Taxes are higher for 2013; customers will notice. Like it or not, most of us avoid thinking about difficult things until or just shortly before a nasty event arrives, even when we know it’s coming. April is here. Advisors, like accountants, should gear up and be ready. Tax angst is upon us!
If you combine state, local and federal tax, people who live in California, even folks who don’t make all that much money, could exceed the 50 percent marginal combined bracket; others could approach 60 percent. Residents of other states will have it bad—compared to past years—but California is probably the tax-sucking king, with New York close behind.
What to Do?
You’re familiar with the new class of investment annuities, yes? I call them trading annuities; they have low fees and no living benefits. These annuities have been discussed in Investment Edge columns. It can be argued that they may in some ways be better investing platforms than brokerage and advisory accounts. For one thing, if you are in to rebalancing, it is a free process with annuity platforms but costly elsewhere. If you rebalance a typical advisory account, there are ticket charges. Brokerage accounts may have ticket charges and commissions. But in the trading annuity—as in all investment annuities—rebalancing is a set-it-and-forget-it process and it’s absolutely done with zero customer or rep charges. And, besides, in brokerage and advisories, there are always taxes to consider.
Though expenses are lower in trading annuities than living benefit annuities, expenses are higher than with a typical direct mutual fund, brokerage or advisory account, however:
In a non-qualified investment annuity, there are no taxes to pay during the accumulation period, so long as no withdrawals are made,
In certain trading annuities (AXA comes to mind), when income is to be turned on, there is a SPIA-like withdrawal benefit that offers an exclusion ratio. This means that for a person who decides to begin income after 10 years—let’s say at 65 or so—that the income is going to be largely nontaxed for a number of years, perhaps 70 percent or more won’t be taxed over a fairly long period of time. Lincoln Financial does it another way, letting one into its annuity with no benefits during accumulation, and then adding its patented I4Life later; it too uses a SPIA-like exclusion ratio.
Let’s reexamine: (1) No tax while an individual accumulates; and (2) Vastly reduced tax for 20 or more years during the income phase. Even if you produced more growth in an account using mutual funds, bonds or dividend-paying stocks, it would be difficult to come anywhere close to the after-tax result and allocation purity (given rebalancing) of the investment annuity, both in accumulation and income phases.
In the high-tax years ahead, trading annuities may become your best friends.
 At some point, of course, the taxman must be paid; when the exclusion ratio has captured all of the cost basis, it ends and all remaining income is taxed, but, by then, the customer may be old enough so that he or she is no longer in the “spend” phase of retirement.