Are deferred annuities in the federal government's crosshairs?

By Kevin Startt

Startt Planning!


Would a revenue-hungry federal government ever tax annuities? The question is interesting in view of the fact that Washington seems to be following Europe’s appetite for oppressive regulation even before half of 2010’s Dodd-Frank law is even implemented.

If deferred compensation is getting more attention from the federal government, can deferred annuities be far behind? Under proposed Federal Reserve compensation disclosures, banks and securities firms would have to tell investors how much and when employees are paid. Deferred compensation agreements provide a tax deduction when employees actually receive income and are used increasingly throughout the financial services industry to reward key employees at a time when current salaries and bonuses are under scrutiny.

Morgan Stanley employees earning more than $350,000 had all their bonuses deferred, affecting thousands of employees. The financial services industry is one of the few industries using deferred compensation while many industries rely on restricted stock and options, so the ability for the industry to attract top talent may be diminished further. Younger employees will soundly question whether it makes sense to defer income at all, given today’s marginal rates. For older employees and corporations who are taxed at some of the highest rates in the world, it may make more sense under the American Taxpayer Relief Act.

Would a revenue-hungry federal government ever tax annuities? The question is interesting in view of the fact that Washington seems to be following Europe’s appetite for oppressive regulation even before half of 2010’s Dodd-Frank law is even implemented. Recently, Europe proposed a financial tax of .01 percent to subsidize welfarism and punish rogue traders. The U.S. balked, but no retirement income specialist will forget the financial plan tax of the former Governor of Michigan — which was soundly rejected.

Dodd-Frank’s creation, the Department of Insurance, has a new leader who is once again a former investment banker. The independent broker-dealer community, which represents Main Street more than Wall Street, has mixed opinions about the new SEC chairperson who has represented several Wall Street firms. If the feds ever attack McCarran-Ferguson, the linchpin law upon which state regulation of insurance lies, then all bets are off. Many life companies have global interests that extend far beyond the United States, so depending on the eventual fallout from the Greenberg lawsuit in defense of AIG’s action during the financial meltdown , the feds could take steps to further regulate the life insurance industry.
The annuity industry enjoys the favor of the current IRS code, and has since 1958, when the first retail annuity was offered. Other sacred cows that once were safe havens for tax deduction are home mortgages and charitable deductions. Slowly, these two benefits, which are not universally accepted in Europe as tax benefits, have eroded or been taxed. Middle-age executives should say yes to deferred comp under the American Taxpayer Relief Act for the same reason qualified plans, like 401(k)s, make sense. But the picture becomes hazy for younger participants, as the certainty of a 39.6 percent rate becomes cloudier for younger executives and employees. Younger employees may opt for a supplemental plan including fixed indexed universal life because they can control the partially tax-free distribution.

The future for income taxes is great for anyone who has given up smoking because it gives your hand something to do — like shake!

A tax on annuities is not likely, however, as the federal government begins to reap the benefit of more retirees benefiting from the income-for-life model. A more palatable proposal would be to provide a tax deduction for any saver or investor contributing to a non-qualified annuity similar to the tax benefits and treatment received by IRA and 401(k) participants.

With more retirees working until death in America than ever before, the Treasury will have its underwater coffers covered by taxable revenue created by more income taken from annuities, retirement plans and earned income. Why not provide a tax deduction to young people who want to take some risk dollars off the table and provide them with a tax deduction for saving in an annuity?

According to the ICI, the average holding period for a mutual fund is a little over two years, while annuities maintain an average holding period of 11 years. A further tax deduction with some golden handcuffs attached would provide consistency, incentives and persistence for younger people who will actually lose 4 percent of their Social Security contributions when they begin withdrawals in 30-40 years.

According to the Employee Benefit Research Institute, the average 401(k) balance went up 12 percent last year, which participants might mistake for performance. Most of the gains came from increased employee and employer participation, while actual gains were about half the return of the S&P 500, because one-third of the money sat in stable value or money market funds and fee transparency rules had not fully been implemented. It will be interesting — now that employees are moving more money back into the market — to see how this performance changes.