Annuities are usually perceived as a safe, conservative vehicle for retirement savings. That's certainly their primary purpose, but they can be used to meet other financial-planning objectives -- such as retirement income for a nonworking spouse or income for a minor child. When the annuitant is a minor, there are a few extra legal steps involved.
In its fundamentals, an annuity is a life insurance policy that's been revamped to provide growth of capital and, eventually, an income. That income can be for life or for a set number of years, depending on the annuity's purpose. Aside from the insurance company issuing the annuity, there are three other parties to the contract. The owner buys and pays for the annuity, the annuitant receives an income from the annuity, and a beneficiary or beneficiaries can inherit the annuity's value if the owner and annuitant die.
Choosing a Minor
There are several reasons to make a minor the annuitant in an annuity contract. For example, parents and grandparents often use an annuity as a vehicle to save for a child's college education. When the child begins school, the annuity provides an income for four or more years, as needed, then terminates. Children who require lifelong care for a physical or developmental disability can also benefit from an annuity. In this instance, it can provide an income until adulthood, or for the duration of the child's life.
Structuring the Contract
Ordinarily, the owner and annuitant are the same, so that person's death triggers a payout to the contract's named beneficiary. When the annuitant is a minor child, the annuitant should also be that beneficiary. At the time of the owner's death, one of two things happen. Ideally, a surviving spouse can take over ownership of the contract and keep it in force as originally planned. Otherwise, the annuity pays a lump-sum death benefit to the minor child as beneficiary, just as an insurance policy would. A trustee must be named to receive those funds in the child's name while he's still a minor.
Payments into an annuity are made in after-tax dollars, so when the child begins drawing an income, those payments won't be taxed a second time. The gains in the annuity are taxable as ordinary income, at the child's base rate. The IRS also levies a 10 percent surcharge on amounts withdrawn before the age of 59 1/2, but in most cases, that still results in a modest tax bill for the child. If the owner of the annuity dies and a death benefit is paid to the child, the gains will be taxable as a lump sum. The impact can be minimized by electing to spread the payments over a five-year period, or over the expected lifetime of the child.
Fred Decker is a trained chef and certified food-safety trainer. Decker wrote for the Saint John, New Brunswick Telegraph-Journal, and has been published in Canada's Hospitality and Foodservice magazine. He's held positions selling computers, insurance and mutual funds, and was educated at Memorial University of Newfoundland and the Northern Alberta Institute of Technology.