Insurance company acting as Trustee

[DHK]

Seen probate cases like this for minors too. Always wondered how a trust owner worked for the pre 59 1/2 10% penalty if annuitant or trust income bene are younger than 59 1/2. Even if interest was never actually deferred, it still has 10% penalty on taxable interest, etc

Minor issue. (Pun intended.)

Just because there is a 10% penalty on the withdrawn interest doesn't make it a bad strategy. It does mean that it must be disclosed and that the rest of it meets their requirements.

Keep in mind that for guardianship / conservatorship, the executor or guardian (whatever the title is) has to report back to the court everything they are doing on the beneficiaries behalf. Showing prudence is key. Managing risk would be prudent as well.

I got this "Handbook for Conservators" from my local estate planning attorney. It equially applies for guardianships as well. While it's specific for California, I'm sure these facets would apply to any state, particularly the fact that they will have to give a financial accounting and report to the court on how the funds have been managed and allocated:

 

[scagnt83]

Just because there is a 10% penalty on the withdrawn interest doesn't make it a bad strategy. It does mean that it must be disclosed and that the rest of it meets their requirements.

I disagree. I feel a judge would as well.

The Trustee has a Fiduciary Duty to act in the BEST INTEREST of the Bene.

This is a Fiduciary Standard, not a Suitability Standard.

Any chosen option must be compared against alternatives. Principal protection is not a good enough reason to take a 10% loss. Principal protection can be achieved using equities that do not give a 10% penalty.

While it might get approved in the situation, it could easily be contested at a later date by any involved parties.... especially when they see that 10% loss! Then the Trustee will have to explain why taking a 10% loss was prudent compared to other low or no risk options that had been available at the time.

The desires of the person funding the Trust are not a determining factor if its being force by a judge. There could even be nefarious reasons they want to limit liquidity or cause penalties.

 

[scagnt83]

Keep in mind that for guardianship / conservatorship, the executor or guardian (whatever the title is) has to report back to the court everything they are doing on the beneficiaries behalf. Showing prudence is key. Managing risk would be prudent as well.

That is a completely separate issue. That is spending the money. Not choosing the investment to fund the Trust... which the guardian/conservator is not a decision maker in legally.

 

[DHK]

Any chosen option must be compared against alternatives. Principal protection is not a good enough reason to take a 10% loss. Principal protection can be achieved using equities that do not give a 10% penalty.

While it might get approved in the situation, it could easily be contested at a later date by any involved parties.... especially when they see that 10% loss! Then the Trustee will have to explain why taking a 10% loss was prudent compared to other low or no risk options that had been available at the time.

Um... 10% penalty on the gain only.

Let's do the math:

Let's assume $100,000 in the annuity.

$100,000 earns 5% interest = $105,000.

A 5% withdrawal = $5,250

Of this, $5,000 is taxable interest upon withdrawal.

10% penalty only applies to the interest = $500 on top of the taxes also due for the interest gained and withdrawn.

It's not 10% of the original amount or $10,000. We're only talking about a penalty on the interest credited.

Now, I would rather explain to a judge why there's a 10% penalty on interest upon withdrawal... than a true loss of principle of 10% - 30% (or whatever) having invested the funds and jeopardizing the plan being able to fund its intentions.

Maybe that's just me.

There could even be nefarious reasons they want to limit liquidity or cause penalties.

In my opinion, having surrender charges helps to ensure that the trustee (or whomever) doesn't go above the amount allowed each year. It's an additional safeguard.

Of course, that won't stop a trustee from violating it if they are absolutely intent on doing so.

 

[Allen Trent]

Um... 10% penalty on the gain only.

Let's do the math:

Let's assume $100,000 in the annuity.

$100,000 earns 5% interest = $105,000.

A 5% withdrawal = $5,250

Of this, $5,000 is taxable interest upon withdrawal.

10% penalty only applies to the interest = $500 on top of the taxes also due for the interest gained and withdrawn.

It's not 10% of the original amount or $10,000. We're only talking about a penalty on the interest credited.

Now, I would rather explain to a judge why there's a 10% penalty on interest upon withdrawal... than a true loss of principle of 10% - 30% (or whatever) having invested the funds and jeopardizing the plan being able to fund its intentions.

Maybe that's just me.



In my opinion, having surrender charges helps to ensure that the trustee (or whomever) doesn't go above the amount allowed each year. It's an additional safeguard.

Of course, that won't stop a trustee from violating it if they are absolutely intent on doing so.

Correct that 10% penalty, if it applies, is only on the annual gain/interest, even if no money distributed out of the annuity in cases where annuity is owned by a non person owner. So, in years an FIA credits say 10%, the trust would owe income taxes on that 10% growth & if taxed at trust tax rates, the tax rate gets extremely high very quickly & there are no standard deductions, etc like there is with individual tax returns.

So, ordinary income taxes at high trust tax rates & possibly a 10% pre 59 1/2 penalty compared to an after tax brokerage account with low turnover rate, dividends & capital gains at much lower rates & no 10% penalty is very likely to be seen as better scenario when considered by a fiduciary. Add in CD rates today, tax free bonds, & some equities without added surrender charges from an Annuity, etc

 

[scagnt83]

A 10% loss on income is a 10% loss on income, regardless if its gains or basis.

And we arent even taking into account the Surrender Charges.

Lack of liquidity is a big factor in something like this.

Its up to the Trustee to oversee and regulate the Custodian. And IF the custodian was irresponsible, a 10% penalty probably is not going to make them stop. Its only going to reduce the account more than it would have with an alternative.

 

[Allen Trent]

Its only going to reduce the account more than it would have with an alternative.

Especially if it is triggering the tax & 10% when money not even distributed to the trust or to the beneficiary. Likely other tax efficient, low cost fixed income securities that might fill that category if under age 59 1/2.

 

[DHK]

A 10% loss on income is a 10% loss on income, regardless if its gains or basis.

And we arent even taking into account the Surrender Charges.

Lack of liquidity is a big factor in something like this.

We're not talking about the same things.

It's not 10% loss on income. It's a 10% penalty on the interest earned and withdrawn (LIFO). It's small.

Surrender charges don't apply unless they are withdrawing more than 10% of the anniversary value. (Which I wouldn't want it based on the anniversary value but the initial contract value or higher.)

Liquidity is a PROBLEM when the money must LAST and should the executor (or whomever) decide they want to spend even more.

***

Well, having actually worked on a case like this... I'd still recommend the annuity, particularly for the capital preservation for the beneficiary of the estate. That's what annuities are good for: distribution of capital over time.

Now, every trust and situation can be different, but an annuity helps ensure that the money will be there for a given span of years. It cannot be said the same for a portfolio of securities. If it was said, I'd want it in writing... and no fiduciary securities advisor can put that in writing without approval from their compliance and jeopardizing their E&O. (What did the market do last year again? Securities are not superior.)

And considering the legal expertise I have available to me and with whom I did consult for this case, he never said anything negative about the possibility of using an annuity for the proceeds for this particular case (which was for the benefit of a minor who was named beneficiary on a $1 million life policy). Now granted, we haven't funded the annuity yet... because the baby mama still needs to establish their guardianship... so the money is still with the insurance company.

I'm not saying it's appropriate for the OP's case as I have little to no details. I'm only saying that it is very viable and very appropriate.

The biggest fears I normally have on these situations for guardianship and conservatorship is that they can't spend the money on themselves, unless it's for their own maintenance (which was the 5% I mentioned). The proceeds must be managed for and the income withdrawn for the benefit for those it's intended.

An annuity can do exactly that - with full disclosure.

 

[DHK]

Especially if it is triggering the tax & 10% when money not even distributed to the trust or to the beneficiary. Likely other tax efficient, low cost fixed income securities that might fill that category if under age 59 1/2.

And how have bonds been doing lately in a rising interest rate environment?

Bonds are great if you hold them to maturity and don't need to touch them... but that's not in this case.

Bonds are still subject to volatility on their values compared to interest rates.

Shift that liability to the insurance company through an annuity contract. Let the insurance company manage their bond portfolio to maturity and let the contract provide the liquidity needs without portfolio volatility.

 

[scagnt83]

We're not talking about the same things.

It's not 10% loss on income. It's a 10% penalty on the interest earned and withdrawn (LIFO). It's small.

This is a deferred annuity inside of a trust. The income is withdrawals. Im not talking about annuitization.

Its a 10% loss on the money they draw out for the Bene. At least initially until they burn through the gains.

There are alternatives that do not require that.

And liquidity is a problem when various lump sum expenses need to be paid. Thats life, it happens. All your eggs in an illiquid basket is not something I consider prudent.