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  • 5 Things to Know About Valuing Annuities and Other Client Assets

    October 16, 2017 by Stephan R. Leimberg, L. Paul Hood, Jr., Jay Katz, Edwin P. Morrow, and Martin M. Shenkman

    Here’s a look, by advanced planning specialists, at valuation planning, a topic of great interest to anyone who wants to start to think about the high-net-worth market.

    “Valuation planning” describes any technique used to affect the valuation of property or business interests for gift, estate, or generation-skipping transfer tax purposes.


    Since the basis for valuation of assets for these purposes is fair market value, which is defined in the regulations as what a willing buyer would pay a willing seller – assuming both had knowledge of the relevant facts, it may be possible to undertake planning moves that can actually reduce the marketable value of the property, and thus reduce federal transfer taxes.

    Valuing property for federal gift, estate, and generation-skipping transfer tax purposes is a complex and often uncertain process. Frequently, the taxpayer’s valuation differs widely from the value established by the Internal Revenue Service. Courts are then asked to resolve the valuation question.

    Value is a variable upon which reasonable minds can and will continue to differ. But value is not determined by a mere flip of the coin. The use of careful and thorough appraisals by qualified experts, documentation of sales of similar property recently sold, and well-drawn arm’s length restrictive agreements (such as a buy-sell arrangement) are effective tools in substantiating favorable values.

    Moreover, an argument for a lower value for estate tax purposes will have a corresponding reduction in the step up in basis and ultimately result in higher income taxes when the property is sold. Valuation discounts are an important factor that must be considered when assets are placed into partnerships and tenancy in common. Eventually, the estate’s personal representative will have to grapple with weighing and comparing the costs and benefits of saving estate or gift tax with the possible cost of higher income tax payable on capital gains — and the impact that decision will have on various parties.

    Here are five ideas that can help ease you into learning more about valuation planning strategies.

    1. The Section 7520 Rate

    Annuities, life estates, reversions, remainders, and terms for years are valued according to a discount rate that changes monthly (the Section 7520 rate). The first step in valuing an annuity based on a life (or on the joint lives of two or more people), a life estate, or a reversion or remainder based on a life (or joint lives) is to convert one of the unknowns (the length of the lifetime involved) to a known (life expectancy). This is done by means of a mortality table, which, based on a study of the longevities of a large number of people over a selected period of time, indicates the expectancy of life (in years) for a hypothetical individual who represents the average experience at each age of life.

    The second step is to determine a proper discount interest rate (the second unknown that should be attributed to the interest being valued). When that interest rate is determined, a valuation table can be constructed which converts the two factors to be applied, life expectancy and the rate of interest, into one factor to be applied to the amount of the periodic payment, to determine the present worth or value of the property interest.

    Valuation must be based on the so called “Section 7520 rate”. This is found with a two-step process. Step one is to compute 120% of the Applicable Federal Midterm Rate in effect for the month in which the valuation date falls. Step two is to round the result to the nearest 0.2%.

    2. Commercial Annuities

    Commercial annuities (annuities under contracts issued by companies regularly engaged in their sale) are valued by reference to the price at which the company issues comparable contracts. A retirement income policy, from the point in time that there is no longer an insurance element, is treated as a contract for the payment of an annuity.


    Where the annuity is noncommercial, such as a private annuity, the present value of future payments determines its fair market value. Likewise, for gift and estate tax purposes, the fair market value of life estates, terms for years, remainders, and reversions is their present value.

    An annuity is defined as a systematic liquidation of principal and interest. Payments might be made for the life of the annuitant (life annuity) or over a period of years (term certain).

    3. Life Estates

    A life estate is a disposition of property in which the primary beneficiary may use the property or receives distributions of only income. Payments might be made for the life of the recipient or could be based on the life of a third party, but the income beneficiary of a life estate receives no right to dissipate the principal. In other words, a life estate is the right of a person for his life, or for the life of another person, to receive the income from or the use of certain property. An example would be, “I give my home to my wife for life.” The wife’s interest would be a life estate. At her death, the property would go to some other party, called a remainder person, or revert to the grantor. The value of the life estate is based on the life tenant’s life expectancy and the appropriate discount rate.

    In the case of a term certain arrangement, the present value of income for a given number of years is found in a like manner.

    4. Remainders

    A remainder (the beneficiary gets the principal after a third party has enjoyed the income for life or for a given period of time) is actuarially equivalent to a reversion. An example of a remainder would be “to my son John, for life, remainder to Mary.” Instead of coming back to the grantor (a reversion), the property “remains” away from the grantor and goes instead to Mary. Mary is said to have a remainder interest. An example of a reversion is where the principal (after a given beneficiary has enjoyed an income for life or for a given period) reverts to the grantor. If the grantor dies before the person enjoying the lifetime interest, his right to “will” that reversion to his heirs, who will someday receive the principal, is valued under the same rules as annuities, remainders, and life estates.

    5. Qualifications

    Two qualifications need to be added to this explanation of the law respecting actuarial valuation of term and life computations: First, these valuation provisions do not apply to interests valued with respect to qualified retirement plans (including tax-sheltered annuities and individual retirement accounts (IRAs)) or in other situations specified in Treasury regulations. Second, if an income, estate, or gift tax charitable contribution is allowable for any part of the property transferred, the taxpayer may elect to use the discount rate for either of the two months preceding the month in which the valuation date falls. However, if a transfer of more than one interest in the same property is made with respect to which the taxpayer could use the same interest rate, that interest rate must be used with respect to each transferred interest.


    The above article was drawn from The Tools & Techniques of Estate Planning, 18th Edition, and originally published by The National Underwriter Company, a Division of ALM Media, LLC, as well as a sister division of ThinkAdvisor. As a professional courtesy to ThinkAdvisor readers, National Underwriter is offering this resource at a 10% discount (automatically applied at checkout). Go there now.

    Originally Posted at ThinkAdvisor on October 16, 2017 by Stephan R. Leimberg, L. Paul Hood, Jr., Jay Katz, Edwin P. Morrow, and Martin M. Shenkman.

    Categories: Industry Articles