Revisiting Annuities in 2025 for Financial and Estate Planning
- Victor Levy
- 3 days ago
- 9 min read
Working with annuities in both financial planning and estate planning presents opportunities and challenges. In one instance, understanding the basics of commercial annuities (annuities issued by insurance companies) can help a financial advisor guide a client toward guaranteed income for life: the focal point of most retirement planning. However, because an annuity creates a “life estate,” it also is an asset with zero value at death; therefore, an annuity popularly known as a “private annuity,” is an attractive estate planning technique. In sum, annuities are at the crossroads of both financial planning and estate planning, thus making them attractive for planning outcomes during life and at death. With interest rates elevated in 2025, these assets should be re-considered.
Annuities - Evolution
The concept of providing lifetime income dates to the Revolutionary War. In 1780, the Continental Congress promised half-pay for seven years to widows and orphans of officers who died in service—a precursor to modern survivor benefits. Over the next decades, Congress expanded these provisions, and though not called “annuities,” these pensions functioned similarly—providing regular payments for life or until remarriage—laying the foundation for survivor income planning in America.[i]
Interestingly, the concept of annuities in America finds its roots in Philadelphia, shortly after the Revolutionary War. Benjamin Franklin left annuities to the cities of Philadelphia and Boston in his Will to support public projects and aid the poor. Additionally, the Presbyterian Ministers Association in Philadelphia pioneered the use of annuities to provide retirement income for aging clergy and their families. These early applications laid the foundation for annuities as tools of financial stability and intergenerational support. Philadelphia thus holds a unique place in the history of annuities.[ii]
The Basics: Fixed Immediate Annuities
A fixed immediate annuity when issued by an insurance company is a straightforward financial product: an individual exchanges a lump sum of money for a guaranteed income stream that lasts for life. A basic annuity is commonly used in retirement planning and offers the dual benefits of financial security and estate exclusion.
From an income tax perspective, the earnings in a non-qualified fixed annuity grow tax deferred, but when they are withdrawn, they are taxed as ordinary income. Because the annuity payments cease upon death and the principal is no longer part of the estate, they do not contribute to estate tax liability.
In recent years, rising interest rates—particularly in long-term Treasury yields—have led to an increase in annuity payout rates. This trend has made fixed immediate annuities more attractive to retirees seeking stable income.[iii]
Insurance companies offer several structures for annuities that guarantee income for life, helping retirees manage longevity risk:
Single Life Annuity
Pays income for the annuitant’s lifetime only.
Pros: Highest payout amount.
Cons: Payments stop at death; no benefit for heirs.
Joint and Survivor Annuity
Covers two lives (usually spouses). Payments continue until both have passed.
Pros: Provides security for surviving spouse.
Cons: Lower monthly payout than single life.
Life with Period Certain
Guarantees lifetime income plus a minimum payment period (e.g., 10 or 20 years).
If the annuitant dies early, payments will continue on to a named beneficiary for the remainder of the stated period.
Joint Life with Period Certain
Combines joint coverage with a guaranteed minimum period.
Ensures income for both spouses and a set number of years even if both pass away early.
Fixed vs. Variable Lifetime Payouts
Fixed: Predictable, level payments; optional cost-of-living adjustment (“COLA”) for inflation.
Variable: Payments fluctuate based on investment performance; potential for growth but with risk.[iv]
A fixed annuity is a simple contract with straightforward features, emphasizing protection and prediction. Because some investors seek greater growth potential along with guaranteed income, the variable annuity offers a different balance.
Variable Annuity with Lifetime Income Features
Variable annuities combine market-based growth potential with the security of guaranteed income through optional lifetime income riders. These riders—such as a Guaranteed Lifetime Withdrawal Benefit (“GLWB”)—create a separate “benefit base” that grows at a guaranteed rate or locks in market gains during the deferral period. When income begins, the insurer applies a payout percentage (based on age and coverage type) to this benefit base, ensuring a predictable stream of income for life—even if the account value is depleted.
This structure allows clients to remain invested for growth while mitigating longevity risk. However, these benefits come at a cost: riders typically add 0.8%–1.2% annually to already high variable annuity fees, and they often impose investment restrictions. For clients seeking both growth potential and lifetime income security, these products can be a powerful tool when used thoughtfully within a comprehensive plan.
Variable Annuities with Lifetime Income Riders – Pros and Cons
Pros
Guaranteed Lifetime Income: Even if account value drops to zero.
Market Participation: For potential growth.
Flexibility: Unlike full annuitization, you retain access to funds.
Spousal Protection: Joint-life options available.
Cons
Added Costs: Riders often add 0.8%–1.2% annually to base cost.
Complexity: Multiple moving parts—benefit base, roll-up rates, payout factors, etc.
Investment Restrictions: Limited subaccount choices to manage insurer risk.
Taxation: Withdrawals taxed as ordinary income.
Estate Planning Considerations
Beneficiary Control: Unlike traditional annuitization, remaining account value can pass to heirs.
Step-Up in Basis: Not available—beneficiaries inherit taxable income.
Liquidity for Estate: Riders preserve some flexibility, but excess withdrawals reduce guarantees.
Spousal Continuation: Joint-life riders can ensure income for surviving spouse.
Overall, commercial annuities play a valuable role in both financial and estate planning. They offer flexibility, income security and potential estate tax advantages. For an estate planning strategy that takes the theory of zero estate inclusion aspects of fixed annuities and creates an approach that potentially allows for the transfer of an asset tax efficiently, there is the private annuity.
Private Annuities: A Strategic Estate Planning Tool
In the realm of estate planning, the private annuity offers a way to reduce the value of an estate, avoid gift taxes and simultaneously provide a lifetime income stream to the original owner. It is a financial structure that, when executed properly, can be a powerful way to pass wealth intergenerationally and possibly with zero estate taxes. However, it comes with risks and there are some challenges to consider.
Private Annuity Explained
A private annuity is a customized agreement in which an individual transfers an asset—often to a family member or trust—in exchange for a stream of payments for life. Unlike commercial annuities issued by insurance companies, private annuities are structured between private parties and are not backed by institutional guarantees. When properly designed, they can remove appreciating assets from the estate, potentially avoiding gift and estate taxes. However, they require careful actuarial planning and documentation to withstand IRS scrutiny and ensure compliance.[v]
Section 7520 Valuation Tables
Section 7520 of the Internal Revenue Code of 1986, as amended (the “Code”) provides the formula to calculate the value of an annuity, a life interest, a term interest or a remainder interest, widely known as the Section 7520 Rate. This rate is published monthly by the IRS and equals 120% of the mid-term “Applicable Federal Rate,” (the AFR”) rounded to the nearest two-tenths of one percent. For example, the 7520 Rate for August 2025 was 4.8%.[vi]
The IRS mortality tables, currently found in Temporary Treasury Regulation §20.2031-7T, are based on U.S. census data and assume average life expectancies. Because these tables apply a uniform approach, planning opportunities can arise when a client’s actual life expectancy is significantly shorter than the tables suggest—but the client is not considered “terminally ill” under Treasury regulations. For instance, if the tables assume a 20-year life expectancy, but the client is realistically expected to live only two more years, certain strategies can leverage this discrepancy to achieve favorable estate planning results.
Discounting
When funding a private annuity with non-voting stock, valuation discounts can significantly amplify the strategy’s effectiveness. Discounts for lack of control and lack of marketability reduce the reported fair market value of the transferred shares for gift and estate tax purposes. This means the annuity payments are calculated on a lower initial value, while the actual economic potential of the underlying business interest remains intact. As a result, more future appreciation may be moved out of the estate and the annuitant receives income based on a discounted value rather than the full economic value of the shares. This combination of tax efficiency and income security makes discounted non-voting stock a powerful tool in private annuity transactions.
Example: Sam, age 65, was recently diagnosed with cancer and has a two-year projected life expectancy. He owns an LLC worth $10M. The LLC holds a family business, some stocks and bonds, and a real estate portfolio. The LLC is structured with 99% of the units issued as non-voting and the 1% voting unit Sam owns in his revocable trust. Sam enters into a private annuity transaction with his son, Ned, whereby Sam sells his $9.9M non-voting shares, discounted down to $7M, in exchange for an annual payment for life of $489,000. Per the 7520 Tables, Sam’s life expectancy is 20 years. Sam dies two years later after two $489,000 payments are made. The result is that the entire $9.9M asset is transferred without causing estate tax inclusion of a similar amount (as would be the case in the sale of the business in exchange for a promissory note).
Private Annuity Considerations
AFR
At the heart of the private annuity is the AFR – a monthly benchmark set by the IRS that determines how annuity payment streams are valued. More recently, this rate has slowly risen, causing the effectiveness of the strategy to diminish. As this rate rises, the present value of the annuity stream decreases, which makes it seem to the IRS that the annuitant is receiving less in return for the initial asset transfer. [vii]
Life Expectancy
Additionally, life expectancy projections play a large role in how private annuities are designed. Estate planners rely on IRS actuarial tables to determine how long the annuitant is expected to live. With people living longer and medical data becoming more personalized, planners now turn to custom life expectancy assessments to structure their private annuities. These assessments use medical history, lifestyle factors and predictive AI-driven models to create more accurate forecasts. While this helps to tailor annuity payments more precisely, it also subjects users to risk if the IRS believes that the life expectancy used was manipulated to benefit one party in the transaction.[viii]
Private Annuity Risks and Compliance
Despite their strategic advantages, private annuities carry several legal and ethical risks that need to be carefully managed. From a compliance standpoint, the IRS closely monitors these arrangements, specifically when custom life expectancy assessments are used to determine the time span of the annuity. If the annuity deviates too far from standard IRS actuarial tables without proper justification, the IRS will recharacterize the transaction as a partial gift to trigger tax liability.
A legal problem can arise if the annuitant dies shortly after the transaction. In these cases, the IRS can argue that the private annuity was a disguised gift, especially if the life expectancy used for the agreement was overly optimistic. This issue was central in Estate of Kite v. Commissioner, where the IRS challenged the validity of three private annuity agreements. In the Kite case, Virginia Kite sold her interest in the Kite Family Investment Co. to her children in exchange for deferred annuity payments scheduled to begin in 10 years. She passed away about three years later, before receiving any payments, which raised questions about the structure of the transaction. The Tax Court ultimately ruled in favor of the estate, holding that the sale was a bona fide transaction for full and adequate consideration and not a disguised gift. The court allowed the use of IRS actuarial tables for valuation because Mrs. Kite was not considered terminally ill at the time of the transfer. This scenario underscores the importance of using defensible, well-documented assumptions when structuring these transactions.
Strategic Applications in Today’s Market
Private annuities continue to serve as a useful tool for transferring appreciating assets out of an estate while minimizing exposure to gift and estate taxes. By converting these assets into a guaranteed income stream for life, individuals can effectively reduce their taxable estate while retaining long-term financial security.
Specifically, they are useful in family business succession planning, where ownership can be passed to the next generation without triggering gift tax consequences. Senior family members can step back from the operations while still receiving periodic income for retirement. Furthermore, their utility extends well beyond business contexts. Families often utilize private annuities to transfer real estate, investment portfolios and other valuable assets between generations while also preserving wealth and control.
Conclusion
While both private and commercial annuities involve the exchange of assets for an income stream, there are many fundamental differences between the underlying purpose and structure. Commercial annuities are standardized financial products offered by insurance companies, which are primarily designed to provide guaranteed retirement income. Private annuities, on the other hand, are custom-made arrangements often used within families or trusts to facilitate asset transfers and estate tax planning. Since these agreements are not backed by insurers, the risk of overpaying for the asset falls on the obligor.
Furthermore, private annuities offer greater flexibility in terms of structuring but are subject to intensified IRS scrutiny, specifically surrounding the valuation of the asset and assumptions regarding life expectancy. Ultimately, the choice between a private or commercial annuity is dependent on the client’s goals – whether they seek guaranteed income streams or a tool for transferring wealth in a tax-efficient manner.
Victor Levy CFP is a Senior Vice President, Financial Advisor with the Wealth Enhancement Group. Victor provides wealth management and consulting services for a broad range of clients, with a focus on optimizing income and managing risk, while aiming to reduce lifetime taxes. He was recently named a Barron's Top 1,200 Financial Advisor.
Jacob Clatterbuck is a rising senior at Penn State University where he is majoring in finance and is expected to graduate in May of 2026.
[i] See 1818 Act: Pensions for indigent veterans; later extended to widows, 1836 Act: Widows eligible if married before the war’s end, 1878 Act: All widows of soldiers who served at least 14 days received $8 per month.
[iii] https://www.bankrate.com/retirement/annuity-market/#:~:text=Single%20premium%20immediate%20annuities%20in,give%20you%20a%20decent%20rate.