Annuity Maximization: Avoid Tax Pitfalls & Enhance Wealth Transfer

Many clients purchase Deferred Annuities to supplement retirement income, only to find later that they don’t need the funds as originally planned. When this happens, their first instinct is often:

"I'll just leave it to my kids."

However, while annuities are excellent vehicles for accumulating retirement savings, they are not ideal for wealth transfer. In fact, when an annuity is inherited, it can be heavily taxed—sometimes up to 70% by the time both income and estate taxes apply. That means a significant portion of the money your client intended to pass on could go to the IRS instead.

The Problem: Annuities Are Tax-Inefficient for Estate Planning

Annuities are tax-deferred during life, but when passed to beneficiaries, the gains are taxed as ordinary income. On top of that, if the total estate value exceeds federal or state exemption limits, the annuity could also be subject to estate taxes.

This means that a client who planned to leave a $500,000 annuity to their heirs could unknowingly pass on as little as $150,000 to $250,000 after taxes, depending on their tax bracket and estate situation.

According to a 2023 LIMRA study, an estimated $300 billion in annuity assets are currently held by retirees who will never use them for retirement income. That’s a huge amount of wealth that could be better positioned to benefit their loved ones.

The Solution: Annuity Maximization Strategy

Financial advisors can help clients reposition annuity assets for maximum tax efficiency while increasing the amount passed on to heirs. The strategy involves converting a Deferred Annuity into a Single Premium Immediate Annuity (SPIA) and then using the income to fund a Life Insurance policy.

How It Works:

1. Exchange the Deferred Annuity for a SPIA

   • The SPIA provides a predictable, structured income stream over a set period, usually based on the client’s age and health.

2. Use After-Tax SPIA Income to Fund a Life Insurance Policy

   • The client gifts the after-tax SPIA income to an Irrevocable Life Insurance Trust (ILIT) or directly to a life insurance policy.
   • The ILIT owns the policy, keeping it outside the taxable estate and ensuring the death benefit is tax-free to heirs.

3. End Result: More Wealth, Less Tax

   • Instead of leaving a highly taxable annuity, the client provides a tax-free life insurance payout that often exceeds the original annuity value.

A Real-World Example

Let’s say your client has a $500,000 Deferred Annuity but no longer needs it for retirement income. If left as-is, their heirs could face $200,000+ in taxes.

Instead, by converting the annuity into a SPIA generating $30,000 annually, and directing those funds into a life insurance policy, they could secure a $750,000 or more tax-free death benefit for their heirs.

This simple asset repositioning strategy ensures that their legacy goes to family, not the IRS.

Why This Matters for Financial Advisors

As an advisor, helping clients navigate wealth transfer efficiently is crucial. Many people don’t realize their annuity assets could be heavily taxed at death. By introducing Annuity Maximization, you’re providing a strategic way to:

✅ Reduce the tax burden on heirs
✅ Increase the total amount passed down
✅ Enhance client satisfaction with long-term planning

Take Action: Start the Conversation

If your clients have old, underutilized annuities, now is the time to review their options. Educate them on how they can turn a taxable asset into a tax-free legacy—one that provides more for their family and less for the government.

Want to learn more about how this strategy can fit into your client’s financial plan? Let’s connect and explore their best options today!