Can a Corporation Own an Annuity? Tax & Accounting Rules

An annuity is a financial contract issued by an insurance company, designed to provide a guaranteed stream of income, often for retirement. It functions as a tool to convert a lump sum or series of payments into regular disbursements over a specified period or for a lifetime. This arrangement helps individuals manage the risk of outliving their savings. While commonly associated with personal financial planning, annuities can also be owned by business entities. This article explores corporate annuity ownership, their applications, and the distinct tax and accounting rules that apply.

Corporate Annuity Ownership

A corporation can own an annuity, acting as the policy owner and holding all contract rights and responsibilities. However, an annuity contract must be based on the life of a natural person, typically an individual associated with the company, such as an owner, executive, or key employee.

This structure differs from individual ownership, where the owner and annuitant are often the same person. Corporations can acquire various types of annuities, including fixed annuities (guaranteed interest rate), variable annuities (value fluctuates with investments), indexed annuities (returns linked to a market index with principal protection), and Multi-Year Guaranteed Annuities (MYGAs) for predictable returns. Unlike individual annuities, corporate-owned annuities generally do not offer tax-deferred growth.

Corporate Annuity Applications

Corporations use annuities for diverse strategic purposes, including employee benefits and liability management. A common application is funding non-qualified deferred compensation (NQDC) plans for executives. The corporation uses an annuity to informally set aside assets for future deferred compensation payouts. The annuity’s cash value growth aims to offset this future liability, though the assets remain subject to the company’s creditors.

Annuities also fund executive benefit plans, such such as Section 162 Executive Bonus Plans. The company provides a bonus to an executive, who then uses it to purchase an annuity. The executive owns the policy and benefits from its tax-deferred growth, while the company often deducts the bonus as a compensation expense, making it an attractive tool for executive retention and reward.

Businesses also employ annuities for structured settlements, particularly in business buyouts or legal liabilities. An annuity can provide periodic payments to a seller or claimant instead of a single lump sum. While non-personal injury structured settlements do not offer tax-exempt income, the recipient typically pays taxes only on the portion received each year, aiding financial planning for both parties.

Annuities are also integrated into broader financial strategies, such as the “corporate insured annuity strategy,” often linked with Corporate-Owned Life Insurance (COLI). This involves using annuity cash flow to pay COLI premiums. The strategy aims to provide a guaranteed income stream while preserving capital and potentially enhancing after-tax returns for the business.

Taxation of Corporate-Owned Annuities

Corporate annuity taxation differs significantly from individual taxation due to Internal Revenue Code (IRC) provisions. A primary distinction is the “non-natural person rule” in IRC Section 72(u). This rule dictates that if an annuity is held by a non-natural person, such as a corporation, tax-deferred growth is lost. Instead, earnings are treated as ordinary income and are taxable annually to the corporation as they accrue, rather than being deferred.

This provision was enacted to prevent businesses from using annuities as tax-sheltered investment vehicles. However, exceptions exist where the non-natural person rule does not apply. For instance, if a trust or other entity holds the annuity merely as an “agent for a natural person,” the annuity may retain its tax-deferred status. This exception applies when the beneficial owner is clearly an individual.

Other exceptions include annuities held under qualified retirement plans (e.g., 401(k)s, IRAs), where tax treatment follows plan rules. Annuities used as qualified funding assets for structured settlements also allow tax deferral. Immediate annuities, which begin payments within one year, are exempt from the annual taxation rule as well.

When distributions are made from a corporate-owned annuity that does not qualify for an exception, payments are treated as ordinary income. For non-qualified annuities, the IRS applies a “last in, first out” (LIFO) rule to withdrawals. This means earnings are withdrawn first and are fully taxable until all accumulated gains are distributed. Only after all earnings have been taxed do original, after-tax contributions become a tax-free return of principal.

Accounting for Corporate Annuities

Corporate-owned annuities are recognized as assets on a company’s financial statements. They are often classified as investments or “cash surrender value” if they have a cash value feature. This asset represents the amount the corporation would receive upon surrendering the contract. Its value fluctuates with the annuity’s performance and contract terms.

Their impact also extends to the income statement. Any increase in the annuity’s cash surrender value or accumulated earnings is recognized as corporate income in the period it occurs. Conversely, premium payments reduce cash balance. The net effect of premiums and value changes can result in an “insurance gain” or “insurance expense,” ensuring financial statements reflect the annuity’s economic substance and performance.