By Margaret Kruse
Broker/dealer and agent use only
The 2003 Jobs and Growth Tax Act improved the tax treatment of certain investments by lowering the tax rates on long-term capital gains (LTCGs) and qualified dividends to 15%, or 5% for people otherwise in the 2 lowest tax brackets. This should be one of the things you consider when deciding whether an annuity works for your client. The change affects variable annuities more than fixed.
The new law.
The new tax law signed in May did not change how annuities are taxed. They are still tax deferred until distribution, and gains are taxed as ordinary income (OI) upon distribution. Ordinary income rates were lowered by the new law, and the highest OI rate is now 35%.
More importantly the new tax law lowered the tax rate on LTCGs and dividends to 15%. This means that an annuity, where gains are taxed as high as 35%, will have to compete against stocks and stock mutual funds which throw off mostly or all 15% gains or dividends. (Short-term capital gains from either the sale of stock or within a mutual fund are still taxed as oredinary income.)
PLEASE NOTE that this provision sunsets on December 31, 2008. Unless the law is extended before then, we’ll revert to the current 20%/10% LTCGs rates, and dividends will once again be taxed as ordinary income.
Variables will be more affected than fixed, because variables contain stock funds. The dividends and long-term capital gains on those funds would be taxed as ordinary income when distributed from the annuity (at 25%, 28%, 33% or 35%), but only 15% if held outside the annuity (again, assuming that distributions took place before the 2008 sunset). Obviously, the higher the client’s tax rate, the more important it is to get capital gain treatment. For example, capital gains treatment saves more for someone in the 35% bracket (20% savings) than someone in the 25% bracket (10% savings).
Fixed annuities are a different story. They are based on bonds, and interest income from bonds is still taxed as ordinary income. So annuities and bond funds are more on a par (although you can get some 15% capital gains from bond funds).
Distributions from IRAs and Qualified Plans will continue to be taxed as ordinary income, regardless of the underlying assets in the account.
This rate difference is one thing you should consider when determining whether non-qualified annuities or stocks and mutual funds are better for your clients. However, variable annuities still have features which may appeal to people regardless of the tax rate difference. These features include:
- Income tax deferral, especially if the client will be in a lower bracket at the time of distribution. In fact, if you hold the annuity for a long enough period of time, the tax deferral itself will produce a bigger after-tax result than annual taxing of gain at the lower 15% rate. The longer your client holds the annuity, the less he misses the 15% capital gains rate.
- Not only are annual gains tax-deferred, but transferring assets inside your annuity will not be a taxable event. Integrity even offers income-tax deferral into the next generation for both IRAs and nonqualified annuities with our Family Wealth Preservation Plan.
- Death benefit on variable annuities. This insurance has proven very valuable to countless families over the last 3 years of the bear market. Families have been able to lock in gains and protect their death benefit from a falling market. Furthermore, Integrity offers an Enhanced Earnings Benefit that pays either 25% or 40% of the gain on premiums, at the time of death. This not only can increase the benefit paid to a family, but also help offset income taxes on the gain at death.
- Guaranteed lifetime income if the client annuitizes the contract.
- Convenience of a whole portfolio under one investment.
- Income deferred through an annuity can keep retirement income low, perhaps helping to keep a lid on how much of your Social Security benefits are subject to income taxes.
- Some states offer creditor and medicaid protection. See your local bankruptcy or elderlaw attorney for information about this.
- As I said, the new 15% rate sunsets December 31, 2008. (Of course, it may be extended by Congress before then.) People who invest long term in stocks and mutual funds may be taking a risk that the 15% rate may go back up.
Apparently, the Jobs and Growth Act was supposed to include annuities in favorable tax treatment, but that was not part of the final legislation. Insurance industry groups have responded to the omission and are still working to improve the taxation of annuities.
This material reflects Integrity Life Insurance Company's understanding of the current federal tax laws and contains information of a general nature. The information provided is not intended to be legal or tax advice. Integrity suggest you or your clients consult a tax advisor or attorney as to the applicability of this material or a specific situation.
For more detail on Integrity Life Annuities please contact your Integrity Life Sales Representative. Products are issued by Integrity Life Insurance Company, Cincinnati, Ohio. Products sold in New York, Vermont and New Hampshire are issued by National Integrity Life Insurance Company, Goshen, NY. All products distributed by Touchstone Securities, Inc. Cincinnati, OH member NASD/SIPC.
Last Updated: 6/30/2003 10:33:00 AM