When a Trust Owns a Deferred Annuity: The § 72(u) Rule

The general rule: no deferral for a non-natural owner

The tax deferral that makes a deferred annuity attractive is not unconditional. If an annuity contract is held by a person who is not a natural person — a corporation, a partnership, or a trust — the Code says it is not treated as an annuity contract for income-tax purposes, and the income on the contract for the year is treated as ordinary income received or accrued by the owner (IRC § 72(u)(1)). In plain terms: the inside gain is taxed every year as it accrues, whether or not anything is withdrawn — the contract’s tax deferral is gone. The statute does, however, contain exceptions: the agent-for-a-natural-person exception is in the flush language following § 72(u)(1), the one that matters most for trust planning and the subject of the section below, while § 72(u)(3) lists the statute’s other enumerated exceptions.

The “agent for a natural person” exception

The statute does not stop there. The flush language of § 72(u)(1) carves out a crucial exception: a contract is treated as held by a natural person if it is held by a trust or other entity as an agent for a natural person (IRC § 72(u)(1)). The idea, drawn from the provision’s legislative history, is that what matters is the beneficial owner: if the nominal owner is a trust but the beneficial owner is a living human being, the contract keeps its deferral. The statute does not define “agent for a natural person,” so the working rules come from the trust’s income-tax character and a long line of IRS private letter rulings.

Two clarifications before going further. A private letter ruling is directed to the taxpayer who requested it and may not be cited as precedent by others (IRC § 6110(k)(3)); the rulings below are useful as a consistent statement of the IRS’s reasoning, not as binding authority. And this page is about the income-tax deferral only — it does not address whether the annuity belongs in the trust for estate-planning or protection reasons, which is a separate question.

Grantor trusts: the grantor is usually the tax owner

The cleanest case is a grantor trust. When a trust is a grantor trust — for example a revocable living trust, where the grantor is treated as the owner of the trust’s assets for income-tax purposes under IRC §§ 671–679 — the grantor, a natural person, is ordinarily the tax owner of the annuity. The Code does not supply a universal grantor-trust test, but in private rulings the IRS has treated certain trusts as holding an annuity contract for a natural person when the trust’s beneficial ownership and other facts supported that result (see, e.g., PLR 202031008). Those rulings are fact-specific and may not be cited as precedent under IRC § 6110(k)(3). As a practical matter, a deferred annuity held in a typical revocable grantor trust is among the few beneficiary-designation-style assets that often sits in the trust without a § 72(u) problem — but the conclusion depends on the specific facts, not on the “grantor trust” label alone.

Non-grantor trusts: a fact-specific inquiry

For a non-grantor trust — an irrevocable trust taxed as its own entity — the “agent for a natural person” test does the work, and no single mechanical rule controls. In its private rulings the IRS has looked to whether the trust’s beneficial ownership runs to natural persons, examining the current and remainder interests and the surrounding facts; where the beneficial owners were living individuals, the IRS has treated the trust as holding the annuity as their agent so that deferral survived. Those rulings are fact-specific and may not be cited as precedent under IRC § 6110(k)(3).

A charitable or other non-individual interest deserves particular care, but it does not automatically defeat the natural-person exception. Before concluding that deferral is preserved or lost, identify all current and remainder interests, the trust’s tax status, the contract owner and annuitant, and the facts of any ruling relied on; the IRS has analyzed such arrangements on their specific facts rather than by a bright-line beneficiary count (see, e.g., PLR 202118002).

The statutory exceptions

Section 72(u) also lists contracts the non-natural-person rule does not reach at all (IRC § 72(u)(3)). The rule does not apply to a contract acquired by the estate of a decedent by reason of the decedent’s death; to contracts held under qualified retirement plans, tax-sheltered annuities, and IRAs; to a contract that is a qualified funding asset for a structured settlement; to a contract purchased by an employer on the termination of a qualified plan; or to an immediate annuity. An immediate annuity, for this purpose, is one purchased with a single premium whose annuity payments begin within about a year of purchase (§ 72(u)(4)). These carve-outs matter mostly for retirement-plan and settlement contexts, not for the ordinary case of a family trust holding a deferred annuity.

The through-line: a deferred annuity is a natural fit for an individual owner and an awkward one for a trust. Sometimes the fit is fine and sometimes it quietly destroys the deferral, but neither grantor-trust status nor a count of human beneficiaries is conclusive — the conclusion turns on the trust’s beneficial ownership and the full set of facts. The point of this page is to make the question visible before the transfer, not after. What happens when a trust is named as an annuity’s beneficiary, rather than its owner, is a different rule set, covered on the next page.

Sources & methodology