Advanced Marketing Forum Question

Turning Deferred Comp into Income

Question:
My client owns a business which started a deferred compensation plan for his benefit several years ago. He is ready to retire and wants to know if there is any negative tax repercussion if the company buys an immediate annuity to insure his benefits. Would this be considered constructive receipt because the account is no longer available to the creditors of the business? How can we structure this to achieve his goal? For instance, could the annuity payments be paid to a rabbi trust and then distributed to him?

Reply #1:
As long as the company is the owner of the immediate annuity and the payee, I don't see a constructive receipt or economic benefit problem. Since the annuity payments would be made to the company, they would still be considered to be available to the creditors of the company. If the company were to go bankrupt, the employee would have no rights in the annuity income stream greater than that of a general unsecured creditor.

Keith Buck, J.D., LLM, CLU, FLMI
Advanced Sales Attorney

Reply #2:
The annuity could be used as an "informal funding" vehicle. Assuming the deferred comp agreement has been in place for at least 12 months and there is no reference of the annuity in the agreement, this should work. The fixed immediate annuity could be used to transfer the payment risk to the insurance company. Annuity payments to the employer would have to be available to creditors. If the corporation owns the annuity and receives income payments directly from the insurance company and there is no evidence of ownership by the employee, my opinion would be that constructive receipt would not have been met as long as the employee substantial risk of forfeiture. The company could purchase the immediate annuity (using another person as the annuitant) with sufficient funds to fulfill the obligation. Of course, if a deferred annuity is purchased, there is no tax deferral.

Jim Fitzpatrick, CFP, CFS, CRS
Advanced Markets
MetLife Investors
Phone: (949) 629-1392
Fax: (949) 717-6721
E-mail: jim.fitzpatrick@investmet.com

Reply #3:
The initial response should be that the purchase of an immediate annuity and transfer of the annuity to an employee will normally trigger "constructive receipt".

If the ownership of the immediate annuity remains with the company (which means they can change the income recipient), then the annuity should still be deemed a general asset of the company and therefore not trigger income recognition until each payment is received by the employee.

The fact that the employee is the owner adds another dimension to the issues in this type of case.

Are there other owners? Is the corp a C or S corporation.? Will the business be sold or liquidated? When the plan was set up did they file with the department of labor? There may be other issues and directions to go if more information is available to us.

Richard L. Olewnik, JD,CLU,ChFC
American Skandia Advanced
Client Solutions Team
Phone: (800) 628-6039 ext.57185
Fax (203) 944-7700
Email: rolewnik@skandia.com

Reply #4:
The business can purchase an Immediate Annuity and as long as the annuity payments are payable to the corporation there would be no negative tax implications to the executive. He would still be taxed only when he receives payment from the corp. There is NO constructive receipt because the corp has simply exchanged an asset for a stream of income. That money is still available to creditors at the time it is received by the corp. The use of the Rabbi Trust simply protects the executive from his own company having a change of heart. In reality, this does not give the kind of protection the executive is looking for but it won't cause a negative tax situation.

* The foregoing is for broker/agent use only, and is intended solely for informational purposes. Nothing contained herein should be construed as legal or tax advice, and should not be relied upon for such. Legal and tax advice should only be obtained from your attorney or qualified tax professional.

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