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Is It a Good Idea for an Elderly Person to Purchase a Deferred Annuity?

January 9, 2013

I have been seeing an increasing number of older clients who have purchased (or, perhaps more accurately, have been talked into buying) a deferred annuity.  Sometimes the annuity fits into the client’s financial plan appropriately, but in many cases the purchase of the annuity can be a horrible move.  Many of my clients find out too late that the annuity they were sold ends up causing problems.  If they need their money back soon after the purchase, they can end up paying surrender charges and can end up with a lot less money than they originally invested in the annuity.

A deferred annuity is an insurance product that receives special treatment under federal income tax law.  The income generated by the annuity is only taxable when the funds are accessed.  After death, the beneficiary of the deferred annuity receives the proceeds free of probate, so the annuity owner’s will has no effect on the annuity (unless the annuity has no beneficiary).

Sometimes from a pure income tax standpoint, buying an annuity is a mistake.  I am seeing that some clients who barely have enough income to pay income tax are being sold deferred annuities.  What then happens is the income is accumulated on a tax-deferred basis, then at death that income ends up going out to beneficiaries who are in a much higher income bracket.   The proceeds are not being taxed at the older client’s lower income tax rate, and end up being on the tax return of beneficiaries at a higher tax bracket, so, overall, from a family standpoint, extra income taxes end up being paid on the annuity income.  (In many cases, if the deceased client had made a different type of investment, it is possible that all of that income could have gone to the beneficiaries free of income tax.)

Often, on deferred annuities sold to elders, the annuity ends up being a blunder for MassHealth or Medicaid purposes.   A deferred annuity is considered an available asset by MassHealth and is never a helpful investment in case of a long-term nursing home stay.  Some of my clients who were sold deferred annuities believe they were told that the deferred annuity is not considered an asset if the client ended up in a nursing home and applied for MassHealth to pay for the nursing home costs.  Unfortunately, a deferred annuity is considered just another asset in the MassHealth application process, and it has to be spent on nursing home care just like any other asset.

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