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A private annuity is an agreement that transfers assets from one party to another person or entity in exchange for periodic payments for the duration of his or her life. The annuitant is the one transferring the assets, whereas the one receiving is the obligor. One requirement for an exchange to be qualified as a private annuity is that the obligor cannot be in the business of providing annuities, such as an insurance company.
Estate planning is where one might see a private annuity. This method may eliminate or greatly reduce estate or gift taxes on the exchange because it changes the transfer from a gift to a sale. The parties involved may be either individuals or a trust that has been set up to transfer assets and money.
Private annuities are often set up between family members to avoid estate taxes. For example, a parent or grandparent may use the private annuity method to transfer stock, a business interest, or other assets to a child or grandchild in exchange for periodic payments for the rest of the parent's or grandparent’s life. This transfer is a legally enforceable contract, although unsecured; since the payments stop at the death of the annuitant, there is no inclusion in the estate.
Only the part of the payment to the annuitant that is considered interest earned is taxable to the annuitant during his or her lifetime. The rest of the payment is considered as the original basis of the property, which is treated as return of capital. As long as the annuity payments are established to end at the death of the annuitant, the property transferred will not be taxable to the estate.
The private annuity arrangement is similar to an insurance policy for estate tax planning. In the United States, payments are based on life expectancy and interest rate tables that are set up by the Internal Revenue Service (IRS). Annuitants can begin their payments at any time, as long as they are under 70.5 years old. Once begun, each payment will be an equal amount and paid in equal intervals.
A private annuity can decrease taxes and allow the annuitant to receive a steady income for the duration of his or her life. This is considered a sale and not a gift, and a portion of the payments will be taxable as interest earned. It typically is important for a person to remember that once a private annuity is created, it is irrevocable and the annuitant will lose control of the assets involved.
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