Private Annuity

A private annuity is an agreement in which an annuitant transfers property to an obligor in exchange for payments for the rest of the annuitant's life. For the agreement to be classified as a private annuity, neither party can be in the business of selling annuities — that is, neither party can be an insurance company. Private annuities are often used by wealthy individuals as a part of estate planning, for business succession and as a means of asset protection. Private annuities can help the reduce gift and estate tax exposure of family inheritors.

In most cases, a private annuity is used to transfer assets to a family member where a normal transfer would be subject to gift or estate taxes. The property transferred to the obligor (frequently children) may include a family business interest, real estate, securities or a variety of other assets. The transaction provides the annuitant with lifetime payments that are generally only taxable at the more favorable capital gains rates. The Internal Revenue Service (IRS) life expectancy table is used to calculate the amount of each annuity payment. If the annuitant dies early, the obligor(s) may receive a windfall.

The tax benefits of the asset transfer are the major advantage of this type of annuity agreement. With the transfer of the property, the property's value and all future appreciation is thereby removed from the annuitant's taxable estate. And as long as the present value of the annuity is about equal with the fair market value of the underlying property, a gift tax is avoided. The private annuity effectively makes the transfer a sale, thus removing high gift and estate taxes that would come with a simple asset transfer. The interest rate that is used for calculating the payments on the annuity is determined by IRS Section 7520 Interest Rates. Once this rate is set, it cannot be changed. This type of annuity will often be held in a trust to defer tax.

Private annuities have what is called "reverse mortality risk," meaning if the annuitant outlives their life expectancy then they will receive more in payments than the transferred property's fair market value. This could lead to relatives making annuity payments to the annuitant that will increase the annuitant's taxable estate. One way to avoid this is with a deferred private annuity, which delays the start of annuity payments. Another risk is that the obligor (the annuitant's children) are unable or unwilling to make payments, in which case the IRS may consider the private annuity a covert gift and tax it accordingly.