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An extended family member just inherited some annuities in a trust from his parents. He said in order to get some money out of one of the annuities the insurance company required him to open up a trust savings / checking account in the trusts name ( annuity would only transfer money to a trust account ). He said the trust has to file an income tax return and it will pay 37% tax on the gains in the withdrawal. Then he said to get the money he will have to pay his normal tax rate again on the gains when he withdraws the money from the trust savings account and puts it in his checking.
[. . .]
I’m thinking I’d just buy VTSAX [. . .] and leave it to my heirs at a stepped up basis
eigenperson gave a good explanation of why there is no double taxation.There is no double taxation under normal circumstances.
When the trust earns income, it either has to distribute it to the beneficiaries or retain it.
If it retains it, the trust must pay tax on the income.
If it distributes the income, the trust issues a K-1 for the distribution. The beneficiary must pay taxes on the distributed amount; however, the trust itself gets to deduct the distribution from its income and so it does not pay taxes on that amount.
A couple of additional items where you, your relative or their advisor may be confusing or over-simplifying things.
1. Don't conflate the step-up potential of the "gains" associated with a non-qualified annuity and the "gains" associated a mutual fund like VTSAX.
The "gains" associated with a mutual fund like VTSAX are categorized as "capital gains" and are eligible for step-up.*
The "gains" associated with a non-qualified annuity are categorized as "income in respect of a decedent" (IRD) and are NOT eligible for step-up. (This is similar to the common situation where a traditional IRA experiences no step up upon the death of the original contributor, and distributions from the inherited tIRA are fully taxable to the beneficiary.)
The above "capital gain" vs "income in respect of a decedent" distinction has nothing to do with whether there was a trust involved or not.*
*(Well, to be complete, at a technical level, estate planning for a small number of estates involves a trade-off between getting step-up and owing estate taxes.
Specifically, "capital gains" are eligible for step-up, as long as they are also exposed to potential estate tax, i.e. are included in the value of the decedent's estate. As long as the trust is one of the sorts where its value is included in the value of the decedent's estate (e.g. a revocable living trust would be a common one), being in trust or not has nothing to do with step-up.
However, if a decedent had previously been very concerned about exposure to federal or state *estate* tax, and had deliberately chosen to set up a more specialized and less common sort of trust specifically designed to remove capital gains from being included in the value of your estate and thus exempt them from exposure to estate tax, that is a different, specialized situation where capital gains wouldn't be eligible for step-up.)
2. As far as paying 37% on ordinary income retained within a trust... It is true that the tax brackets for Form 1041 (fiduciary return for some sorts of trust) are very compressed compared compared to those for Form 1040, so income hits the top tax bracket a lot faster than for a Form 1040. But there *are* tax brackets, plus the concepts of deductions and exemptions, so ... if the distributed gains from the non-qualified annuity were the trust's only income ... it wouldn't *all* be taxed at 37%. (Whether or not that is a distinction without a difference depends on the magnitude of the trust's retained income and the magnitude if the trust's deductible expenses.)
However, more importantly, as eigenperson pointed out, as long as the gains distributed from the annuity were then distributed out of the trust to the beneficiary within the same tax year, trust tax rates would never be applied.
3. I have a suspicion there is a bit of a "game of telephone" going on here as information travels from your relative's tax advisor (if any) to your relative to you. However ... it has been the occasional case in boglehead's threads in the past where sometimes someone will hire a "tax preparer" who turns out to be completely incompetent when it comes to taxation of estates and trusts. So ... you know ... if your relative is absolutely sure that their tax preparer is telling them that double taxation is unavoidable ... it might be time to make sure that they hired an advisor is who competent with Form 1041.
Statistics: Posted by cas — Mon Dec 16, 2024 11:26 am