Elderly With VAs Face Many Decisions
Regulatorsincluding the National Association of Securities Dealers, the Securities and Exchange Commission, and several state insurance departmentshave been raising questions about the suitability of selling deferred variable annuities to the elderly or making tax-free exchanges of such products for elderly contract owners.
The concern stems from the belief that elderly consumers have too short a time horizon before death or retirement for the tax savings inherent in a deferred VA to overcome the costs that are also inherent in the product. There also has been much concern about the increasing number of tax-free exchanges of variable annuities among elderly VA owners.
Despite these concerns, little guidance has been given about what existing owners of such VAs need to know in order to make an intelligent decision about whether to keep, surrender, sell or exchange their contracts.
And unfortunately, some regulators have started promoting a “one size fits all” approach to the question of what, if anything, a deferred VA owner should do with the contract.
We do not believe the same solution is appropriate for everyone who owns a deferred VA.
When thinking about whether to keep, surrender, sell or exchange the VA, the policy owner must base the decision on multiple factors that vary from individual to individual. These factors include family longevity history, availability of other resources, liquidity needs, value of the contract in comparison to the tax basis for the contract, and length of time to retirement and family obligations.
Another important factor: How the VA contract features compare to some of the more modern, enhanced benefits now available. Also, elderly VA owners might well consider annuitizing the contract to ensure retirement income they cannot outlive. Many insurers offer many enhancements for annuitizationenhancements not contained in the original contract.
It is surely obvious that federal and state income tax considerations are basic to ownership questions involving deferred variable annuities. Tax reduction was probably an important element in the decision to purchase the deferred VA in the first place. Taking into consideration the long-term tax ramifications of the transaction, tax reduction should remain fundamental to the decision of whether to keep, surrender, sell or exchange a deferred VA.
We have written previously about the choice between surrendering or selling a VA where the current contract value is below the contracts tax basis. As noted, the surrender or sale of such an “underwater” VA could have beneficial outcomes resulting from the potential to deduct the amount of loss on the contract on the federal income tax return. Although many commentators were then of the opinion that a surrender of such an underwater VA would give rise to a deduction for federal income tax purposes, there was no established authority for this. Fortunately, the Internal Revenue Service now has provided such authority.
In IRS Publication 575 (which provides information to taxpayers for preparation of their 2004 federal income tax returns), the IRS states (on page 19) that a taxpayer can claim a loss on the federal income tax return upon receipt of a lump-sum distribution that is less than the contract owners cost basis in the contract. Publication 575 says such loss should be taken as a “miscellaneous deduction” subject to the 2% of adjusted gross income limit applicable to such deductions.