What Is An Annuity?
Fixed or Variable or Index?
FIXED ANNUITY - An annuity is an insurance contract that provides a rate of interest based on current economic conditions.

ALL Interest on annuities accumulates on a tax-deferred basis.

There are numerous advantageous to annuities. Annuities can be used to fund IRA's, SEP's, replace certificate of deposit's, pension plans, college funds, to name a few.

Many annuities offer a guaranteed minimal interest rate.
Types of Annuities & Information On Bonds
A fixed annuity - is an annuity contract that declares an interest rate fixed for one (1) full year from the date of the contract. That interest rate will not fluctuate with economic conditions. On the anniversary date of the contract the insurance company declares a new rate that is guaranteed for one (1) full year.

Fixed annuites have provisions that allow for withdrawal on a portion of money without incurring a penalty. Some fixed annuities have provision that allow for full withdrawal of money in the event of a disability or institutionalize for nursing or home health care.

Variable annuities - Usually have the same provisions as a fixed annuity. Rate of return is measured by purchasing units purchased and number of units.

A variable annuity rate of return changes daily based on the end of the day results. Their are a variety of variable annuities that offer a variety of investment instruments.

Index Annuities - Usually have the same provisions as a fixed annuity. Rate of return is predicated on the performance of the Dow Jones, Treasury or S&P 500 Index.

Rate of return is predicated on the type of instrument as indicated above. Index annuities can be arranged to coincide with monthly or daily or annual figures.

Some index annuities have caps on rate of returns and all guarantee either ALL or a portion of original investment deposited against loss. Most index annuity have a minimal guarantee interest rate.

Not too many years ago every bond had coupons attached to it. Every so often, usually every 6 months, bond owners would take a scissors to the bond, clip out the coupon, and present the coupon to the bond issuer or to a bank for payment. Those were "bearer bonds" meaning the bearer (the person who had physical possession of the bond) owned it. Today, many bonds are issued as "registered" which means even if you don't get to touch the actual bond at all, it will be registered in your name and interest will be mailed to you every 6 months. It is not too common to see such coupons. Registered bonds will not generally have coupons, but may still pay interest each year. It's sort of like the issuer is clipping the coupons for you and mailing you a check. But if they pay interest periodically, they are still called Coupon Bonds, just as if the coupons were attached.

When the bond matures, the issuer redeems the bond and pays you the face amount. You may have paid $1000 for the bond 20 years ago and you have received interest every 6 months for the last 20 years, and you now redeem the matured bond for $1000.

A Zero-coupon bond has no coupons and there is no interest paid.

But at maturity, the issuer promises to redeem the bond at face value. Obviously, the original cost of a $1000 bond is much less than $1000. The actual price depends on: a) the holding period -- the number of years to maturity, b) the prevailing interest rates, and c) the risk involved (with the bond issuer).

Taxes: Even though the bond holder does not receive any interest while holding zeroes, in the US the IRS requires that you "impute" an annual interest income and report this income each year. Usually, the issuer will send you a Form 1099-OID (Original Issue Discount) which lists the imputed interest and which should be reported like any other interest you receive. There is also an IRS publication covering imputed interest on Original Issue Discount instruments.

For capital gains purposes, the imputed interest you earned between the time you acquired and the time you sold or redeemed the bond is added to your cost basis. If you held the bond continually from the time it was issued until it matured, you will generally not have any gain or loss.

Zeroes tend to be more susceptible to prevailing interest rates, and some people buy zeroes hoping to get capital gains when interest rates drop. There is high leverage. If rates go up, they can always hold them.

Zeroes sometimes pay a better rate than coupon bonds (whether registered or not). When a zero is bought for a tax deferred account, such as an IRA, the imputed interest does not have to be reported as income, so the paperwork is lessened.

Both corporate and municipalities issue zeroes, and imputed interest on municipals is tax-free in the same way coupon interest on municipals is. (The zero could be subject to AMT).

Some marketeers have created their own zeroes, starting with coupon bonds, by clipping all the coupons and selling the bond less the coupons as one product -- very much like a zero -- and the coupons as another product. Even US Treasuries can be split into two products to form a zero US Treasury.

There are other products which are combinations of zeroes and regular bonds. For example, a bond may be a zero for the first five years of its life, and pay a stated interest rate thereafter. It will be treated as an OID instrument while it pays no interest.

(Note: The "no interest" must be part of the original offering; if a cumulative instrument intends to pay interest but defaults, that does not make this a zero and does not cause imputed interest to be calculated.)

Like other bonds, some zeroes might be callable by the issuer (they are redeemed) prior to maturity, at a stated price.
What Is A Grat Trust?


After clients with multimillion-dollar estates have used Unified Credit Shelter Trusts, Life Insurance Trusts, annual exclusion gifts, etc. to reduce their estate taxes, they are faced with the reality that they still have a substantial estate tax liability to pay on their death or their spouse’s death if they are married.

Married clients will eventually be able to shelter $2,000,000 from estate taxes as the Federal Unified Credit gets phased in over the next several years. A single client can eventually shelter $1,000,000 from estate taxes.

But what if a client has an estate that exceeds $2,000,000 if married or $1,000,000 if single. What if that estate is destined to be even larger because of added earnings prior to death or appreciation in the value of the client's assets such as stock or real estate?

The federal estate alone on estates over $1,000,000 is as follows:

Over $1,000,000, but not over $1,250,000 $345,800, plus 41 percent of the excess of such amount over $1,000,000.

Over $1,250,000, but not over $1,500,000 $448,300, plus 43 percent of the excess of such amount over $1,250,000.

Over $1,500,000, but not over $2,000,000 $555,800, plus 45 percent of the excess of such amount over $1,500,000.

Over $2,000,000, but not over $2,500,000 $780,800, plus 49 percent of the excess of such amount over $2,000,000.

Over $2,500,000, but not over $3,000,000 $1,025,800, plus 53% of the excess over $2,500,000.

Over $3,000,000 $1,290,800, plus 55% of the excess over $3,000.000.

Please note the above rates are federal rates only and do not even take into consideration any state estate taxes which may be payable by the client's estate.

What is a client to do?

Assume a client has an estate that is over $1,000,000 and is single or $2,000,000 and is married and the estate can reasonably be expected to appreciate in value prior to the client's death.

I recently had a conversation with a client's broker who indicated that the client's investments were producing about a 20% total return, 2% of which was income and 18% of which was capital appreciation.

For example, if we took $500,000 of the stock in the client's portfolio, and assumed a 20% total return compounded annually, that $500,000 will be worth approximately $3,095,868 in ten years. The estate tax on that $3,095,86 would been approximately $1,547,934 assuming a 50% combined federal and state estate rate.

While these are only estimated numbers and it is impossible for any of us to predict what the stock market will do over the next 10 years, I think we can be pretty assured that the $500,000 worth of stock will appreciate in value and that over 50% of that appreciation, what ever it is, will be paid in Federal and state estate taxes.

I would like to suggest a common estate planning strategy to totally avoid federal and state estate taxes on all of the future appreciation on that $500,000 on the death of either the client or their spouse, while still retaining the income from the stock for 10 years.

The strategy used in this type of situation is referred to as a Grantor Retained Annuity Trust or a "GRAT". There is a statute which allows the use of a GRAT and as long as you follow all the rules, the estate tax savings that can be achieved are astronomical.

The basic premise of a GRAT is that the $500,000 of stock is transferred to an irrevocable trust with the client (the Grantor) retaining the right to receive an annuity (a fixed payment of the income of the GRAT), for a period of years.
I have run some annuity computations for a 54-year-old client, which illustrates the use of a GRAT.

I have used a Section 7520 Rate of 6.8 % for March, 1998; an annuity factor of 0.517950 from Table B of Treasury Regulation 20.2031-7 and a 10 year term of years annuity calculation under Treasury Regulation 20.2031- 7 (d) (iv) of 7.0889 (1-.517950 = .48205/.068 = 7.0889). The value of a 10 year retained annuity will be 7.0889 x the value of the annual annuity payment. The value of the gift will be the value of the annuity subtracted from the $500,000 placed into the trust. If we use the 2% rate of return on the stocks, the value of the annuity is $70,889 ($10,000 x 7.0889).

For example, if the client transfers $500,000 of stock to a GRAT, and retained the right to the income from the $500,000, (approximately $10,000 per year), the client would have made a gift of the $500,000 of stock for gift tax purposes of $429,111 ($500,000 - $70,889). The value of the client's retained annuity for 10 years would be $70,889. There would be no federal gift taxes on the $429,111 gift because we can use the federal unified credit, but there might be a small state gift tax depending upon whether your state has a gift tax.

At the end of 10 years, if the $500,000 of stock was worth $3,000,000 and the client were to die after the expiration of the 10 years; there would be approximately $3,000,000 of stock in the GRAT that would pass free of estate taxes saving approximately $1,500,000 in estate taxes. If the stock was only worth $2,000,000 there would be approximately $2,000,000 of stock in the GRAT that would pass free of estate taxes saving approximately $1,000,000 in estate taxes.

Of course, if less money was placed into the GRAT, the estate tax savings would be less or if more money was placed into the GRAT the estate tax savings would be more.

Note that this assumes a 20% total return with 2% dividend income being paid annually to the client for ten years. If your rate of return were smaller the tax savings would be smaller, but the concept still holds that all future appreciation escapes estate taxation.

Also please note that this does not reduce the current estate taxes on the client's death, but eliminates the approximately $1,000,000 - $1,500,000 of estate taxes that would be due on the growth of the $500,000 ($2,000,000 - $3,000,000) over the next 10 years on the $500,000 that could be placed in the GRAT now. Of course, we are using part of your unified credit in the process.

This is obviously a technique that should be given serious consideration.

I strongly suggest that you consider the use of a GRAT for your estate plan if you have an estate in excess of $1,000,000 if you are single, or $2,000,000 if you are married.

While the use of a GRAT is a rather complex estate-planning tool, the GRAT produces significant estate tax savings.

I have tried to take some of the mystery out of the use of a GRAT in your estate plan in this short letter.

1035 Tax Free Exchange Information - Click Here

How Does Life Insurance Really Work? - Click Here

To Obtain A Life Quote/Tentative Offer - Click Here

To Obtain A Individual Health Quote/Tentative Offer - Click Here

Information On Rollover Of IRA, 401k, SEP Pension/Profit Sharing plans - Click Here

Buyers Guide To Fixed Deferred Annuities - Click Here

Common Mistakes Regarding Estate Planning

Glossary On Bonds & Types Of Bonds