaries who will inherit your assets upon your death. These beneficiaries can include family members, friends, charities, or even pets. It is important to clearly identify your beneficiaries and specify their respective shares or interests in your estate.

Additionally, appointing an executor or personal representative is crucial to ensure that your estate is administered according to your wishes. This person will be responsible for managing the distribution of assets, paying off debts and taxes, and handling any legal matters that may arise. Choosing someone you trust and who has the necessary skills and knowledge is essential.

Variable annuities can be an important tool in estate planning, providing a variety of benefits that can help people protect their financial futures. These annuities offer a unique combination of investment growth potential and guaranteed income, making them an appealing alternative for people wishing to protect and increase their assets while also providing a consistent source of income in retirement.

Below, we will look at the benefits of variable annuities from several angles, providing light on why they should be considered as part of your estate planning strategy.

1. Tax-deferred growth: One of the key advantages of variable annuities is their ability to provide tax-deferred growth. Unlike traditional investment accounts, where taxes are due on any gains made each year, variable annuities allow your investments to grow without being subject to immediate taxation. This can be particularly advantageous for individuals in higher tax brackets, as it allows them to potentially accumulate more wealth over time.

For example, let’s say you invest $100,000 in a variable annuity and it grows to $150,000 over a period of ten years. If you had invested the same amount in a taxable investment account and earned the same returns, you would have had to pay taxes on any gains made each year. However, with the variable annuity, you can defer paying taxes until you start withdrawing funds from the annuity.

2. Investment Flexibility: Variable annuities offer a wide range of investment options, allowing individuals to tailor their portfolios according to their risk tolerance and financial goals. These options typically include various mutual funds that invest in stocks, bonds, or both. By diversifying your investments within the annuity, you can potentially mitigate risk and take advantage of market opportunities.

Read Also: Tax Benefits and Implications of Variable Annuities

For instance, if you believe that technology stocks will perform well in the coming years, you can allocate a portion of your variable annuity toward technology-focused mutual funds. On the other hand, if you prefer a more conservative approach, you can opt for bond funds that provide a steady income stream with lower volatility.

3. Guaranteed lifetime income: One of the most appealing features of variable annuities is the option to convert your accumulated assets into a guaranteed lifetime income stream. This can provide peace of mind during retirement, as it ensures a steady paycheck regardless of market fluctuations or how long you live.

Key Considerations for Estate Planning with Variable Annuities

When it comes to estate planning, variable annuities can help ensure that assets and money are transferred smoothly to future generations. However, managing the complexity of estate planning with variable annuities necessitates careful thought and awareness of a variety of considerations.

Below, we will look at some of the most important factors to consider when adding variable annuities into one’s estate strategy.

1. Beneficiary Designation: One crucial aspect of estate planning with variable annuities is selecting the right beneficiaries. The beneficiary designation determines who will receive the annuity’s death benefit upon the policyholder’s passing. It is essential to review and update beneficiary designations regularly to ensure they align with your current wishes. Failure to designate beneficiaries or keeping outdated designations can lead to unintended consequences, such as assets passing to ex-spouses or causing unnecessary tax burdens for heirs.

For example, let’s say John initially designated his ex-wife as the primary beneficiary on his variable annuity policy but forgot to update it after their divorce. Unfortunately, upon his demise, the ex-wife would still be entitled to receive the death benefit, potentially leaving John’s current spouse or children without any financial support.

2. Tax Implications: Variable annuities have unique tax characteristics that can impact estate planning strategies. While contributions made to a variable annuity are typically made with after-tax dollars, any growth within the annuity is tax-deferred until withdrawals are made. Upon the policyholder’s death, the accumulated gains are subject to income taxes for non-spouse beneficiaries.

For instance, if Sarah leaves her variable annuity to her daughter Emily as part of her estate plan, Emily would need to pay income taxes on any gains realized from the annuity when she receives distributions. understanding these tax implications can help individuals make informed decisions about how and when to distribute assets from variable annuities.

3. Estate Taxes: Another critical consideration is how variable annuities may impact estate taxes. In some jurisdictions, the death benefit from a variable annuity is included in the policyholder’s taxable estate, potentially subjecting it to estate taxes. However, utilizing certain estate planning strategies, such as creating an irrevocable life insurance trust (ILIT), can help mitigate these tax liabilities.

How to Use Annuities in Your Estate Plan

Annuities—insurance contracts that pay you income for a set period of time or for the rest of your life—are one method to capitalize on a sudden influx of cash, such as a bonus or inheritance. This is because, unlike typical tax-advantaged retirement funds, annuities have no contribution or income limits, yet they nevertheless allow your money to grow tax-deferred until you start receiving dividends.

Those who discover they don’t require much income when they retire may be able to use their annuity to pass wealth to heirs, support philanthropic efforts, and save taxes. (Annuities have associated charges, such as commissions, that can change.)

Here are five ways to put an existing annuity to use in your estate plan—depending on whether you’re in the accumulation phase or the payout phase.

Accumulation phase

For deferred annuities, the accumulation phase is the time during which your contributions add to your annuity’s value and potentially grow tax-deferred. Depending on how close you are to reaching your contract’s maturity date—when payouts can begin and earnings become taxable—there may be several options for your annuity that better meet your current needs, such as:

• Surrender it for a lump sum: You may be able to cash out your annuity if you’ve reached the end of its surrender period—the time frame during which you cannot withdraw the funds without paying a hefty charge of as much as 20% of the contract value, plus an additional 10% penalty if you’re younger than age 59½. However, even if you’re still within your surrender period, your annuity may allow annual withdrawals up to a certain percentage without being subject to a surrender charge.
• Transfer ownership to a trust: If you’re certain you won’t need the money at any point in the future, you may be able to transfer ownership of the contract to a nongrantor irrevocable trust, which removes the current value and all future appreciation from your estate. You will still be the annuitant—the person whose life expectancy is used to determine payouts—but the trust becomes both the owner and the recipient of payouts. Upon your death, the trust receives the remaining death benefit, and the trust’s beneficiaries—your heirs—receive payouts according to the terms of the trust.

For either of these strategies, be aware they can be considered a withdrawal and may create a large taxable event. It’s critical to scrutinize your annuity contract and consult a tax professional before implementing any changes.

Payout phase

Once the contract begins making payments—known as annuitization—it becomes irrevocable, and you typically can’t change its terms. However, you can still use the payouts to further your estate-planning goals. For example, you could:

• Make annual gifts to heirs: If estate taxes are a concern, you could use your annuity distributions to make yearly gifts to your children, grandchildren, and/or other heirs, up to the annual gift tax exclusion of $17,000 per recipient ($34,000 for a married couple) in 2023. You’ll still owe taxes on the distributions, but they won’t become part of your taxable estate and the gifts won’t eat into your lifetime estate tax exemption ($12.92 million per person in 2023).
• Purchase life insurance: Most annuities have death benefits that will pay out to your named beneficiaries upon your death, though such payouts may be subject to ordinary income tax rates. To potentially increase the amount your heirs inherit, you could use your annuity payouts to cover the premium payments on a permanent life insurance policy, assuming you qualify. (Individuals over 70 or in poor health may be denied coverage.) Proceeds from a life insurance policy do count as part of your taxable estate (unless placed in a specialized trust; see schwab.com/ILIT) but generally are tax-free for your heirs.
• Give to charity: Donating your annuity payments to a charitable organization can reduce your taxable income in the year of the donation, assuming you itemize. (The annual tax deduction for cash gifts to public charities is limited to 60% of your adjusted gross income.) Donating the payouts excludes them from your estate as well. You could also open a donor-advised fund account, which allows you to invest contributions for potential growth and establish a legacy of giving among future generations.

Mix and match

Depending on your situation, you may find that employing several of these strategies could help you further your estate-planning goals. Whatever you decide, be sure to discuss your needs with a qualified estate-planning attorney and tax advisor in order to make the most of the excess funds.

Successful Estate Planning with Variable Annuities

Estate planning can be a complicated and intimidating process, but when combined with variable annuities, it can provide unique benefits and opportunities for people trying to protect their financial futures.

In this part, we’ll look at case studies that demonstrate successful estate planning techniques that include variable annuities. Examining these real-life examples allows us to gather useful insights from many viewpoints and better appreciate the potential benefits of implementing variable annuities into estate strategies.

1. Tax Efficiency: One of the key advantages of using variable annuities in estate planning is their tax efficiency. Let’s consider the case of Mr. Smith, a high-net-worth individual who wants to pass on his wealth to his children while minimizing the tax burden. By structuring his estate plan with a variable annuity, Mr. Smith can take advantage of the tax-deferred growth within the annuity contract. This means that any investment gains generated by the annuity are not subject to immediate taxation, allowing Mr. Smith’s assets to grow more rapidly over time.

2. Probate Avoidance: Another significant benefit of incorporating variable annuities into estate planning is the ability to avoid probate. Probate is a legal process that validates a deceased person’s will and distributes their assets according to their wishes. However, probate can be time-consuming, and expensive, and may expose the details of an individual’s estate to public scrutiny.

By designating beneficiaries directly within a variable annuity contract, assets held within the annuity can bypass probate entirely, ensuring a smoother transfer of wealth to heirs. For example, Mrs. Johnson utilized this strategy by naming her children as beneficiaries on her variable annuity contracts, allowing them to receive the proceeds without going through probate.

3. Creditor Protection: Variable annuities can also provide an added layer of creditor protection for individuals concerned about potential claims against their estate. In some cases, creditors may attempt to seize assets during the probate process or pursue claims against an individual’s estate.

However, by structuring an estate plan with variable annuities, individuals can shield their assets from such claims. For instance, Mr. Thompson, a business owner facing potential lawsuits related to his company, transferred a portion of his wealth into a variable annuity to protect those assets from potential creditors.

While variable annuitization can be a valuable tool in estate planning, it is important to consider the potential risks and drawbacks.