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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.

The impact. 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:
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: 9/23/2012 10:05:00 PM