Estate Tax Cliff: The Implications For Annuities

January 11, 2013

By Linda Koco

Annuities appear nowhere in the deal to avoid the fiscal cliff, but the legislation does have at least three indirect implications for annuity advisors and clients.

The implications include:

The measure makes federal estate taxes permanent.

The certainty this injects into the estate tax area could help lay the groundwork for teachable moments related to certainty — in the broad financial environment and in discussions of annuities. More on this later.

The measure increases taxes for individuals earning more than $400,000 a year ($450,000 for marrieds filing jointly).

For instance, it sets the top income tax rate for these households at a permanent level of 39.6 percent, up from 35 percent in 2012. For the relatively few advisors who have clients in this very high income category, this may make the tax deferral feature of annuities more attractive, at least during the client’s accumulation years.

However, the measure also sets taxes on capital gains and dividends at 20 percent for these wealthy households. Estate planning expert John Olsen of Olsen Financial Services cautions that this “could make annuities look relatively less attractive because income from an annuity is treated as investment income.” Advisors will need to sort out the pros and cons here along with the other tax law changes.

The measure officially repeals the CLASS (federal long-term care program) that had been included in the Affordable Care Act but also calls for establishment of a 15-member Commission on Long-Term Care.

The new commission will be charged with developing “a comprehensive, coordinated, and high-quality system that ensures the availability of long-term services and supports for individuals in need of such services and supports.”

That could be an opportunity for annuity experts to correspond with the commission on combo products — the annuity and life insurance products that include long-term care benefits. Making such an effort may be worthwhile, especially since the new law states that the commission members shall include, among others, those who represent the interests of “consumers of long-term services and supports and related insurance products, as well as their representatives.”

The certainty aspect

The American Taxpayer Relief Act of 2012 has made federal estate taxes permanent for individuals with estates valued at over $5 million ($10 million for couples).

Permanent means the law is fixed, unless and until Congress enacts new estate tax law. Congress is unlikely to make any changes soon, given everything else that legislators have on their plates and given that there has been a huge outcry from the estate planning ranks about the temporary nature of the preceding legislation.

As readers will recall, the last 12 years saw annual changes in federal estate tax exemptions and rates, accented by a sunset in the law after year 10, a two-year extension after that, another sunset and incessant talk about whether federal estate taxes would even exist in the near future.

The new law brings an end to the yearly flux, sun-setting and so on. A lot of insurance people are relieved about this, even though many would have preferred the permanent exemption amount be set lower, say at $350,000. 

They are relieved because the new permanence means advisors and clients can now develop estate plans with assurance that estate taxes are still in the picture for estates over $5 million.

That is widely viewed as a positive on the life insurance side of the house, because life insurance intersects directly with estate tax planning.

But annuity advisors can benefit too, though in a more indirect fashion. Specifically, they can use the permanent status of the law as a springboard to discuss the importance of certainty with clients, and how annuities are an ideal vehicle for building financial security.

This discussion should find receptive ears. After all, the nation has been awash in economic uncertainty ever since the recession of 2008-2009. You know the drum-roll: “Employers aren’t hiring because of uncertainty.” “Businesses aren’t expanding due to uncertainty.” “Consumers aren’t investing because of uncertainty.”

Advisors across the country have reported that certain customers have avoided or scaled back new annuity purchases due in large part to all the uncertainty.

What’s more, a multitude of surveys have shown that many consumers have played the certainty card for quite some time. For instance, even though variable annuities have a full complement of equity subaccounts in which to invest, the ultra-safe fixed interest accounts inside those products tend to represent 20 percent to 25 percent of total variable annuity assets, according to Frank O’Connor, a VA analyst at Morningstar. The percentage rose even higher, to 28 percent, during the height of the recession in 2009, when securities values swooned and interest rates plunged.

Despite the ever-rising Dow Jones average, this is a bearish environment. In the week ending Jan. 2, for instance, an online survey at the American Association of Individual Investors website reported that investor’s bearish sentiment was up 6 percent from the previous week while bullish sentiment was down 5.7 percent in the same time frame.

Optimism is half-empty also. In mid-December 2012, a Wells Fargo/Gallup survey reported that overall U.S. investor optimism had plummeted to -8 in November, down from +16 in July and +24 in May.

The fact that annuity advisors now have a “permanent” estate tax law to reference won’t douse all that uncertainty. But it will provide the advisor and client with a new reason to discuss how permanence and uncertainty both play a role in decision-making.

That can lead to a look at how annuities — with their liquidity, death benefit, tax deferral and various guarantees — contribute to financial certainty in all types of economies.

The link between annuities and certainty will strenghten in the months ahead, regardless of tax law, expressly because uncertainty hangs in the air like a persistent cloud and because annuities can help.

In a detailed report just issued by Security Benefit Life Insurance Co., for example, researchers point out that uncertainty, in the form of fear of loss, is dominating retirees’ thought processes to the point that focus is shifting from return on investment to return of investment. The solution?  A retirement income solution that includes indexed annuities is a “viable option and one that results in improved outcomes for generating and sustaining retirement income,” writes Milliman, which conducted the study for the carrier.

It is the search for certainty that reports like this address, and that annuity advisors can also address.

A little odd?

Some advisors may think it a little odd, if not unwise, for annuity advisors to use the estate tax law as a door opener to such discussion.

After all, annuity specialists usually focus on accumulation planning and retirement income strategies, and leave the estate planning to life insurance experts and estate planners. And many annuity clients don’t have assets over the $5 million exclusion amount anyway, so they may not take a shine to talking about estate taxes. Some critics will point out that talking about estate tax and certainty holds no water at all if the advisor involved is mostly transaction-oriented and provides little or no ongoing advice.

There is some truth to that criticism. However, for a number of annuity advisors, this will be comfortable leverage to apply. These include advisors who also sell, or make recommendations about, life insurance as well as annuities or who work in tandem with estate planning teams.

Certain clients may find the topic of interest, too, especially high-net-worth individuals who are close to maxing out their $5 million exclusion or who think they might get there in a few years. Such people (and their financial teams) will probably have more interest in life insurance — for liquidity and longevity purposes — but that won’t rule out use of annuities too. Private annuities are an option here.

Some clients may even broach the topic on their own. For instance, people who have already set up estate plans or who are thinking of doing so might do that. Some people are already asking, in casual conversation, if there is anything in the new estate law that will affect them.  And this is only one week after the President signed the law.

If these individuals bring that question to an annuity professional, boom, that’s the teachable moment—on life insurance and annuities and estate tax law, and perhaps other product and services too.

A final consideration: Chances are strong that most annuity professionals have already grown accustomed to discussing estate implications of annuities with clients. During the sales process, for instance, they will have pointed out that the annuity value at time of a policyowner’s death will become part of the estate—unless the contract is already making lifetime income payments that terminate upon the owners’ death.  (There is more to these annuity/estate tax laws, but that at least give the overall flavor.)

A good foundation

Advisors who provide such education will have a good foundation on which to bring up the new estate tax law, the associated issue of certainty, and how annuities help feather the bed for security-seeking investors.

Certainty, like beauty, is probably in the eye of the beholder. But that doesn’t stop people from wanting to behold it anyhow.

Linda Koco, MBA, is a contributing editor to AnnuityNews, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].

© Entire contents copyright 2013 by Inc. All rights reserved. No part of this article may be reprinted without the expressed written consent from



Comment on this article




Featured Offers