“We’re sleepwalking towards a retirement death,” warned former Congressman Earl Pomeroy at an Insured Retirement Institute (IRI) conference earlier this year. I’ve known the congressman for decades—dating back to our days as insurance commissioners. So when my friend uttered those words, I knew how serious he was.
Pomeroy said it would be outrageous to put into question the tax incentives that are encouraging Americans to save for retirement, at a time when nation is not saving nearly enough. Yet with the so-called fiscal cliff on our doorstep, leaders in Washington are studying tax expenditures, hoping to identify new revenue. With retirement savings ranking among the largest tax expenditures, those same tax incentives are now in jeopardy and the repercussions for the insured retirement industry could be vast.
Among the tax incentives on the table that could be reduced or eliminated: the tax-deferred status of the inside buildup of annuities and other retirement savings vehicles. Given that these incentives are helping Americans attain financial freedom and security during their retirement years, in no uncertain terms, this would be a retirement death.
Demand for lifetime income
According to a new report from IRI and Cogent Research, “The Evolution of the Annuity Industry 2012,” annuities are increasingly considered by consumers to be a vital part of a retirement strategy. Additionally, 71 percent of advisors reported having a client request to purchase an annuity during the past year. There’s no question that consumers are seeking certainty during uncertain times and this has renewed interest and spurred the demand for insured retirement products. But this is only part of the story.
One cannot discount the importance of tax deferral in leading consumers to select an annuity as a source of lifetime income. The same IRI and Cogent report found that tax deferral is among consumers’ top reasons for including annuities within a holistic retirement plan, and more than half of the advisors surveyed identified tax-deferred growth as a very or extremely important factor when evaluating and selecting a variable annuity—with nearly 30 percent of advisors believing that tax deferral will take on added importance during the next five years.
Importance of tax deferral for middle-income Americans
The tax-deferred growth of annuities provides Americans with an important incentive to save for retirement and attain financial security. This incentive has been most utilized and valued by one population segment more than any other: middle-income Americans. IRI’s research shows that annuity owners are overwhelmingly middle income, with eight in 10 buyers of non-qualified annuity contracts having annual household income of less than $100,000. This includes 64 percent who earn less than $75,000.
Tax deferral has been a valued feature in attracting this market segment to annuities. In fact, more than three in four middle-income baby boomers place importance on tax deferral when selecting a retirement investment. And just as tax deferral has helped to lead them to attain retirement security through annuity ownership, a reduction or elimination of this powerful incentive would have the opposite effect—about a quarter of middle-income boomers report that they would be less likely to save for retirement if tax deferral were to be reduced or eliminated.
Tax deferred does not mean tax free
Tax deferral is commonly misunderstood to mean tax free, which is simply not the case. With tax-deferred retirement savings vehicles such as annuities, the buildup of assets inside the account is not subject to taxation until assets are withdrawn. Upon withdrawal, these assets are taxed as ordinary income. And thus, while reducing or eliminating tax deferral would negatively affect retirement savings, cutting this incentive would not necessarily increase federal tax revenue over time. To the contrary, a Congressional Budget Office study determined that tax-deferred retirement savings would moderately increase federal revenues as a percentage of gross domestic product over the long term.
The tax-deferred status of annuities must be protected
Overall, annuity owners are more confident in their retirement expectations, with nine in 10 baby boomer annuity owners believing they are doing a good job preparing for retirement. While the quest for certainty and financial security has led many to consumers to annuities, the importance of tax-deferred growth should not be overlooked.
Many Americans are still struggling to recover from the financial crisis and recent recession. With the responsibility and the risks associated with saving for retirement falling squarely on the shoulders of Americans, now is not the time to cut a tool that is helping consumers to save for a financially secure future. Doing so would be a retirement death. We need to protect tax deferral and the incentives available to Americans to help them attain financial freedom and peace of mind in retirement.
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