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Home >> Estate Planning Articles >> More Bang for Your Buck: Education Planning with Deferred Annuities

More Bang for Your Buck: Education Planning with Deferred Annuities

September 25, 2015 by Robert Kulas.

Compliments of Our Law Firm,
Written By: The American Academy of Estate Planning Attorneys

College costs have been steadily rising for years, and there does not appear to be an end in sight. If you are a new parent, you might want to grab some smelling salts: according to current estimates, the total cost for a four-year public university education for your little bundle of joy could top $200,000.

Faced with this financial reality, parents and grandparents are looking for ways to get the most bang for their education bucks. One option is to combine two existing strategies: the education trust and the deferred annuity.

Education Trusts

Education trusts are not a new idea. For decades, parents and grandparents have been using them to help finance college education costs for the children in their lives.

Under a typical scenario, parents transfer up to $28,000 per year for each child into an irrevocable trust using each parent’s $14,000 annual gift tax exclusion. This sounds fine, but there’s a problem. It’s hard to accumulate enough funds in the trust because the income tax rates of trusts are “compressed.” For 2013, this means that a trust will pay income tax at the top rate of 39.6% if its taxable income exceeds $11,950. The parents will not pay tax at this rate until their taxable income reaches $450,000.

With rising tuition costs, the search is on for a way to preserve more trust income to apply toward educational expenses. One solution is the deferred annuity.

Deferred Annuities

A deferred annuity is a contract under which an investor pays premiums to an insurance company for a specified period of time in order to receive a steady stream of income later. It has two phases: the savings phase and the income phase.

When a deferred annuity is owned by an individual, things are relatively simple. During the savings phase, the insurance company takes the premiums and invests them. In this phase, you don’t pay income tax on the money that accrues. Later, during the income phase, the insurance company distributes regular payments to you. At this point, you pay taxes on your annuity income.

Trust Ownership of a Deferred Annuity

When you combine a deferred annuity with another entity, like a trust, the rules get more complicated. Ordinarily, if a trust owns a deferred annuity, IRS rules require that income tax be paid on any annual increases in the value – whether or not any money is distributed.

However, when an education trust owns a deferred annuity, the ordinary rules don’t apply. Because the beneficiary of an education trust is a college student (or a future college student), the trust is subject to a special exception that treats it as holding the annuity as an “agent” for the individual beneficiary. Under this exception, a typical education trust may invest in deferred annuities and delay taxation on the income from those annuities until cash is actually distributed. This allows the trust to accumulate significantly more money over the course of a beneficiary’s childhood.

When the time comes to pay for college, the trustee of the education trust withdraws the necessary funds and distributes them. At this point, the distributed funds are subject to income tax at the beneficiary’s lower income tax rate – not at the trust’s compressed rate. (Note, however, that income taxed to a beneficiary who is a full-time student under age 24 may be taxed at their parents’ rates pursuant to the “kiddie tax.”)

If you are planning for your children’s or grandchildren’s college education, talk to your estate planning attorney or financial advisor about how deferred annuities may fit with your plan.

Kulas & Crawford

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"Everyone treated us extremely well.  Robert explained how a trust works and the benefits of having one.  We decided to move forward and complete the process.  He was very kind and knowledgeable.  Julie was also very helpful and very patient with our questions.  We felt very comfortable with this firm handling our affairs.  We would highly recommend this firm to our friends and family."

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Robert Kulas and staff made making a will an easy to understand process. They were very knowledgeable and attentive to my wishes. All my documents were provided in an organized binder which will be a great asset to my family. I would definitely recommend them.

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I have worked with Mr. Kulas & staff before. And they are very professional. I am very satisfied with Mr. Kulas and his staff and give them the highest satisfaction and 5 star rating.

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Mr. Kulas and his staff have been extremely helpful & knowledgeable for the over 3 years we have been associated. They are easy to talk to and explain everything without feeling rushed. Very competent and professional.

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I have known Robert Kulas for 20 years since I was co-executor for friends who had Mr. Kulas prepare a Trust for them. When I felt I needed a trust also, I came to him. I have always been completed satisfied with his work and that of his charming, competent staff.

Joan C.
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We began our estate plan process in 2004 (12 years ago) and have been pleased with the periodic reviews we have gone through and when changes have been needed the firm has been thorough and professional in making those changes.

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