Offshore Investment Journal
2-10-04
Alexander A. Bove, Jr.
In various parts of the world the laws of many jurisdictions provide that the cash value and proceeds of life insurance and annuity contracts issued in such jurisdictions are protected from creditors of the owner of the contract. See, for instance, the laws of a number of U.S. states, including Michigan, Illinois, Florida, and Texas, and the European jurisdictions of Austria, Liechtenstein, and Switzerland. Of all these, however, perhaps the extensive creditor protection provided by Swiss annuities offers the greatest attraction to the average person.
Under Swiss law, life insurance policies (which term is specifically defined under Swiss law to include annuity contracts) that are recognized by the government agency overseeing such products (the Federal Office for Private Insurance Matters) are protected against debt collection procedures brought against the policy owner and will not be part of the policy owner’s bankruptcy estate, even when a foreign judgment or court order expressly directs the seizure of such policy. For instance, if a U.S. or U.K. bankruptcy court found that a Swiss annuity contract owned by the (U.S. or U.K) debtor was a part of the debtor’s estate (for bankruptcy purposes) and issued a finding to that effect, Swiss law with limited exception would nevertheless prohibit a Swiss court from issuing an order for the transfer or liquidation of the Swiss annuity in recognition of the foreign bankruptcy court order.
Furthermore, Swiss law dictates that as to any matters between the owner (whether foreign or domestic) of a Swiss insurance contract and the issuing Swiss company, the law of the domicile of the issuing company, typically, Switzerland, shall apply.
Protection Dependant on Beneficiary Designation
The extensive statutory protection of Swiss annuities from creditors of the owner depends solely upon the designation of beneficiaries of the policy and whether the designation is revocable or irrevocable by the owner. If the designation is revocable, protection will be granted only where the spouse and/or descendants of the owner are named as beneficiaries. In this situation, an individual would enjoy the protection during a creditor’s attack, and if the matter was subsequently settled, he could later revoke the designation and liquidate the policy, if he wished. In the event of a bankruptcy, however, Swiss law provides that ownership of the contract automatically transfers to the protected beneficiaries. Thus, upon a declaration of bankruptcy of the debtor/owner of the Swiss Annuity, the debtor no longer would own the contract by “operation of law”, and any order or instructions from the debtor or on his behalf (including a court order), would be ineffective.
If the owner wants the protection but wishes to name an entity or someone other than a spouse or descendants as beneficiaries (as may be the case with a large policy the proceeds of which would have an impact on the owner’s estate plan), he must make the beneficiary designation irrevocable. A beneficiary designation is made irrevocable by the owner executing and delivering to the insurance company a written waiver of his right to revoke the designation of beneficiary and by a physical delivery of the policy to the beneficiary.
In the event of a foreign attack on a Swiss annuity contract, say, in a bankruptcy proceeding, it would be expected that, among other things, a court would order the owner/annuitant to revoke a previous beneficiary designation and name the trustee in bankruptcy as the beneficiary. If the previous beneficiary designation was irrevocable (as in the case of naming a trust as beneficiary as suggested below), Swiss law precludes the insurance company from complying with the request, under its “anti-duress” provision.
Naming a Trust as Beneficiary
If the beneficiary designation is to be irrevocable, the owner may name his estate planning trust as the beneficiary, with the same creditor protection under Swiss law, and perhaps with additional protection offered by the trust itself. The ability to name a trust as a “third party” beneficiary is particularly important, since one of the concerns many estate planning practitioners have had concerning the use of Swiss annuities was that in the case of large annuities and/or annuities purchased by individuals with large estates, the designation of the spouse and/or children as beneficiaries of the annuity usually would not be consistent with a sound estate plan. Therefore, although the asset protection aspect of the annuity was attractive, the perceived estate planning limitations were a hindrance. It is clear, however, that an “entity” can be named as irrevocable beneficiary of a Swiss annuity, so that on the annuitant’s death the estate planning concerns could be eliminated by naming the individual’s estate planning trust as the irrevocable beneficiary of the annuity contract. In such a case, it would be important that the trust, as beneficiary, was not revocable by the annuitant.
If the individual is concerned about keeping control over the trust, she can name a trust that, although irrevocable, is nevertheless subject to a reserved special power of appointment held by the individual, or to a power held by another but exercisable only with her consent, to avoid unwanted tax results and to retain a substantial degree of control.
Tax Issues
Speaking of tax results, when naming an irrevocable trust as the irrevocable beneficiary of the contract, advisors must be keenly aware of the tax issues associated with this as imposed by the individual’s domicile jurisdiction. For instance, if the individual is a U.S. person and names a trust as the beneficiary of the contract, the income tax deferral on the inside build-up of the contract funds will be lost unless the trust is a “pass-through” trust (a so-called grantor trust) as to the individual. Furthermore, the trust must be drafted so that it continues to be a grantor trust even after the death of the individual.
Fraudulent Conveyance Rules
Virtually every jurisdiction around the world has some form of fraudulent conveyance rules, allowing creditors of an individual to recover transfers made by the individual if such transfers were made with the intention of depriving the creditors of a fair chance to collect their just debts. Of course, the rules vary greatly from one jurisdiction to another, but the underlying universal concepts include 1) a period of time within which the transfer may be attacked, 2) the question of whether the transfer rendered the transferor insolvent, and 3) the intent of the transferor in making the transfer.
For purposes of the creditor protection offered by the Swiss annuity, the protection could be lost if the Swiss fraudulent transfer rules apply, even though an irrevocable, asset protection trust may be the owner/beneficiary. Under Swiss law, if the contract was purchased or the beneficiary designation (in a way to secure protection) was made within a year of bankruptcy or seizure, or within a year of the commencement of an action which eventually led to bankruptcy proceedings, or if the purchase of the contract rendered the individual insolvent, then the contract may be vulnerable to attack, overriding the other protective rules. Note, however, that the creditor’s action to seize the contract must be brought in a Swiss court. Further, the open period is extended to five years if the individual purchased the contract with the clear intent to prejudice creditors. In either case, however, the creditor must prove in a Swiss court not only that the policyholder had the requisite intent but also that the beneficiaries had knowledge of such intent.
Courts’ Attitude
Perhaps there is one more significant benefit worth mentioning. In the recent past, many courts, especially U.S. Courts, have demonstrated a greater and greater cynicism, if not a prejudice, against debtors who place their assets beyond their own control in a foreign asset protection trust. In one recent case, it was observed that U.S. courts “have, recently, cast a discerning eye at the substantiality of offshore spendthrift trusts in order to find the proverbial ‘chink in the armor’.” In light of this attitude it may well be that the purchase of an annuity, which is not nearly as “foreign” or offensive to the courts as offshore trusts, may be regarded as more acceptable by them.
Fixed or Variable Annuity?
Swiss insurance companies, like most, offer annuity contracts that pay a fixed return on cash value or a return based on the investment performance of funds chosen by the contract owner from a list offered by the company. Thus the fixed annuity contains virtually no risk (subject to the financial strength of the issuing company) but also offers very limited growth, while the variable annuity carries with it investment risk but offers the potential for considerable growth.
Further, the advisor must be mindful that the question of fixed or variable annuity may also have tax implications based on the law of the owner’s domicile. For instance, if a U.S. person purchases a foreign annuity that is fixed in its return, she will lose the income tax deferral, since U.S. tax laws treat the contract as an “original issue discount” security and tax the income each year, even though not received. Accordingly in this case, a variable annuity would be the only logical choice.
Summary
A Swiss annuity (or an annuity from another jurisdiction with similar laws) can offer significant asset protection, tax and investment benefits, and when combined with a trust, can offer considerable long-term estate planning benefits, as well. Having a trust as owner/beneficiary of the contract enhances the asset protection features and offers the opportunity to plan for distributions from the annuity (through the trust) to the individual and members of her family both during the individual’s lifetime and long after the individual’s death. In addition, it is far more likely to be accepted by the courts as a reasonable means of protecting investment assets.
Copyright 2004 by Alexander A. Bove, Jr. All rights reserved.