This post was originally published on May 6th, 2024, and updated on June 2nd, 2025.
A private annuity is a legally binding agreement in which an individual transfers property or assets to another party, typically a family member, in exchange for a promise of lifelong payments. Unlike commercial annuities offered by insurance companies, private annuities are personalized arrangements used for estate planning, wealth transfer, or tax-deferral strategies. They function as unsecured promises between private individuals, allowing the annuitant to convert an asset into an income stream while shifting future growth out of their taxable estate.
A private annuity functions as a structured agreement that converts property into an income stream. This section breaks down the components and operational flow of a private annuity.
These two parties define the private nature of the agreement. The obligor is typically not an institution, but rather a family member or trusted individual.
The annuitant transfers an asset, typically real estate, shares in a business, or securities, at its fair market value. An independent appraisal is often conducted to determine value, ensuring the annuity arrangement satisfies IRS requirements.
The annual payments are calculated based on:
This calculation is crucial, as improper valuation could trigger gift tax or result in the IRS reclassifying the transaction as a gift.
Private annuities often allow the annuitant to defer capital gains taxes until each payment is received, effectively spreading tax liability over time. However, under the 2006 IRS ruling (Revenue Ruling 2006-34), this treatment is only available for unsecured private annuities. If the annuity is secured with collateral, the gain must be reported upfront.
Private annuities offer several benefits for individuals seeking financial and estate planning strategies. Each advantage is tied to either tax efficiency or wealth transition.
Because a private annuity is structured as a sale rather than a gift, it avoids triggering gift taxes. This allows the annuitant to transfer a highly appreciated asset to a family member while removing it from their estate. If structured properly, the value of future appreciation is also excluded from the estate, maximizing long-term tax efficiency for both parties.
For unsecured private annuities, capital gains taxes on the transferred asset are deferred and spread out over the payment period. This provides significant relief for those who would otherwise face a large lump-sum tax bill from an outright sale. Tax is recognized proportionally with each annuity payment, allowing for controlled income and better tax planning.
A private annuity is a direct agreement between individuals and does not require an insurer, financial institution, or government agency to act as an intermediary. This provides both parties with flexibility in setting terms, customizing payment schedules, and minimizing administrative costs. It also ensures privacy in financial affairs.
Business owners or real estate investors often use private annuities as part of succession planning. By transferring ownership to a family member while retaining an income stream, they can exit active management while securing retirement funds. This approach also minimizes the disruption often associated with a full business sale or liquidation.
While private annuities offer compelling benefits, they also come with notable risks and drawbacks. Understanding these is crucial for determining suitability.
The annuity payments are typically unsecured, meaning the obligor has no legal obligation to offer collateral. If the obligor experiences financial hardship or simply chooses not to pay, the annuitant has limited legal recourse. This makes trust and careful financial evaluation of the obligor essential before entering into a private annuity agreement.
A private annuity obligates the buyer to make lifetime payments. If the annuitant outlives actuarial expectations, the obligor may pay significantly more than the value of the asset received. This risk can have long-term financial consequences, particularly if the asset is illiquid or has depreciated.
Private annuities must be structured to comply with the Internal Revenue Service (IRS) rules. Mistakes in valuation, payment calculation, or documentation can lead to adverse tax consequences, including gift taxes or denial of capital gains deferral. Legal and tax advisors are crucial in avoiding costly errors and ensuring the proper execution of transactions.
Following Revenue Ruling 2006-34, secured private annuities must recognize all gain at the time of the transfer. This limits the flexibility of using collateral in the arrangement and increases the risk of large, upfront tax obligations. It also eliminates one of the main advantages, deferral, unless the annuity is kept unsecured.
Mary, a 68-year-old property owner, holds a commercial building valued at $2 million. To simplify her estate and provide a steady retirement income, she enters into a private annuity agreement with her son, Alex. Mary transfers full ownership of the building to Alex in exchange for an annual payment of $120,000 for the rest of her life. This payment is based on IRS life expectancy tables and the Section 7520 interest rate.
Since the agreement is unsecured, Mary is allowed to defer recognition of capital gains, instead paying taxes gradually as she receives each payment. Alex now owns and operates the building, fulfilling his financial obligation through annuity payments. This arrangement allows Mary to reduce her taxable estate, retain income during retirement, and avoid upfront tax liability.
Private annuities and SCINs are both tools used in estate and tax planning, but they have structural and tax differences. This section outlines their distinctions.
Any private annuity must be meticulously structured to comply with IRS regulations. Failure to meet legal standards may result in reclassification, immediate tax liability, or penalties.
Use of IRS actuarial tables is necessary for determining accurate payment amounts. Proper documentation should also include:
Given the complex tax implications, it is recommended to work with both an estate planning attorney and a tax advisor. They ensure the annuity qualifies for desired tax treatments and doesn't inadvertently trigger gift or estate taxes.
Not all assets are ideal for private annuities. The asset must hold enough value to support lifelong payments and should ideally appreciate in the hands of the obligor. Common asset types include:
These asset types are chosen not only for their value but also for their potential to generate future returns that support the annuity obligation.
Private annuities are ideal under circumstances where tax deferral, estate reduction, and intergenerational wealth transfer are key goals. They work best when:
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