Insurance Insight Group (IIG)
New President, new taxes: Where do annuities fit in?
By Chris Conklin
Now that Senator Barack Obama has been elected president, we know that tax changes are on the way. He has made tax changes one of the major platforms of his campaign, and his overall theme is to cut taxes on those earning lower incomes and increase taxes on those earning upper incomes.
What sort of changes should we expect, and how will they affect the attractiveness of annuities?
Tax changes we can expect
Dow Jones Newswire reports that President-elect Obama's plans include:
Impact on the attractiveness of annuities
All of the tax changes mentioned above increase the attractiveness of annuities. Annuities offer tax deferral, which means that annuity owners can control the recognition of income for tax purposes by controlling their annuity withdrawals.
Suppose, for example, that Jim and Cindy Wallace are a retired couple living off of Social Security, pensions and investment income. They get all the cash they need from their Social Security and pensions, and they view their investments as their rainy-day fund, which they hope never to have to use. Thanks to their taxable investment income, which they are merely reinvesting, they are earning more than $50,000 per year.
If Jim and Cindy were to move their investments into an annuity, any income that they do not withdraw would not be taxed in the current year. We already know that their Social Security and pension income is below $50,000 per year, so under President-elect Obama's tax plan, moving their investment money into an annuity would eliminate their income taxes altogether.
Now, let's look at Tom and Lisa Henderson, a working couple who earn $200,000 in wages but also have some investment income. They already maximize the contributions they can make to wage-deferral programs such as 401(k)s. Their investment income, which they also never withdraw and simply reinvest, puts them well above $250,000 in taxable income.
If Tom and Lisa move their investment money into an annuity, they can eliminate the interest and investment earnings on that money from taxation until they choose to withdraw them from the annuity. Doing so would keep them out of the highest income tax brackets, and it would also allow them to continue to deduct their personal exemptions and itemized deductions from their taxable income.
One tax code provision that has favored alternatives to annuities over the last decade is the low capital gains tax rate. Wealthy individuals have often felt it is better to pay a 15-percent capital gains tax rate now than to defer taxes in an annuity. Since Obama plans to increase the capital gains tax rate for wealthy individuals, tax deferral will once again gain some additional appeal for these taxpayers.
The bottom line is that our President Elect's planned tax changes should make annuities more attractive for many middle- and upper-income individuals and families. The tax deferral treatment of annuities can be used by annuity owners to control when they recognize income for tax purposes by simply controlling their withdrawals from their annuities.
The long-run outlook
Regardless of Obama's immediate plans, there remains considerable pressure on the federal government to continue to increase tax revenue over time. The Congressional Budget Office has projected that due to the retirement of the baby boomers, yearly entitlement outlays such as Social Security, Medicare, Medicaid and similar programs will grow to exceed the entire 2008 federal government budget by 2018.
What will this mean for annuities? The same theme applies. When tax rates are high, tax deferral is valuable.
Is it possible for the popularity of annuities as tax-deferral vehicles to become so noticeable that the President and Congress begin to view them as exploiting a loophole in the tax code? That is possible, and as the appetite for new sources of tax revenue becomes more voracious, they could at some point in the future decide to close that loophole. Taking this possibility into account, the arguments for buying an annuity now are even more compelling. Why? A look at history reveals the answer. In the early 1980s, universal life insurance became a very popular product for deferring taxes and, by certain uses, avoiding taxes. By the mid-1980s, the IRS closed the tax-saving opportunity for new contracts going forward. However, contracts entered into before the tax law was changed were grandfathered. To this day, they still enjoy the favorable tax treatment that their owners sought when they made their insurance purchase.
So, as you make recommendations to clients, keep in mind the tax-deferral feature of annuities. It's one of the many reasons to purchase an annuity, but it is gaining extra appeal now that we know the tax code will be changing.
*For further information or to contact this author, please use the forum below.
What sort of changes should we expect, and how will they affect the attractiveness of annuities?
Tax changes we can expect
Dow Jones Newswire reports that President-elect Obama's plans include:
- Exempting seniors earning less than $50,000 from income tax.
- Increase the top two marginal tax rates from their current levels of 33 percent and 35 percent to 36 percent and 39.6 percent, respectively. Based on 2009 income thresholds, that would result in a tax increase on singles making $171,550 or more and married couples making $208,850 or more.
- Taxpayers in those brackets also face increased taxes because President-elect Obama plans to restore phase-outs of personal exemptions and itemized deductions. This means that high-earners would not only face higher tax rates, but they would also lose some or all of their personal exemptions and itemized deductions.
- Obama has also proposed raising the tax rate on capital gains income from 15 percent to 20 percent for single taxpayers making more than $200,000 and for married couples earning more than $250,000 annually.
Impact on the attractiveness of annuities
All of the tax changes mentioned above increase the attractiveness of annuities. Annuities offer tax deferral, which means that annuity owners can control the recognition of income for tax purposes by controlling their annuity withdrawals.
Suppose, for example, that Jim and Cindy Wallace are a retired couple living off of Social Security, pensions and investment income. They get all the cash they need from their Social Security and pensions, and they view their investments as their rainy-day fund, which they hope never to have to use. Thanks to their taxable investment income, which they are merely reinvesting, they are earning more than $50,000 per year.
If Jim and Cindy were to move their investments into an annuity, any income that they do not withdraw would not be taxed in the current year. We already know that their Social Security and pension income is below $50,000 per year, so under President-elect Obama's tax plan, moving their investment money into an annuity would eliminate their income taxes altogether.
Now, let's look at Tom and Lisa Henderson, a working couple who earn $200,000 in wages but also have some investment income. They already maximize the contributions they can make to wage-deferral programs such as 401(k)s. Their investment income, which they also never withdraw and simply reinvest, puts them well above $250,000 in taxable income.
If Tom and Lisa move their investment money into an annuity, they can eliminate the interest and investment earnings on that money from taxation until they choose to withdraw them from the annuity. Doing so would keep them out of the highest income tax brackets, and it would also allow them to continue to deduct their personal exemptions and itemized deductions from their taxable income.
One tax code provision that has favored alternatives to annuities over the last decade is the low capital gains tax rate. Wealthy individuals have often felt it is better to pay a 15-percent capital gains tax rate now than to defer taxes in an annuity. Since Obama plans to increase the capital gains tax rate for wealthy individuals, tax deferral will once again gain some additional appeal for these taxpayers.
The bottom line is that our President Elect's planned tax changes should make annuities more attractive for many middle- and upper-income individuals and families. The tax deferral treatment of annuities can be used by annuity owners to control when they recognize income for tax purposes by simply controlling their withdrawals from their annuities.
The long-run outlook
Regardless of Obama's immediate plans, there remains considerable pressure on the federal government to continue to increase tax revenue over time. The Congressional Budget Office has projected that due to the retirement of the baby boomers, yearly entitlement outlays such as Social Security, Medicare, Medicaid and similar programs will grow to exceed the entire 2008 federal government budget by 2018.
What will this mean for annuities? The same theme applies. When tax rates are high, tax deferral is valuable.
Is it possible for the popularity of annuities as tax-deferral vehicles to become so noticeable that the President and Congress begin to view them as exploiting a loophole in the tax code? That is possible, and as the appetite for new sources of tax revenue becomes more voracious, they could at some point in the future decide to close that loophole. Taking this possibility into account, the arguments for buying an annuity now are even more compelling. Why? A look at history reveals the answer. In the early 1980s, universal life insurance became a very popular product for deferring taxes and, by certain uses, avoiding taxes. By the mid-1980s, the IRS closed the tax-saving opportunity for new contracts going forward. However, contracts entered into before the tax law was changed were grandfathered. To this day, they still enjoy the favorable tax treatment that their owners sought when they made their insurance purchase.
So, as you make recommendations to clients, keep in mind the tax-deferral feature of annuities. It's one of the many reasons to purchase an annuity, but it is gaining extra appeal now that we know the tax code will be changing.
*For further information or to contact this author, please use the forum below.
