As Estate Planners, we often have clients who want to leave a lifetime income stream to a beneficiary when the client dies. The beneficiary can be anyone – a spouse, child, friend, housekeeper, long-time companion or domestic partner. This is often done using a trust, however, when the amounts involved are not large some practical considerations can interfere with accomplishing the client’s intent.
For example, if the client wants to provide income for the life of the beneficiary, the client has to reserve a large amount of principal to be certain that the money doesn’t run out before the beneficiary dies – knowing how much to set aside is pure guesswork. Next, the money has to be managed and invested, accounted for, and paid out. If the principal is placed in a trust with a corporate trustee, there will be trustee fees for management and fees for investment services. What happens when the trust investments don’t perform well? Amounts available to the beneficiary are reduced. Also, if the amount is below one million dollars, a corporate trustee may not want the job at all, or charges so much that it reduces the amount going to the beneficiary. A corporate trustee certainly deserves its fees, but didn’t the client intend to benefit the beneficiary? Alternatively, if you use an individual as the trustee, say, a friend, relative, CPA or attorney, the funds might not be as well managed and invested as with a professional corporate trustee, and you will need to provide successor trustees in case the individual you have named does not outlive the beneficiary. Individuals also may want trustee’s fees.
One way of avoiding these problems is to provide that, at the client’s death, instead of creating a trust, an annuity is purchased for the beneficiary that will begin to pay out immediately and for the rest of the beneficiary’s life. These can be purchased with a “successor beneficiary” in case the primary beneficiary dies before complete payout. You can prevent the beneficiary from drawing down all the money at once by using an annuity with a “Restricted Beneficiary Designation”. (Although the annuity beneficiary can “sell” their income stream, there are techniques to make sure that this doesn’t happen.)
The annuity will be protected against claims of the beneficiary’s creditors and provide a guaranteed periodic payment for life. No guesswork in determining how much to reserve for the beneficiary or over-funding or under-funding the trust. No trustee’s fees. No annual accountings. No disputes between the beneficiary and the trustee. No market-performance risk. No determining trustee succession. No risk of fraud or misappropriation by the trustee. Do annuities cost money? Of course they do – and well worth it if you have saved all of the administration expense and risk of traditional trusts – and guaranty a lifetime payout.
Always seek the advice of a professional. And be careful that you don’t do something that disqualifies your beneficiary from government benefits, like Medicaid.