Private Annuity
Trusts: Financing your Retirement
A few entries back I wrote
about my friend selling her auto mechanic business
and how she could use a PAT to sell the business and
reap capital gains tax deferral benefits. Not only
does she experience tax benefits using a PAT, but
she has a stream of passive income to help fund her
retirement.
PATs can help with retirement
income for anyone, not just business owners or
holders of greatly appreciated illiquid assets. In
fact, selling stock in a retirement portfolio or
exercising stock options in a PAT is a great way to
get retirement income while minimizing the capital
gains burden and without having to worry about
interest or penalties.
PATs work the same way with
securities or stock options as they do with business
assets. Before the sale, you set up a PAT and place
the securities into the trust. The trust sells the
securities or exercises the options and begins to
pay you an income stream (assuming you haven’t
deferred the payments). Part of the income stream is
“payment” for the trust’s purchase of the securities
(your cost basis in the securities), part of it is
capital gain on the sale of the securities, and part
of it is income generated by the new assets in the
trust. You pay a little tax with each payment,
thereby spreading out and alleviating your tax
burden. You no longer have control of the stocks, so
they are out of your estate for estate tax purposes.
Now, when you talk about stock
options and retirement it’s only natural, these
days, that you start to think about the usual
retirement account options: IRAs and 401Ks and all
their various permutations and pensions. This is not
what I’m talking about here. These types of
accounts, known as qualified accounts, cannot be
sold into a PAT without losing their tax-exempt
status. While I’m at it, a hedge fund is another
type of security holding that cannot be placed in a
PAT because of its high tax liabilities.
PATs are for unrestricted
investment accounts. PATs are for that mutual fund
or index fund you’ve been holding onto ever since
they came onto the investment scene. They are for
the stock account you inherited from Aunt Sarah last
year. PATs are for the stock options you got when
you first signed on with your company. If you have
an unrestricted securities account sitting around at
Charles Schwab or RBC Dane Rauscher or wherever,
then a PAT may be for you. Because the account is
unrestricted, however, you don’t get any tax breaks
when you sell the securities. You would still get
the long term capital gains tax federal rate if
you’d held the stocks for more than one year.
The only way to reduce the capital gains
bite is by selling the stocks through a PAT or a
Charitable Remainder Trust (which I’ll explain about
in a later post).
Another thing to note here is
that you only should place the securities into the
PAT when you are ready to sell them. Actually, this
is true of any asset you are going to sell through a
PAT, but securities make for a good example as to
why you should do so. Securities are volatile – they
can gain a lot in value or lose a lot of value in a
short period of time. If there are two types of
assets you do not want to have in a PAT they are
assets that are going to appreciate further and
assets that are going to lose significant value. The
reason being is that if the asset appreciates inside
the PAT, the PAT will have to pay capital gains tax
and there is no way for the trust to defer the tax.
If the asset loses value, the trust will be unable
to support the contractual payments to you, which it
must make if it is to be considered valid by the
I.R.S. If you just set up a PAT and park your
securities there for a while, there’s a good chance
they will go up or down in value before you sell
them, triggering one of those two negative
consequences.
If you have any questions about
placing your security accounts into a PAT, feel free
to contact me at 760-917-0858 to set up a no-cost
initial consultation.
Paula Straub
Save Gains Tax
This material is not
intended as an offer or solicitation for the purchase or sale of any
security or other financial instrument. Securities, financial
instruments or strategies mentioned herein may not be suitable for
all investors. Any opinions expressed herein are given in good
faith, are subject to change without notice, and are meant for
informational use only. The information contained on this site does
not constitute advice on tax or legal issues. This material does not
take into account your particular investment objectives, financial
situations or needs and is not intended as a recommendation of
particular securities, financial instruments or strategies to you.
Before acting on any recommendation in this material, you should
consider whether it is suitable for your particular circumstances
and, if necessary, seek professional advice.
