An inherited Fixed Annuity
My mother passed away in February 2012. The estate has not been distributed to the beneficiaries yet. Mom had an annuity paying 3.5% fixed interest. Each of us will get $122,000 from the annuity with $33,000 being taxable. We still have to file a 2012 income tax return for Mom next year. She was in a low tax bracket. We are in a higher tax bracket. Is there a way to have the estate pay the taxes before distributing the money to each individual?
Permalink Submitted by Alan Spross on Mon, 2012-06-11 03:04
Tax rates for an estate are generally higher than that of an individual. And that is not even an option if there were named beneficiaries on the annuity.
You should check with the insuror to see what distributions options are available if beneficiaries were named OR in the event the estate is the beneficiary. If the estate is the beneficiary perhaps annuity distributions can be taken in more than a single year and passed through to the beneficiaries on a K1, although that would require the estate be kept open for more than one year. Even though beneficiaries are in a higher bracket, spreading distributions out over more than a year or two can reduce income tax liability for the beneficiaries.
Also, note that distributions taken after your mother’s death cannot in any circumstances be reported on her final 2012 return.
Permalink Submitted by Joe Williams on Fri, 2012-06-15 21:32
Thank you very much! This is helpful information. Mom’s estate is appx. 1.4 million divided between 4 kids. Most of the estate is in mutual funds except for the annuities I mentioned. We are told that we weren’t named as beneficiaries on the annuities. The estate is still open because we are unsure what to do about the tax situation. We are all willing to wait. We have until July 2013 to close the estate without having to pay court fees etc. We are told we owe no taxes on the mutual funds.
Maybe the K-1 is the way to go…
Permalink Submitted by mk foss on Fri, 2012-06-15 21:51
To give you an idea of the rate difference – an estate or trust reaches the 35% tax bracket for 2012 at $11,650 of income; an individual reaches 35% at $388,350. If distributions are made to the beneficiaries within the same tax year that the annuities are received, the tax burden is shifted to the beneficiaries and reported to them on a Schedule K-1. None of this is elective, if there are distributions you use the Schedule K-1; without distributions the estate pays the tax.
You need advice fromthe attorney representing the estate as to when distributions can be made. If the court system requires a delay, income could be trapped within the estate and subject to tax at the highest possible rate.
Permalink Submitted by Joe Williams on Sat, 2012-06-16 05:57
Mary, thank you for taking time to reply to my post. You really helped to clarify the situation. Is it true that neither her estate nor the beneficiaries need to pay capital gains tax for gains before her death? We would only pay the gains since her death in February 2012?
Permalink Submitted by Alan Spross on Sat, 2012-06-16 21:17
What you indicated is generally true for inherited assets that are NOT retirement plans, such as the mutual funds.
Retirement plans including 401k accounts, IRAs and non qualified annuities are IRD assets. IRD is income with respect to a decedent and this is income that the decedent had a right to realize while living, but did not and therefore the retirement asset was inherited. When inherited, the untaxed portion of these plans are taxed as ordinary income, not capital gains (NUA is an exception). Therefore, your 33,000 taxable portion must be reported as ordinary income which has a higher tax rate than capital gains. Gains occurring since Feb are also taxed as ordinary income and are not separated from the gains prior to February.
If a partial distribution is taken and the annuity investment was made less than 30 years ago, the amounts received first come from the earnings and the invested amounts comes out last.
Permalink Submitted by Joe Williams on Sat, 2012-06-16 21:35
Thank you again, Alan. Really appreciate your assistance. Have a great weekend!