Variable annuities suffered a blow last month when President Bush’s new tax law, the Jobs and Growth Tax Relief Reconciliation Act of 2003, failed to give dividends paid on stocks held in annuity subaccounts the same favorable treatment afforded to stocks held in mutual funds. The oversight “could prompt investors to shift away from annuities and into after-tax mutual funds or ETFs,” says Dan Foley, a CFP with Principal Financial Group in Steamboat Springs, Colorado.
President Bush was originally seeking to eliminate the double taxation on dividends, but instead ended up reducing the dividends tax rate at 15%. Because of this, “investments both in variable annuities and 401(k) plans that invest in stocks that are paying dividends will still have to pay the taxes at income tax rates, not at the dividend rate,” says Gumer Alvero, executive VP of annuities at American Express Financial Advisors in Minneapolis, Minnesota. So “a large part of consumer assets are still being taxed at income tax rates.” Alvero says the annuity industry also lobbied to include the investments underlying an annuity in the new tax law, but to no avail, since the bill included a sunset provision of 2008. In fact, he says, the sunset provision was the likely reason annuity language was left out of the President’s bill. “If you have a sunset provision in a product that has accumulation in it, you can’t approve it because you can’t sunset a tax benefit on an annuity that [a client is] going to have for a much longer period of time.”
Jack Dolan, a spokesman for the American Council of Life Insurers (ACLI) in Washington, D.C., says the life insurance industry lobbied hard for “Capitol Hill not to harm us” in the new tax law, but the harm has been done nonetheless. “We thought that if individual stocks were going to get a reduced rate on earnings and on dividends received, that it should also be accorded to variable annuities.” Even Maurice “Hank” Greenberg, chairman and CEO of American International Group (AIG), fired off a letter to Treasury Secretary John Snow voicing his disapproval of the new tax law. “…The tax law did not cure the problem for variable annuities, hence the life insurance industry will be at a disadvantage against the mutual fund industry,” he told Snow.
The ACLI and other insurance groups are now lobbying to attach annuity language to any additional tax legislation that comes down the pike this year. “The Administration is talking about a variety of tax-cut bills,” Dolan says. “We know we have support in Congress for annuities.”
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But Alvero says that before annuity language can be attached to pending legislation, the insurance industry has to figure out “how to work through the sunset provision.” He says the last batch of tax law changes (EGTRRA, the Economic Growth and Tax Relief Reconciliation Act of 2001) included sunset provisions, which have made it difficult for consumers to plan for retirement. “Right now, we don’t know if we’re going to have an estate tax or not, we don’t know what our income tax rates are going to be, and we don’t know what our capital gains rates are going to be,” he says.
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One likely Congressional proponent that may come to insurers’ aid is Rep. Ben Cardin (D-MD), a member of the House Ways and Means Committee. Cardin told attendees at the Securities Industry Association and Investment Company Institute joint retirement savings conference in Washington in early June that while it’s too early to get a handle on all of the new tax law’s negative ramifications for annuities, he believes the bill “could have been worse.” He said his committee will be reviewing the law, and hinted that it may play a part in finding some kind of annuity remedy.
But there are some bright spots for annuity owners in the new tax law, says Michael DeGeorge, general counsel for the National Association for Variable Annuities (NAVA). One benefit is that the bill lowers the marginal income tax rates from 38.6% to 35%. “Annuity income is taxed at ordinary income tax rates,” he says. “So owners of annuities who withdraw money from their annuities or annuitize and start receiving lifetime annuity payments will pay taxes on the gains of those annuities at a lower rate now.”
Edward Spehar, a Merrill Lynch analyst, says a good piece of news for annuities arising from the new law is that “variable annuity sales no longer hinge on tax deferral.” DeGeorge begs to differ: “I wouldn’t say that [the tax law] eliminates tax deferral as a factor; tax deferral is still a benefit that annuities and other qualified plans, which likewise are not covered by the tax bill, still offer.” Case in point, he says, is someone who invests in a deferred annuity when they’re 25 and doesn’t withdraw from the annuity for 50 years. “That’s 50 years of tax deferral; even though the advantage of that tax deferral has been lessened by the lowering of the capital gains rate and the tax rate on dividends, that’s still 50 years of complete deferral of taxes.” DeGeorge adds: “I think tax deferral is still a factor. It may just take a little longer before the benefits of the compounding effect of tax deferral will outweigh any additional costs that the annuity may have.”
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