Can an Irrevocable Trust Own an Annuity? Tax and Estate Rules

Yes, an irrevocable trust can own an annuity. Federal tax law allows it, and most insurance carriers will issue or accept a transfer of a contract to a trust that has the right powers written into it. The harder question is what happens to the tax treatment. Two federal rules do most of the work: transferring an existing annuity into the trust can trigger income tax on the built-in gain in the year of transfer, and once the trust owns the contract, the annuity keeps its tax-deferred growth only if the trust qualifies as an agent for a natural person under Section 72(u) of the Internal Revenue Code.

The Tax Bill Triggered by the Transfer Itself

Before worrying about how the trust will be taxed going forward, look at the transfer. Federal law treats the transfer of an annuity contract without full consideration as a taxable event for the person making the transfer.¹ The transferor reports the difference between the contract’s cash surrender value and the original investment as ordinary income in the year of the transfer. Pay $200,000 for an annuity that has grown to $300,000 and move it into an irrevocable trust, and you owe income tax on the $100,000 of gain that year.

One narrow exception applies: transfers between spouses, or transfers incident to a divorce, are not treated as taxable distributions.¹ Outside that exception, calculate the embedded gain before signing anything. In some situations it makes more sense for the trust to buy a new annuity with a cash contribution than to move an existing contract with substantial appreciation.

The Non-Natural Person Rule and the Agent Exception

Once the trust holds the annuity, the next question is whether the contract still grows tax-deferred. Under Section 72(u), when any entity other than a human being owns an annuity, the contract is no longer treated as an annuity for tax purposes, and its annual growth is taxed as ordinary income each year even if nothing is withdrawn.¹ This is the non-natural person rule, and by itself it would strip a trust-owned annuity of its main tax advantage.

The statute carves out an exception. If the trust holds the contract as an agent for a natural person, the non-natural person rule does not apply and the annuity keeps its deferral.¹ Most family estate planning trusts fit within this exception because they exist solely to benefit individual beneficiaries. The IRS looks at whether the trust functions as a conduit for human beings rather than for a business entity. Name a corporation or partnership as a beneficiary and the exception is likely to fail, exposing every year’s growth to current tax.

Who Pays the Tax: Grantor vs. Non-Grantor Trusts

How annuity income gets reported depends on how the trust is classified. That classification also affects how cleanly the natural-person exception applies.

Grantor Trusts

A grantor trust exists when the person who created the trust retains certain powers or interests, such as the ability to control who receives income or the right to substitute assets of equal value. Federal law then treats the grantor as the owner of the trust’s assets for income tax purposes, and all income, deductions, and credits flow through to the grantor’s personal return.² Because the IRS looks through the trust to a human being, the non-natural person rule is satisfied and the annuity retains its deferral.

A parallel provision treats someone other than the grantor, typically a beneficiary, as the trust’s owner for tax purposes when that person holds a power to withdraw trust assets for their own benefit.³ As long as a natural person is treated as the trust’s owner, the deferral survives.

Non-Grantor Trusts

A non-grantor trust is a separate taxpayer with its own EIN and its own compressed tax brackets. For 2026, the top 37% federal rate hits at just $16,000 of trust income, compared to over $600,000 for an individual filer.⁴ The 3.8% Net Investment Income Tax also applies to trust income above $16,000, and annuity earnings count as net investment income.⁵ A non-grantor trust holding a growing annuity can face a combined federal rate above 40% on income over that threshold.

If a non-grantor trust fails the agent-for-a-natural-person test, the annuity’s growth is taxed annually at those rates even without distributions. Distributing income to beneficiaries shifts the tax to their personal returns, usually at lower rates, but the trustee must file Form 1041 and issue a Schedule K-1 to each recipient.⁶

What Happens When the Annuitant Dies

When the trust owns the annuity, federal law still imposes payout deadlines tied to the primary annuitant’s death. Section 72(s) sets two rules:

If the annuitant dies after payments have started, the remaining interest must be distributed at least as rapidly as the method already in use at death.
If the annuitant dies before the annuity start date, the entire interest must be distributed within five years.¹

The five-year deadline can be avoided if a portion of the annuity is payable to a designated beneficiary, meaning a specific individual rather than an entity, and distributions based on that person’s life expectancy begin within one year of the annuitant’s death.¹ If the designated beneficiary is the annuitant’s surviving spouse, the spouse can step into the holder’s shoes and continue the contract as their own.

For the life-expectancy option to work with a trust as contract holder, the trust document must clearly identify the human beneficiaries who will receive the annuity proceeds, sometimes called a “see-through” provision. If the trust fails to name a qualifying individual, the five-year rule applies by default and a large sum can be forced through a short taxable window.

Gift and Estate Tax Exposure

Moving an annuity into an irrevocable trust is a completed gift for federal gift tax purposes. The transfer is reported on Form 709 and valued at the contract’s fair market value on the date of the transfer.⁷ The first $19,000 per recipient in 2026 is covered by the annual gift tax exclusion, though the exclusion depends on whether the beneficiaries receive a present interest in the gift.⁸ Amounts above the exclusion reduce the donor’s lifetime estate and gift tax exemption, which is $15,000,000 for 2026.

Estate tax is where retained control becomes dangerous. If the annuity is receivable by a beneficiary after the annuitant’s death and the annuitant had the right to receive payments during life, the annuity’s value may be pulled into the annuitant’s gross estate under Section 2039.⁹ Even when the trust technically owns the contract, if the grantor kept any right to income or enjoyment from the trust, or the power to decide who benefits from it, the entire trust value can be pulled back into the grantor’s estate under Section 2036.¹⁰ A grantor who retains too much control defeats the estate tax reason for making the trust irrevocable in the first place.

No Step-Up in Basis for Annuities

Many people assume that annuities held in a trust get a step-up in basis when the annuitant or grantor dies, wiping out the tax on accumulated gains. They do not. Federal law specifically excludes annuities described in Section 72 from the step-up rules that apply to most inherited property.¹¹ Every dollar of gain inside the annuity will eventually be taxed as ordinary income when distributed, whether the original owner or a beneficiary receives it.

The IRS reinforced the broader point in Revenue Ruling 2023-2, holding that assets in an irrevocable grantor trust do not receive a basis adjustment at the grantor’s death when the assets are not included in the grantor’s gross estate.¹² For annuities the answer is the same either way, because the statutory exclusion prevents a step-up even when the contract is included in the estate.

Setting Up the Trust to Hold the Annuity

Two practical requirements decide whether a carrier will actually issue or accept a transfer of a contract to the trust. First, the trust instrument has to authorize the trustee to purchase or hold insurance products. Without that language, beneficiaries can later challenge the investment as outside the trustee’s authority. Second, the trustee needs to provide the insurance company with a Certification of Trust identifying the grantor, current trustees, the trust’s Employer Identification Number, and the trustee’s investment powers. The EIN is obtained by filing Form SS-4 with the IRS.¹³

The insurance company still requires a living annuitant whose life expectancy drives the timing and size of payouts.¹⁴ That is usually the grantor or a primary beneficiary. The trust remains the owner, and its beneficiary designations on the contract, whether the trust itself, named individuals, or a mix, affect both tax treatment and how fast proceeds have to be distributed after the annuitant’s death.

A non-grantor trust receiving annuity income must file Form 1041 each year. For calendar-year trusts, the return is due April 15 of the following year, and the trustee can request an automatic five-and-a-half-month extension on Form 7004.¹⁵ Any income distributed to beneficiaries flows to them on Schedule K-1.

1
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
2
Office of the Law Revision Counsel. 26 USC 671 – Trust Income, Deductions, and Credits Attributable to Grantors and Others as Substantial Owners
3
Office of the Law Revision Counsel. 26 U.S. Code 678 – Person Other Than Grantor Treated as Substantial Owner
4
Internal Revenue Service. 2026 Form 1041-ES – Estimated Income Tax for Estates and Trusts
5
Internal Revenue Service. Topic No. 559, Net Investment Income Tax
6
Internal Revenue Service. About Form 1041, U.S. Income Tax Return for Estates and Trusts
7
Internal Revenue Service. Instructions for Form 709 (2025)
8
Internal Revenue Service. What’s New – Estate and Gift Tax
9
Office of the Law Revision Counsel. 26 U.S. Code 2039 – Annuities
10
Office of the Law Revision Counsel. 26 U.S. Code 2036 – Transfers With Retained Life Estate
11
Office of the Law Revision Counsel. 26 U.S. Code 1014 – Basis of Property Acquired From a Decedent
12
Internal Revenue Service. Internal Revenue Bulletin 2023-16
13
Internal Revenue Service. Instructions for Form SS-4 (12/2025)
14
Internal Revenue Service. Annuities – A Brief Description
15
Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1 (2025)