Possible changes in annuity tax deferral threatens middle income Americans
By Cathy Weatherford
Insured Retirement Institute (IRI)
The National Commission on Fiscal Responsibility and Reform recently recommended the elimination of more than 150 so-called tax expenditures, generally understood to include the protections afforded to insurance products. However, the removal of the tax-deferred treatment of annuity earnings would create a significant burden on the population who presently owns the product — middle income earners.
With millions of Americans turning 65 this year, 2011 is poised to represent the “great awakening” in terms of retirement planning and preparedness. Insured Retirement Institute (IRI) research shows that nearly 7 in 10 boomers within five years of retirement, and nearly 8 in 10 boomers outside of that window, stated that they are concerned about having adequate income during retirement. Considering that an average of 7,000 people turn 65 each day in 2011, millions of consumers now, more than ever, will be looking for ways to provide income throughout their retirement.
IRI recently completed an exclusive report on the connection between retirement income and tax deferral, and its implications for annuity contract owners. Our examination of this topic was prompted by a December 2010 report from the National Commission on Fiscal Responsibility and Reform that detailed its proposals to the fiscal challenges facing the United States. Among its recommendations was the elimination of more than 150 so-called tax expenditures, generally understood to include the protections afforded to insurance products.
Among the conclusions of the IRI report, "The Tax Advantages of Annuities: How Tax Deferral and Lifetime Income Strategies Can Benefit All Consumers," was that removal of the tax-deferred treatment of annuity earnings would create a significant burden on the population who presently owns the product — middle income earners.
First, households in the middle class are far more likely to need supplemental income in retirement than their affluent counterparts. Second, contrary to the widely held belief that annuities are products for the wealthy, data shows us that middle income earners comprise the majority of annuity owners. The removal of tax deferral would require annuity owners to tap other sources for the funds to pay the annual taxes, reducing long-term savings in the process, and effectively raising the cost of the annuity creating a disincentive for working class Americans to secure their financial future.
Retirement income and tax deferral
The tax-deferred nature of annuities is of great significance to both investors and their financial advisers. Nonetheless, the key purpose of an annuity is to provide guaranteed retirement income, a function that is held in very high regard by advisers. Research shows that the top three factors impacting the decision to place client assets into an annuity are retirement income, principal protection and tax deferral. And tax deferral is also mentioned by annuity owners among the top reasons they are satisfied with their purchase, citing safety over the long term, providing supplemental retirement income and an effective way to get tax-deferred growth potential. IRI analyzed this data in tandem to assess the impact of tax deferral on the level of retirement income ultimately received by the investor. The amount of reserves required to cover the annual taxes can be staggering — nearly $13,000 in the first 10 years, assuming a 5 percent annual return and 20 percent income tax rate. This represents a significant amount for middle income investors in particular.
Impact on mddle income earners
As indicated earlier, a repeal of the tax deferred protections afforded to Americans who own annuities would result in potentially burdensome restrictions to access insured retirement solutions. This is supported by a number of trends.
First, there is an inverse relationship between investors’ pre-retirement income levels and their ability to pay for basic retirement expenses. According to the Employment Benefit Research Institute (EBRI), more than half of pre-retirees in lower income brackets are unprepared to cover these expenses in full. This is in sharp contrast to the highest income bracket, in which only 20 percent cannot fully cover these expenses.
Fortunately, middle income Americans comprise the majority of annuity owners, showing some personal responsibility to closing this shortfall. Data from the IRI Annuity Fact Book shows that the majority of owners of non-qualified annuity contracts had household incomes between $20,000 and $74,999. Eight of 10 annuity owners have annual household incomes less than $100,000 and the average annual household income is just over $75,000.
Insured retirement strategies are designed with the goal to help provide guaranteed retirement income for all consumers who seek to ensure a stable and secure financial future. It is evident that these products are indeed serving those whom need them most — hard-working, middle class Americans.
Today, the personal responsibility attached to retirement income is at an all-time high. Millions of Americans are looking for ways to provide themselves with the “mailbox money” that will give them a guaranteed paycheck for life. We must continue to identify ways to incentivize retirement savings for all Americans. Now is not the time to consider potentially burdensome restrictions on the ability of those lacking financial security to access insured retirement solutions. Annuities, and their tax deferred status, are uniquely poised to provide middle class Americans with the retirement peace of mind they seek.