Annuities Are Good For Tax-Qualified Retirement Plans
By Norse N. Blazzard and Judith A. Hasenauer
A considerable amount of controversy, and even some litigation, has arisen in the past few years about whether annuities–particularly variable annuities–are appropriate for use in qualified retirement plans.
The plaintiffs lawyers who have brought litigation on this issue have used the justification that placing a VA inside a qualified retirement plan is redundant and unnecessary. Their argument is this effectively results in the placing of a “tax-shelter within a tax-shelter.”
Since the VA has costs associated with it, the reasoning these people use against the inclusion of a VA within a qualified retirement plan is that it is an unnecessary additional cost for the tax-deferral advantages already afforded by the qualified retirement plan.
This reasoning fails to recognize the true purpose of an annuity. This purpose is not to obtain tax deferral. Rather, it is to guarantee income that cannot be outlived. It is an insurance policy–not insurance against dying too soon, but insurance against living too long.
This lack of understanding about the VAs true nature is what gives rise to the confusion about the charges that are incorporated into the product. This is also what has spawned litigation over the use of VAs in qualified plans.
As an interesting historical note, probably the largest block of VAs in existence has been with a form of qualified retirement plan called the tax-sheltered annuity (TSA). This form has been available to employees of public schools since 1962 in accordance with Section 403(b) of the Internal Revenue Code.
The people who question the use of annuities with qualified plans should research the fact that, until 1974, the only product the government permitted to be used with the TSA was an annuity contract issued by a legal reserve life insurance company.
Indeed, until 1968, all VAs issued in this country were issued exclusively to qualified retirement plans. It was not until 1968 that the first VA was issued outside of such a qualified retirement plan. Moreover, it was not until the early 1980s that the use of VAs with nonqualified retirement plans became widely accepted.
In 1974, the Employee Retirement Income Security Act permitted, for the first time, products other than annuity contracts to be used with TSAs. At that time, custodial accounts utilizing mutual funds were also permitted to fund TSAs.
The confusion over the basic nature of a VA has added to the lack of understanding about why the product is appropriate for use with qualified retirement plans.
Many of the popular and financial news media have mischaracterized the elements of a VA. Much of this confusion no doubt relates to some of the ancillary benefits commonly included in VAs.
For instance, the minimum death benefit, which has been part of VAs almost from the beginning, is the most frequently confused product feature.
Originally, the minimum death benefit merely guaranteed a return of principal in the event the contract owner died when his or her contract value was lower than the original premium. As the years passed, insurers began offering enhanced minimum death benefits that had the ability to provide not only return of principal, but also some element of investment gain.