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July 20, 2003 at 08:00 PM
Every time there is a significant change in tax law, the first question those of us in the insurance business ask is ‘what does this mean to annuities?’
The short answer, in the case of recent legislation, is that as significant as it is for our economy, it really isnt particularly significant for annuities. Its important to note that the legislation certainly didnt do anything to help annuities, but it didnt hurt them much either. Heres why.
As it relates to annuities, the relevant parts of the new tax law are the cuts in capital gain tax rates and the cuts in dividend tax rates. For many annuity buyers, this results in tax rates for dividends and capital gains at the 15% level. This is contrasted to annuity distribution tax rates at a level of ordinary income, which now stands at a maximum of 35%. The obvious consequence is to increase the break-even holding time for VAs. This is the time necessary to allow the tax-deferred attributes of annuities to become sufficiently positive to overcome the lower tax rate of a mutual fund. But theres more to it than that; first, lets narrow the argument.
This isnt simply a comparison of all annuities to mutual funds. Fixed annuities arent particularly affected by capital gains or dividend tax rates due to the fact that the alternative to fixed annuities is usually not equity mutual funds. Instead they are normally compared to other relatively safe investments. Its probably worth noting that some bond funds (usually considered pretty safe) may be an alternative to fixed annuities, and that gains attributed to bond funds held longer than a year may have the capital gain advantage. But this is a relatively small issue when viewed in context of all the available fixed annuity alternatives. Next we note that the tax law change is irrelevant as it relates to qualified annuities. In other words, the changes apply to neither qualified plans inside annuities nor outside annuities.
Therefore when you consider that qualified annuities, roughly 40% of the market, and fixed annuities, roughly 50% of the market, according to LIMRA and VARDS, are not substantially impacted by this tax law change, this leaves only 30% of the annuity market to be impacted. Of this 30%, I would expect that the new tax law would influence only about 20% of these potential buyers. Consequently, I believe that the impact of the new tax law on annuities will be less than 10%. Heres why.
