Overview
Main Menu Name: Priv. Ann.
Calculates the annual payment for a private annuity measured by one or two lives. It then calculates the tax-free, capital gain, and ordinary income portions of each payment.
In this article:
Background
This calculation determines the annual payment for a "private annuity." It also calculates the tax-free portion of each payment, the portion that qualifies for capital gains treatment, and the portion reportable as ordinary income.
Under a private annuity, an agreement is signed. That document requires one party (the transferor-annuitant) to transfer ownership of property to another party (the transferee-buyer). In return, the transferee-buyer makes periodic (typically monthly, quarterly, semi-annual, or annual) payments to the transferor for a specified period (usually the lifetime of the transferor or the transferor and transferor's spouse).
The private annuity is a useful tool for an individual who wants to spread gain from a highly appreciated asset over his or her life expectancy.
The private annuity is also as a useful federal estate tax saving tool because, by design, payments end when the transferor dies and the entire value of the asset sold is immediately removed from the transferor's gross estate. In other words, there is no estate tax in the transferor's estate from the transferred property - because it belongs to the buyer from the moment the private annuity document is signed.
Another advantage is that the private annuity allows someone who owns non-income-producing property to make that property productive.
The ideal transferor/payor situation is one that meets the following criteria:
- The transferor is in a high estate tax bracket or has no marital deduction.
- The property is capable of producing at least some income and/or is appreciating rapidly.
- The payor is capable of - at least in part - paying the promised amounts.
- The parties trust each other (the private annuity must be unsecured).
- The transferor has other assets and sources of income.
- The transferor has less than a normal life expectancy. This makes the arrangement more of a "bargain" for the buyer
Getting Started
When a private annuity agreement is arranged, one party (the transferor-annuitant) signs over complete ownership of property to another party (the transferee-payor). In return, the transferee makes periodic payments to the transferor for a specified period of time (usually the lifetime of the transferor).
The private annuity is a useful tool for an individual who wants to spread out over his lifetime payments from selling a highly appreciated asset.
The private annuity is also as a useful federal estate tax saving tool because payments end when the transferor dies and the entire value of the asset sold is immediately removed from the transferor's gross estate. The private annuity allows someone who owns non-income-producing property to make that property productive.
The ideal transferor/payor situation is one that meets the following criteria:
- The transferor is in a high estate tax bracket or has no marital deduction.
- The property is capable of producing income and/or is appreciating rapidly.
- The payor is capable of paying the promised amounts.
- The parties trust each other (the private annuity must be unsecured).
- The transferor has other assets and sources of income.
Entering Data
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Transfer Date: Enter the month and year (dd/yyyy).
Note: For May or June of 2009, you have the choice of using mortality Table 90CM or 2000CM (see http://www.irs.gov/retirement/article/0,,id=206601,00.html). After June 2009, the program will automatically use Table 2000CM. For dates before May 2009 and after June 1999, the program will use Table 90CM. For May or June of 1999, you have the choice of using Table 80CNSMT or Table 90CM. For dates before May 1999 and after April 1989, the program will automatically use Table 80CNSMT. For dates before May 1989, the program uses Table LN from Treas. Reg. section 20.2031-7A(d)(6).
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§7520 Rate: The program automatically enters the correct §7520 discount rate if you have kept the AFR Rates Manager up-to-date. If the AFR Rates Manager is not up-to-date, the program shows a 30% value for the selected transfer date. The program automatically rounds the rate to the nearest 2/10 of 1% as required under §7520.
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FMV of Property: Enter the fair market value of the property.
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Client's Basis: Enter the transferor's adjusted basis (cost).
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Payment Period: Select the number of payments that will be made each year to the beneficiary (Annual, Semiannual, Quarterly, Monthly, Quarterly, and Weekly).
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Growth of Payments: Enter the percentage (if any) by which the annual payments should grow each year after the first payment is made.
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Payment Timing: Select Begin or End to indicate when the payment should be made for the selected payment period. A Begin case is assumed to be the same as an End case with an additional payment made at the beginning of the period.
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Deferral Period: Enter the number of years (if any) by which the payments should also be deferred.
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Number of Annuitants: Enter the number of annuitants (1 or 2).
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Ages: Enter the age of the annuitant(s). Valid age inputs are 5 to 109.
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Apply Proposed Regulations (REG-141901-05)?: In 2006, the Treasury proposed new regulations, under which the full amount of any gain or loss in a private annuity transaction will be realized immediately, instead of ratably over the life expectancy of the annuitant. If adopted, the regulations may be applied to transactions after the date they were proposed (10/18/2006). Choose "Yes" to apply those regulations, or "No" to show how the gain is realized under prior law.
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Annuity Payments from a Trust: Select "Yes" if the annuity will be payable from a trust or other limited fund.
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PV of Limited Fund: Enter the value of the trust or other limited fund before the transfer is made in exchange for the annuity agreement.
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Exhaustion Method: Select either the IRS Method or the Illustrated Method to be used in calculating when the annuity might exhaust the trust or other limited fund.
Results
The program calculates an annuity factor and adjusts it with payout frequency factors. It then divides the resulting factor into the fair market value to arrive at an annual payout. Basis is then divided by joint life expectancy to arrive at the tax-free portion of each annual payment. If 'Apply Proposed Regulations' is checked, then the life expectancy is also used to arrive at the capital gain portion. Subtracting the tax-free and capital gain portions from the total payment computes the ordinary income portion.
When the annuity is deferred, the life expectancy used to calculate the tax-free portion (and capital gain portion) of the annual payments is the life expectancy based on the age of the annuitant(s) at the end of the deferral period.
When the annuity payments grow by a percentage each year, that growth is taken into account in calculating the "Expected Return Multiple," which is no longer the life expectancy of the annuitant(s) but the total amount that is expected to be received over the lifetime(s) of the annuitant(s), measured as a multiple of the initial payment. The Tax-Free Portion, Capital Gain Portion, and Ordinary Income Portion will also increase in proportion to the increase in the total annual payments.
Annuity Factor Example
Assume:
7520 Rate: 4.60%
Age: 70
Deferral: 5
Quarterly
Table: 2000CM
Annuity Factor (Age 75): 7.9763 (from "Factors" module)
Payout Frequency Factor: x 1.0171
Adjusted Annuity Factor: 8.1127
Deferral Discount: (1 / 1.046) ^ 5 = .79862
Prob. of Survival 70 => 75: x .86318 (Age 75 64561 / Age 70 74794)
Deferred Annuity Factor: 5.5925
Annuity Factor (Age 75): 7.9763 (from "Factors" module)
Deferral Discount: (1 / 1.046) ^ 5 = .79862
Prob. of Survival 70 => 75: x .86318 (Age 75 64561 / Age 70 74794)
Annuity Factor: 5.4985
Payout Frequency Factor: x 1.0171
Adjusted Annuity Factor: 5.5925
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