Why You Need an Integrated System
A deferred annuity has proven to be a powerful investment vehicle when used inside a Charitable Remainder Trust (CRT). Specifically, combining the ability to make up distributions from the Net Income with Makeup Charitable Remainder Unitrust (NIMCRUT) and the income deferral flexibility of the fixed and variable annuity provides the trustee with the maximum ability to satisfy the interest of both the income and charitable beneficiary. Renaissance has developed a system, that takes full advantage of flexible trust language, the uniqueness of deferred annuities and administration requirements for CRTs. When carefully followed, this integrated system results in the maximum flexibility and benefit of using the income deferral strategy associated with a NIMCRUT. When not followed, the results can be disastrous for the insurance company, the professional advisors, the trustee and the income beneficiary.
The CRT requires two separate types of accounting. The first type, fiduciary accounting, tracks the principal and income accounts, including the amount of income to be distributed. The second type, tax accounting, tracks the taxable nature of each distribution under the 4-tier accounting system. Without an integrated system, making distinctions between reportable trust income and the tax consequences of actual distributions to the income beneficiary becomes a difficult and labor intensive process.
The Unitrust Document: Part One of an Integrated System
Having appropriate language in the NIMCRUT document is necessary to assure that the trustee will have the flexibility to defer income to meet the desires of the income beneficiary. The trust document must provide a special definition for trust income that allows the effective use of a deferred annuity as the investment in the trust. An annuity contract not owned by a "natural person" loses its tax deferred status, therefore the owner is required to report the annual increase in annuity value as taxable income. When special annuity language is included in the trust document, a distribution of income is not made to the income beneficiary until the trust actually receives the income in the form of a cash withdrawal or surrender. Since a charitable remainder trust is a non-taxable entity, the taxable income, although reported on the trust tax return, is not taxed.
The trust document must contain language that allows for the appointment of an Independent Special Trustee (IST) with the power to make all decisions regarding the annuity contract. An Internal Revenue Service ruling indicates a preference for the IST to apply for the annuity and retain control. Without an IST, the IRS may argue that the trust is in violation of specific grantor rules.
The Insurance Company: Party Two of an Integrated System
The annuity contract should contain certain product features as outlined in the section "The Ideal Annuity" in this manual. In addition, the issuing company should adhere to certain administrative requirements that will make the administration process flow smoothly.
The ability to send transactional information and statements to the third party administration firm. Generally the insurance company is prepared to send information to the broker and the contract owner. The ability to produce a third statement or provide electronic download to the trust administrator is essential for accurate trust administration. Missing statements or transaction information is the single greatest cause for an administrator's delay in preparing year-end tax returns.
The ability to recognize when a request for withdrawal has invaded principal. The administrator of a CRT is responsible for calculating the income distribution and deciding if a withdrawal request can be taken from the principal paid for the annuity contract. With day-to-day market fluctuations, the insurance company must be able, when asked by the administrator, to identify situations where the request for a withdrawal has invaded principal. The insurance company must have procedures to do one of the following:
- Reverse funds withdrawn that invade principal without market risk, or
- Halt the request process and recalculate withdrawal amount, or
- Automatically reduce the withdrawal request if principal will be invaded.
Communication between the insurance company and administrator is critical. The administrator will typically receive a limited power of attorney from the trustee to process distributions. Proper communication channels between the insurance company and the administrator are essential for overall client satisfaction. Renaissance recommends that insurance companies designate a specific contact person for the administrator. The insurance company should have procedures that will allow for the administrator of the trust to:
- Receive contract values directly on a timely basis
- Submit requests for withdrawals
- Receive requested withdrawal amounts directly.
The insurance company should provide electronic transfer of information. Technology is making it possible to process more information more quickly at significant cost savings to everyone. Reducing paperwork flow should be a primary concern for the insurance company. Renaissance prefers to receive the following information electronically:
- Annuity values
- Transaction history
- Fund transfers
- Quarterly statements
- Annual statements
Administration Requirements: Part Three of an Integrated System
As mentioned earlier, the administrator must track the annual income produced by the annuity contract each year; and track actual income received by the trust in the form of a cash payment due to withdrawal or surrender. Form 1099 income as reported by the insurance company does NOT provide adequate information for accurate tax reporting. The administrator must follow the reporting guideline outlined in IRC 72(u). The administrator should perform a reconciliation each year to compare trust tax reporting with the annual statements produced by the insurance company. Typically, the annual statement produced by the insurance company does not accurately reflect the trust tax reporting requirements and is only used to validate the reassignment of income to the four tiers.
The administrator must receive copies of all statements, transactions and investment changes, preferably in an electronic format. Information may be supplied by the trustee or, whenever possible, the administrator should seek the information directly from the insurance company.
Please note: The most efficient way for the administrator to receive appropriate information directly from the insurance company is to list the administrator as the address of record for all correspondence on the application.
