Tax-deferral & Irrevocable Trusts – What’s Old is New Again

September 19, 2013

It's funny how sometimes everything old is new again.

Just the other day, I was in the front yard with my oldest son, watching and listening to a 2013 Ford Mustang Shelby GT500 cruise by. I then asked my son if he has ever heard the phrase, "everything old is new again?"

I went on to explain that with the right conditions and a few modifications, great ideas often return to popularity – just like his new interest in playing video games from the mid-80s like Space Invaders and Galaga and how I have a renewed interest in listening to many of my old vinyl records from back in the day.

Having said that, most recently the Advanced Marketing Group has been receiving more and more calls from advisors regarding tax-deferral options for irrevocable trusts. I suspect many trustees of irrevocable trusts might also be experiencing the feeling of "what's old is new again" - unfortunately it's in the form of higher taxes. In the 1980s income tax rates were as high as 70%1, as of 2013 some trusts (as well as high income individuals) may be subject to new taxes as well as higher tax rates. The following chart illustrates some of the taxes for 2013:

Higher Tax Rate in 2013

Income Tax Rates - The American Taxpayer Relief Act of 2012 (ATRA) permanently extended the lower income tax rates for most taxpayers, but created a new top tax rate of 39.6%. Thus, higher-income earners are subject to this new 39.6% rate when taxable income exceeds:

  • Single filers – $400,000
  • Married filing jointly – $450,000
  • Estate & Trusts – $11,950
New Taxes in 2013
Capital Gains & Qualified Dividend Rate - ATRA also extended the capital gains and qualified dividend tax rates of 0% and 15% for most taxpayers, but created a new top rate of 20% for higher-income earners. For trusts, the 20% rate will apply to capital gains and dividends if the trust is in the highest income tax bracket of 39.6%.

3.8% Net Investment Income Tax (NIIT) - The Patient Protection and Affordable Care Act of 2010 (Affordable Care Act) has ushered in a new 3.8% NIIT on net investment income beginning January 1st of 2013. For trusts that exceed the modified adjusted gross income (MAGI) threshold, the 3.8% tax will apply to the lesser of:

  • undistributed net investment income; or
  • excess of trust's MAGI over $11,950.


Tax-deferral option for irrevocable trusts

Depending on the objectives of the irrevocable trust (such as income or growth), certain traditional investments may not be tax efficient. Bonds, stocks, and mutual funds may provide growth opportunities, but can also produce taxable annual income in the form of dividends and interest that can subject the trust to the top income tax rate and/or the new tax on net investment income. If the goal of the trust is to maintain tax-deferral and the trust satisfies the "natural person" (IRC section 72(u)) rule, a deferred annuity may be an attractive option to consider. Tax-deferral can help the trustee manage the higher/new taxes outlined in the table above.

What's old is new again

Just like my old vinyl records being new again, it's nice to see the tax-deferral feature of annuities returning to popularity to help clients consider options in managing taxes.

To learn more about this strategy, the "natural person" rule or contract structuring, please contact the Retirement Strategies Group at (800) 722-2333, extension 3939 or email at

Picture of Gary Pence

Gary is the Home Office Manager of the Retirement Strategies Group in the Retirement Solutions Division at Pacific Life. With over 24 years of experience in the financial industry and for the past 15 years, he has worked with the Retirement Strategies Group dedicated to helping advisors address complex tax, estate, charitable, and retirement planning issues for their clients and their tax and legal professionals.

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