One of the most powerful estate planning tools available to the modern international financial planning practitioner is the FOREIGN DEFERRED PRIVATE ANNUITY (FFDPA)
An FFDPA is a contract between an individual (the “Annuitant”) and a foreign entity that is neither an insurance company nor in the business of selling annuities (the “Company”).
In an FFDPA, the Annuitant transfers cash or other property to the Company in exchange for the Company’s contractual promise to make payments to the Annuitant for a specific number of years, usually for the remainder of the Annuitant’s life.
Assets may be “Appreciated Property” and the recognition of any taxable gain (capital gains or ordinary income) inherent in the asset may be deferred even though the assets may be “cashed in” and the funds invested elsewhere.
The annuity payments are usually made on a quarterly, semi-annual or annual basis. These payments may be deferred until the Annuitant turns 70, so that the Annuitant can defer paying taxes on the exchange for many year; and then pay them on a pro-rata basis as annuity payments are received over the course of many more years.
The Foreign Company which issued the FFDPA may invest anywhere in the world, including the U.S., and has investment advantages that are not offered to US investors. For example, there are various tax provisions only available to foreign persons that the US has enacted to encourage investment in the US and the use of US banks and savings institutions. As a result, the FFDPA Company may invest tax-free in US stocks and financial accounts. The Company may sell appreciated stocks utilizing an FFDPA with no tax recognition and reinvest the funds back in the US on a private and tax-free basis.
The FFDPA offers a wide range of benefits that no other single business and estate planning device can match. These include the following benefits:
Similar to the taxation of installment sales, an FFDPA permits the Annuitant to defer gain on the sale of any type of property by spreading it ratably over the life expectancy of the Annuitant and, in the case of an FFDPA subject to a term, over a stated term rather than reporting the entire amount of the gain in the year of sale. However, the Tax Reform Act of 1986 made installment sales much more difficult, and in many cases impossible. For example, installment sales are not allowed for certain assets, such as publicly traded stock. In contrast, an FFDPA permits the Annuitant to receive a tax deferral on any appreciated asset, including publicly traded stock. Appreciated assets may be transferred to the Annuity Company and converted into investment funds without payment of any income tax on capital gains or ordinary income.
An FFDPA also allows the removal of the transferred property from the Annuitant’s gross estate without triggering any U.S. gift tax. Therefore, upon the death of the Annuitant, the transferred property as well as any future appreciation in such property will not be included in the decedent’s gross estate. If the annuity is an FFDPA based on a single life as opposed to two lives, the annuity payments are also excluded from the Annuitant’s gross estate for estate tax purposes. With appropriate estate planning, appreciated foreign investments may be passed to heirs without estate tax consequences.
Furthermore, since property that is properly transferred in an FFDPA transaction is no longer considered owned by the Annuitant, the transferred property is beyond the reach of creditors and lawsuit or bankruptcy judgments. As long as the present value of the annuity is equal to the fair market value of the property transferred for the annuity, the transfer will not be overturned under the fraudulent conveyance laws. An IPAC holds property away from U.S. jurisdiction, thus providing automatic Asset Protection against future creditors, ex-spouses, and attack from government agencies.
One of the primary tax benefits of an FFDPA is its ability to defer payment of Capital Gains taxes. For example, the sale of appreciated capital assets normally requires the immediate and full payment of Capital Gains taxes in the year of the sale. If, instead, an individual transfers the capital assets in exchange for an FFDPA, a pro-rata portion of the Capital Gains taxes is paid in each year the annuity payments are actually received by the Annuitant.
Since property in an FFDPA transaction is transferred free of income taxes on capital gains or ordinary income (at least, until the annuity payments are received by the Annuitant), the transferred property can be used to earn greater investment returns. There is no reporting of the interim growth or U.S. tax payable at any time on FFDPA investments. Since taxes may be paid at some time in the future, when and if the Annuity is activated and funds flow back to the U.S., this investing is best called tax-advantaged. Well planned, investments may result in tax-free returns. Foreign investments can grow tax-free and in privacy. An FFDPA may invest anywhere in the world without the oversight of the U.S. Government. In contrast, U.S. Persons are not allowed to invest internationally unless the investment has been approved by the SEC. A high percentage of the most successful mutual fund and bank investments are outside North America and not available to U.S. Persons.
An FFDPA can be structured to operate an international business venture, with indefinite life, and yet the profits are not taxed in the US unless they are “effectively connected” to business activity there.
An FFDPA is extremely useful for an Annuitant who desires the security of a fixed income for life and wants control of the asset or business to remain in the family but does not wish to exercise that control personally. By transferring property to a family member utilizing an FFDPA, the Annuitant is able to shift management of the property to descendants rather than waiting to bequeath it subject to the possible burden of estate taxes. (It is also possible to have annuity payments made to either a trust or an LLC in certain cases, but not to a corporation. However, the tax consequences of such a transfer should be examined prior to making such a decision.)
An FFDPA also allows the Annuitant to remove property from his gross estate without the loss of the unified tax credit.
An FFDPA provides financial security to the Annuitant since the annuity payments are fixed, usually, over the life of the Annuitant. The annuity could be also be structured so that the fixed payments serve as a minimum threshold while allowing for increased profits from the international investments to increase the value of the annuity payments.
In anticipation of a catastrophic illness or escalating medical costs incident to old age, a person may want to transfer property to prospective heirs in order to minimize the amount of shrinkage that will occur in the estate due to medical, hospital or institutional costs. Retaining assets or an outright gift of assets may disqualify that individual for federal or state assistance (I.E., Medicaid, Medi-Cal, etc.). The FFDPA can usually be used to allow a client to exchange these assets while avoiding disqualification for federal or state assistance. Generally, the transferred assets will not be included in the annuitant’s estate for Medicare purposes.
The FFDPA is NOT a loophole! The IRS originally determined that certain transactions would be treated as private annuities in 1969. Since that time, while the IRS has attempted to reduce the opportunities to abuse private annuities it has never suggested eliminating private annuities as a whole. When US tax laws change, they are very rarely made retroactive. So, if there is a law change, most likely, it will not affect pre-existing Foreign Private Annuities. Furthermore, there is nothing in the transaction that should cause an audit flag, but if there is an audit, it should be remembered that the transaction is 100% legal. Lastly, unlike the 401(k) program there are no limitations on the amount of assets transferred to the FFDPA Company in exchange for the Annuity without causing a taxable event. This makes the FOREIGN DEFERRED PRIVATE ANNUITY an excellent choice for establishing, what can be thought of as, a private pension plan or retirement account.
If the FFDPA is issued in conjunction with a legally non-controlled foreign company structure, all of the benefits noted above are not only retained, but are enhanced because the Annuitant will participate in the management of the foreign company structure that acquires the FFDPA and owns the assets. Additionally, the Annuitant will be able to pass his ownership interest and management rights in that structure to his heirs on a virtually tax-free basis. The heirs can choose to continue the structure and enjoy the asset protection, tax reduction, estate planning and investment benefits it provides, OR, after waiting one year, can liquidate it and repatriate the assets as long-term capital gains income.
ONE MAJOR CAVEAT: Since the FFDPA is not secured, you could lose everything invested in it if you deal with the wrong people. Remember, ANYTHING THAT SOUNDS TO GOOD TO BE TRUE, PROBABLY IS JUST THAT…
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