ANNUITY CONTRACTS Florida Statute Section 222.14 provides as follows:Exemption of cash surrender value of life insurance policies and annuity contracts from legal process. -- The cash surrender values of life insurance policies issued upon the lives of citizens or residents of the state and the proceeds of annuity contracts issued to citizens or residents of the state, upon whatever form, shall not in any case be liable to attachment, garnishment or legal process in favor of any creditor of the person whose life is so insured or of any creditor of the person who is the beneficiary of such annuity contract, unless the insurance policy or annuity contract was effected for the benefit of such creditor. The above statute has been read to mean that the cash value of a deferred flexible variable annuity contract will be an exempt asset. When such an annuity contract has a cash surrender value, the above language may be read to only protect the proceeds of annuity contracts where the debtor is the beneficiary of the contract. It would be assumed that the owner of an annuity contract is its beneficiary, although by the terms of the contracts the beneficiary is typically the party designated to receive the payout of the annuity upon the death of the initial owner. A. IT SOUNDED GOOD TO DR. GOLDENBERG, AND IT TURNED OUT IT WAS! What do the "proceeds of annuity contracts mean? What is an annuity contract? In Sawczak v. Goldenberg, 253 F.3d 1271 (USCA 11th Cir. June 12, 2001), Dr. Goldenberg had performed gallbladder surgery on Mrs. Sawczak without malpractice insurance and filed bankruptcy on the day of the jury trial. The jury awarded Mrs. Sawczak $4,000,629. Dr. Goldenberg filed bankruptcy schedules showing $3,751,678 out of $3,791,119 in assets as being exempt. This included $355,894 in annuity contracts which were single premium deferred annuities for which Dr. Goldenberg had paid a single premium which accumulates interest until the maturity date. Each of the contracts provided for a future date as to which sums owed would become payable to Dr. Goldenberg or his survivors, and each of them contained a provision for surrender of the contract in exchange for a specified lump sum payment. The Bankruptcy Court held that the cash surrender value of variable investment annuity contracts were protected from creditor claims under Florida Section 222.14, but on appeal the United States District Court found that Dr. Goldenberg did not have annuity contracts "until the funds in the annuity account reached maturity. He had, instead, option contracts to buy annuities at a future date which options could be revoked by him at any time prior to the maturity date... This sent shudders through the annuity and creditor protection community in 2000 and 2001." Fortunately the Eleventh Circuit Court of Appeals certified this case to the Florida Supreme Court, and the Florida Supreme Court decided in a 7 to 0 decision that if the Florida legislature had wanted to limit what would qualify as an annuity, they would have so stated in the statute. The court noted that this was a sales charge type annuity, but there is no reason that the decision should not apply to a no load annuity. Dr. Goldberg reportedly spent over $200,000 in legal fees, but at least these were tax deductible. ONE MORAL OF THE STORY IS NOT TO PUT ALL YOUR EGGS IN ONE BASKET AND THE SECOND MORAL OF THE STORY IS WHAT WE THINK THE LAW SAYS IS NOT NECESSARILY WHAT THE JUDGE IN THE NEXT APPELLATE COURT WILL THINK THE LAW SAYS. B. INCOME TAX ASPECTS. Tax deferral offered by commercial annuity contracts may result in greater after-tax returns. But consider whether the client would be better off paying 20% capital gains tax as opposed to ordinary rates if appreciated stocks are the primary underlying investment. Consider the penalty imposed upon taxable income withdrawn before age 59 ½. C. STRUCTURED SETTLEMENTS. Structured settlements should be considered for any clients settling a personal injury claim, and these have been construed to be creditor protected assets under Florida law. See In re McCollum, 986 F.2d 436 (CA-11). Under a structured settlement, annual fixed payments received based upon a specified settlement will all be tax free, notwithstanding the interest income element inherent in such contracts. See Alan S. Gassman and Randal E. Gassman, Structured Annuities: What Every Plaintiffs Lawyer Should Know, The Practical Litigator, (May, 1997). In LeCroy v. McCullam, 612 So.2d 572 (Fla. 1993), the Florida Supreme Court found that Section 222.14 exempted an annuity that was created in lieu of a defendant in a lawsuit paying a lump sum settlement. Apparently the conversion of a cause of action in a personal injury suit to a structured settlement annuity will not be considered a fraudulent transfer. In LeCroy, the Supreme Court noted that annuities have been defined as "the right to receive fixed, periodic payments for a term of years or life." Florida Statute 238.01(15), which is part of the State Teachers Retirement System Law, defines annuity as "annual payments for life...from the accumulated contributions of the member." Where a structured settlement is arranged whereby the defendant insurance company has all legal and equitable interest in an annuity contract and agrees to make payments over time to the plaintiff/debtor, such arrangement has been held not to be exempt. The LeCroy decision with respect to the definition of an annuity will likely be expanded by the decision expected in Sawczak v. Goldenberg. In In re Craig Charles Turner, 2005 WL 2616220 (Bankr. N.D. Fla. 2005), the Court found that an annuity contract did not exist under Florida Statute 222.14 where the litigant released her claims against the insurance company in order to receive a structured settlement. The agreement did not specify that settlement proceeds were to be paid under an annuity contract, and nowhere in the agreement was the litigant referred to as beneficiary or payee. The LeCroy case was sited for the rule that an exemption is more likely to be allowed where an individual is specifically named as a beneficiary. However, the court in In re Craig Charles Turner pointed out that, absent a designation as a beneficiary the individual is not totally precluded from exempting the settlement under Florida Statute 222.14 as an annuity contract. NOTE - D. LOTTERY ARRANGEMENTS. Can Lottery payments be considered as exempt assets? In In re Pizzi, 153 Bankruptcy Reporter 357 (So. Dist. Fla. 1993), the Bankruptcy Court of the Southern District of Florida held that a lottery contract actually made payable to the State of Florida, which in turn makes payments to the lottery winner, is not creditor protected. In In re Solomon, 95 F.3d 1076 (11th Circuit 1996), lottery winnings paid to the beneficiary in the form of an annuity are exempt from claims of creditors where the state discharges its obligation by purchasing the annuity contract naming the debtor as beneficiary. E. ESTATE TAX PLANNING. Private Annuities can be used as an Estate Tax savings device, especially when an older client has adverse health conditions, but is reasonably expected to live more than one year. Standard life expectancy tables can be used as long as the Seller/Payee has a better than 50% chance of living at least one year at the time the transaction is entered into. There will be an irrebutable presumption that the good health requirement is satisfied if the person lives at least 18 months. See Treasury Regulations at Section 25.7520-3(b)(3), issued in 1995. Clients who fear nursing home confiscation may feel more comfortable with assets being conveyed to children or an Irrevocable Trust that would have an obligation to make annual payments for the lifetime of the client. Consider having a client receive a life annuity or other annuity payment rights from a Defective Grantor Trust in exchange for a joint and survivor annuity. Not only is the joint and survivor annuity protected from creditors, but there are significant estate tax savings results that will occur, particularly if the rate of return on the installment obligation and subsequent reinvestment thereof exceeds the Section 7520 rate assumptions implicit in the second-to-die annuity tables. F. WHAT YOU RECEIVE FROM A GRANTOR RETAINED ANNUITY TRUST IS AN ANNUITY! Do not forget how effective Grantor Retained Annuity Trusts ( GRAT )are for estate tax planning purposes. In Audrey J. Walton v. Commissioner of Internal Revenue (115 T.C. 41 - December 22, 2000), the U.S. Tax Court held that a two year GRAT could be zeroed out for estate and gift tax purposes. In this case, Sam Walton’s widow transferred approximately $100,000,000 of Walmart stock to a GRAT for the right to receive 49.35% of the initial value 12 months after inception, and 59.22% of the initial value 24 months after inception. The obvious purpose of the trust arrangement was to facilitate having any excess value remain in the trust for the beneficiaries on an estate and gift tax-free basis if the property had grown in value. In this case, the Tax Court found that a GRAT can be zeroed out, and thus Example 5 of Gift Tax Regulation Section 25.2702-3(e) is invalid. The right to receive payments from the charitable remainder annuity trust should also qualify as an annuity right that should be protected from creditors. G. THE PRIVATE ANNUITY TRUST. The "private annuity trust" is a heavily marketed arrangement whereby an individual establishes an irrevocable trust that purchases appreciated assets for income tax planning purposes, in exchange for which the grantor/seller receives the right to receive annuity payments over a specified period of time. The trust then sells the appreciated asset and will not have to pay income tax unless or until the grantor dies before having received annuity payments equal to the agreed value of the asset. The receipt of annuity payments will be subject to income tax based upon the rules under Internal Revenue Code Section 72. H. CONSIDER GOING OFFSHORE. Life insurance and annuity products offered in offshore jurisdictions may allow the underlying investments to be managed by selected money managers or a broad range of mutual funds, and many offshore jurisdictions have creditor protection statutes which may require that a creditor obtain a judgment in the offshore jurisdiction before such an annuity contract would be susceptible to creditor claims. Reputable offshore trust and insurance companies can custom make annuities, modified endowment contracts, and traditional life contracts that may qualify for tax deferral or complete income tax avoidance under applicable income tax law, with the client having the ability to choose a money manager or possibly even the client’s broker to oversee investment of the product. This helps to bring new meaning to the word variable. However, recent Treasury Regulations make tax deferral on offshore annuity products somewhat doubtful in many situations. Foreign bank account disclosure requirements do not apply to investments in offshore life insurance and annuity products. Since such policies can qualify under the tax and state law without fulfilling expensive and strenuous requirements imposed by state insurance commissioners, clients investing large sums may be able to save money on large policies and have more flexibility as to investments by going offshore. I. NEW BANKRUPTCY ACT ISSUE. Is an annuity a "similar device" that would not be protected in bankruptcy where within 10 years of filing a transfer is made with the actual intent to hinder, delay, or defraud present or future creditors "to a self-settled trust or similar device"? At one point the proposed legislation with respect to this provision had it applicable to "a self- settled trust or similar device", but specifically excluded qualified retirement plans. Is the language "self-settled trust or similar device" broad enough to include annuity and life insurance arrangements where money is given to a life insurance company that invests it and makes cash available at a later time, subject to state or foreign jurisdiction creditor protection laws and arrangements? Time will tell. See Bankruptcy Code Section 548(e). For conventional annuity contracts, the owner, who has the right to withdraw and/or to receive payments during his or her lifetime, would be considered the "beneficiary" under Florida law, while the "beneficiary designation" under the annuity contract might be in favor of a trust or other person as the "survivor owner or beneficiary."Annuity and life insurance contracts are protected in many states, including Florida and New York, which have unlimited creditor exemptions for life insurance and annuity products that are properly owned and structured.