Treasury Proposes Curbs on Use of Life and Annuities in Wealth Planning

The proposal would change the rules by creating a new class of "covered contracts," including:

1. Any domestic product now classified private placement life insurance policy or private placement annuity contract.

2. A variable life contract with premiums paid in kind, rather in cash.

3. Any variable life contract with underlying assets purchased, directly or indirectly, from the policyholder or related persons.

4. Any variable life insurance contract issued outside of the United States if a domestic version of the policy would be classified as a private placement life insurance policy.

For a covered contract, "in addition to partial or full surrenders of cash value, distributions would include amounts payable as death benefits, amounts received as policy loans, and amounts of policy cash value assigned or pledged to any person," officials write.

Today, beneficiaries of a life insurance policy can usually get the benefits and many other kinds of distributions free from federal income taxes.

Under the proposal, clients could continue to pay ordinary income taxes on distributions coming out of a private placement annuity after the annuity payment start date.

If beneficiaries received death benefits because the individual insured by a covered contract died, those payments "would be taxable as ordinary income, but only to the extent the beneficiary's share of the contract's investment value exceeds the beneficiary's share of the contract's investment in the contract," according to the Greenbook. "A contract's investment value and investment in the contract would be allocated to multiple beneficiaries in proportion to the allocation of the death benefit itself to those beneficiaries."

In most other cases, recipients of the cash taken out of the arrangements would pay ordinary income taxes along with a 10% penalty.

The U.S. Treasury Building in Washington. Credit: Bloomberg