Private Annuity Trusts: Financing your Retirement

A few entries back I wrote about my friend selling her auto mechanic business and how she could use a PAT to sell the business and reap capital gains tax deferral benefits. Not only does she experience tax benefits using a PAT, but she has a stream of passive income to help fund her retirement.

PATs can help with retirement income for anyone, not just business owners or holders of greatly appreciated illiquid assets. In fact, selling stock in a retirement portfolio or exercising stock options in a PAT is a great way to get retirement income while minimizing the capital gains burden and without having to worry about interest or penalties.

PATs work the same way with securities or stock options as they do with business assets. Before the sale, you set up a PAT and place the securities into the trust. The trust sells the securities or exercises the options and begins to pay you an income stream (assuming you haven’t deferred the payments). Part of the income stream is “payment” for the trust’s purchase of the securities (your cost basis in the securities), part of it is capital gain on the sale of the securities, and part of it is income generated by the new assets in the trust. You pay a little tax with each payment, thereby spreading out and alleviating your tax burden. You no longer have control of the stocks, so they are out of your estate for estate tax purposes.

Now, when you talk about stock options and retirement it’s only natural, these days, that you start to think about the usual retirement account options: IRAs and 401Ks and all their various permutations and pensions. This is not what I’m talking about here. These types of accounts, known as qualified accounts, cannot be sold into a PAT without losing their tax-exempt status. While I’m at it, a hedge fund is another type of security holding that cannot be placed in a PAT because of its high tax liabilities.

PATs are for unrestricted investment accounts. PATs are for that mutual fund or index fund you’ve been holding onto ever since they came onto the investment scene. They are for the stock account you inherited from Aunt Sarah last year. PATs are for the stock options you got when you first signed on with your company. If you have an unrestricted securities account sitting around at Charles Schwab or RBC Dane Rauscher or wherever, then a PAT may be for you. Because the account is unrestricted, however, you don’t get any tax breaks when you sell the securities. You would still get the long term capital gains tax federal rate if you’d held the stocks for more than one year.  The only way to reduce the capital gains bite is by selling the stocks through a PAT or a Charitable Remainder Trust (which I’ll explain about in a later post).

Another thing to note here is that you only should place the securities into the PAT when you are ready to sell them. Actually, this is true of any asset you are going to sell through a PAT, but securities make for a good example as to why you should do so. Securities are volatile – they can gain a lot in value or lose a lot of value in a short period of time. If there are two types of assets you do not want to have in a PAT they are assets that are going to appreciate further and assets that are going to lose significant value. The reason being is that if the asset appreciates inside the PAT, the PAT will have to pay capital gains tax and there is no way for the trust to defer the tax. If the asset loses value, the trust will be unable to support the contractual payments to you, which it must make if it is to be considered valid by the I.R.S. If you just set up a PAT and park your securities there for a while, there’s a good chance they will go up or down in value before you sell them, triggering one of those two negative consequences.

If you have any questions about placing your security accounts into a PAT, feel free to contact me at 760-917-0858 to set up a no-cost initial consultation.

Paula Straub
Save Gains Tax


This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are meant for informational use only. The information contained on this site does not constitute advice on tax or legal issues. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.

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