By Linda Koco
Contributing Editor, AnnuityNews
Thirty-seven percent of all advisors consider tax deferral a key criterion when recommending an annuity to clients, points out a study on the tax advantages of annuities.
This criterion is most prominent (43 percent) in the independent advisor channels, where most annuity sales occur, reports a study from the Insured Retirement Institute.
The 14-page document cites industry research — from IRI as well as other organizations — in support of the argument that tax deferral in annuities is beneficial to investors, especially middle-income consumers, and valued by advisors.
IRI included the study in a request it sent this month to new Congressional Super Committee, asking the bipartisan body to “protect access to retirement savings strategies for the millions of Americans who rely on insured retirement strategies.”
Officially called the Joint Select Committee on Deficit Reduction, the Super Committee is charged with developing a plan to reduce the U.S. budget deficit.
“We do not believe that deficit reduction should be done at the cost of individual retirement savings,” said IRI, adding “we urge committee members to protect savings incentives for all American workers.”
Those incentives include tax deferral in annuities, the trade group indicated.
Concern
IRI and other annuity industry groups and leaders have been concerned that the Super Committee might decide to recommend removing the tax deferral feature from annuities as part it its national debt-reduction plan.
“The tax-deferred nature of annuities is of great significance to both investors and their advisors,” the IRI researchers maintain.
Fifty-six percent of annuity owners responding to an Allianz survey in 2010 said one of the reasons they were satisfied with their annuity is that they consider an annuity to be “an effective way to get tax-deferred growth potential,” the IRI researchers point out. That is the same percentage of owners who told Allianz that supplemental retirement income was also a reason for being satisfied with annuities.
The data on advisor views on tax deferral came from a study by Cerulli Associates. Not only did 37 percent of advisors tell Cerulli that they consider tax deferral when recommending an annuity, 67 percent also said that they consider retirement income (such as annuities can provide) to be a very important criterion when recommending an annuity, the IRI study says.
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Middle-income issue
The tax deferral feature is of greater benefit to middle income Americans than higher income Americans, the IRI study maintains.
To illustrate, the study shows three charts that IRI developed. Each chart shows the internal rate of return for a tax-deferred annuity versus a non-tax-deferred investment for households at three different income levels — for household incomes of $50,000, $75,000 and $200,000, respectively — over three to 20 years.
According to the figures, the cross-over point is longer for investors at the higher income levels. (IRI defines cross-over point as the time at which the post-surrender annuity with tax deferral overtakes the product that is not tax deferred.)
Assuming 5 percent annual interest, the crossover point at the $50,000 and $75,000 levels would be roughly 10 years, the IRI charts show. But the cross-over point for a $200,000 earner is between 10 and 15 years.
Therefore, “while middle-income earners must still hold an annuity for a long period to realize the benefits of tax deferral, the length of time may be more palatable than that required for higher income earners,” the IRI researchers conclude.
The study sums up IRI’s view of the key advantages of tax-deferral in annuities this way:
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· Tax deferral is a key selling point for advisors and investors.
· Removing it would not necessarily increase the tax revenue generated by the products, but it might result in the reduced use of annuities among the population that has come to rely on the products (the middle class).
· Tax deferral correlates favorable with retirement income. Removal of the feature “would require investors to tap other personal assets to pay for taxes on the annual build-up within the annuity, resulting in a lower level of funds available for retirement,” the researchers say.
· The tax-deferred treatment of the inside build-up within an annuity can amount to a significant sum over a period of many years, often resulting in a higher level of savings available at retirement compared to a similar investment that incurs income taxation every year
Why tax deferral is an issue now
The IRI Tax Benefits of Annuities study provides the following background on why tax-deferral in annuities is, or could be, an issue now:
In December 2010, the National Commission on Fiscal Responsibility and Reform (the Fiscal Commission) published a report detailing its proposals to the fiscal challenges facing the United States. The report, The Moment of Truth, cited several ideas to address tax reform, including the elimination of more than 150 “tax expenditures,” generally understood to include the protections afforded to insurance products. In Section 2.1.3, the Fiscal Commission wrote that “Congress and the President must decide which tax expenditures to include in the tax code in smaller and more targeted form than under current law, recognizing that any add-backs will raise rates.” Later in this section, however, it was recommended that there must be provisions for several programs, including retirement savings and pensions.
Although the President’s proposed budget, released Feb. 14, 2011, did not address any changes to the current tax treatment of annuities, this is only the beginning of the tax reform debate. The Moment of Truth document brought the tax treatment of annuity products into the limelight. Several leading economists and tax attorneys have opined that a complete overhaul to the U.S. tax system would put the tax benefits of annuities—particularly the deferral of taxes on the investment earnings (often referred to as inside build-up)—in jeopardy. This is key, as numerous studies show that tax deferral plays an important role in the decision to invest in an annuity, and that middle class investors would face significant tax impacts should this come to fruition.
According to the Insured Retirement Institute’s (IRI) 2010 Annuity Fact Book, 80 percent of annuity buyers in 2009 had household incomes of less than $100,000, and 64% earned less than $75,000.
Linda Koco, MBA, is a contributing editor to AnnuityNews, specializing in life insurance, annuities and income planning. Linda can be reached at linda.koco@innfeedback.com.
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