Benjamin Franklin once said "…in this world nothing can be said to be certain, except death and taxes" so perhaps its little surprise that lawyers, tax planners and insurers should all have seized the opportunity to apply themselves to the vast and universal market for annuities.
Annuities are an effective instrument enabling tax-deferred accumulation of investments for retirement planning, and are subject to tax only when actually distributed from the policy. Annuity products are emerging globally, and AMS manages several such companies in the BVI - on both sides of the Atlantic. This article is a simple overview on annuities for US citizens under the IRC Regulations.
Annuities are available to eligible clients who have taken expert tax advice in their own domicile and who have sufficient initial premiums to invest in a stable of fund options offered through the annuity company. Minimum investments may be as low as $100,000 although additional premiums may be invested in additional units of $10,000. Annual annuity benefits are payable from a selected maturity date which can continue for the life of the annuitant.
If the annuitant dies before the full distribution of the retained assets, any residual value may be payable to the beneficiary or policy owner. Since annuity returns can vary with the value in the retained assets, the contract is classed as a variable annuity under the US Internal Revenue Code.
Different annuity providers each offer their own stable of fund choices and these would typically be US Equities, US Small Cap Equities, US Bonds, Money Market and Global Equities. The Diversification Rules require that there be at least five funds with predetermined maximums allowed in each of the fund choices. The annuitants are to some extent protected against themselves and precluded from putting 'all their eggs in one basket'. Adequate diversification means that no more than 55% of total asset value may be in a single fund, no more than 70% in two, 80% in three and 90% in four – hence the need for at least five funds.
Probably the most commonly asked question by prospective annuitants is that concerning investor control and it the one with the greatest degree of contention and misunderstanding. A compliant annuity has very little investor control, but the exact scope is a 'gray area'.
The policyholder may not control the investments, nor can anyone designated by the policyholder or anyone who might be considered subject to his control. None of the investments must be available to the general public although cloned funds available exclusively through the annuity company are admissible. The policyholder may control the timing of transfers between fund options or liquidations of assets to provide annuity payouts or surrender proceeds, but the insurer must control the transfer or application and not allow the policyholder the right to require the distribution or transfer of any particular type of asset.
The Insurance Act, 1994 in the BVI provides rigorous supervision of annuity providers. Annuity monies must be held in segregated accounts separate and apart from the insurer's assets. Audited financial statements are required. Insurers in the BVI are not subject to local taxes and are thus able to make distributions to policyholders free of local taxes.
Interest and earnings in the contract are not subject to US taxation until they are distributed from the contract. For Estate Tax planning purposes, it is preferable that the annuity contract be held in an irrevocable trust established three years before the death of the annuitant to enable the proceeds on death to pass to beneficiaries free of estate tax. However, there are still gift and income tax issues to consider which do require very specialist tax advice.
A 1% Federal Excise Tax is imposed by the US Government on premiums paid to a foreign annuity and should be filed on Form 720. Distributions made from the annuity are subject to income tax on the gain on an income out first basis, and there are additional tax penalties on premature distributions under the IRS Regulations.
Licensing and securities rules in the US prevent us from promoting non-US annuity companies other than in an offshore context. Interested prospective annuitants are encouraged to contact us though their tax advisors or lawyer to arrange a discussion in the BVI. Since we do not give tax advice and the compliance rules and IRS Regulations are a minefield, we require any interested prospective annuitant to have taken proper legal and tax planning advice and further recommend they explore the formation of an irrevocable trust with their attorneys.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
