While the middle class is usually cited as the prime beneficiary whenever Congress ratchets up tax reform rhetoric, talk of possibly eliminating the deferral of taxes on income generated from annuities has financial advisors and their middle-class clients on edge.

According to a report released Monday by the Insured Retirement Institute, rumblings derived from the National Commission on Fiscal Responsibility and Reform's December report titled "The Moment of Truth" suggesting that nixing the deferral status on annuity income could help bolster the federal coffers would ultimately result in less saving by middle-class Americans and generate very little capital for the government.

The commission report offered up several ideas to address tax reform, including the elimination of 150 "tax expenditures" which included the protections afforded to insurance products like annuities that more and more Americans are relying on to subsidize their retirement above and beyond social security.

While President Obama's proposed budget released earlier this month did not address any changes to the current tax treatment of annuities, the IRI, financial advisors, broker-dealers, investors and leading economists are concerned that any future efforts to reform tax legislation could put these protections at risk.

"Numerous studies show that tax deferral plays an important role in the decision to invest in an annuity, and that middle class investors would face significant tax impacts should this come to fruition," the report said.

The report contends that 80% of annuity buyers have annual incomes of less than $100,000 a year and nearly two-thirds (66%) earn less than $75,000 a year. Unlike their higher-earning brethren -- who have a bevy of alternative investment products to choose from by virtue of their higher risk tolerance and earnings capacity -- these middle-class investors are the ones who have historically relied on annuities to supplement their retirement income.

"Insured retirement strategies are designed with the goal to help provide guaranteed retirement income for all consumers who seek to ensure a stable and secure financial future," IRI President and CEO Cathy Weatherford said in the report. "Today, the personal responsibility attached to retirement income is at an all-time high. Annuities, and their tax deferred status, are uniquely poised to provide middle class Americans with the retirement peace of mind they seek."

For financial advisors, the prospect of eliminating the deferral of income generated from annuities -- keep in mind it's a deferral, not an elimination of taxes altogether -- will make selling annuities even more difficult proposition. The report found that the deferral of taxes on the inside buildup of annuity contracts was identified as a key selling point by 37% of advisors and a significant reason that 56% of retail investors opted for an annuity in the first place.

Further, the report contends, the removal of tax deferral would force most middle class investors to dip into other personal assets to pay taxes on their annuity income, thereby geometrically reducing their total achievable retirement income.

Less interest in annuities and lower savings, particularly by the onslaught of new and soon-to-be retired Baby Boomers, would put even greater strain on the government to provide medical care and other services to this rapidly growing segment of the American population.
"The removal of the tax deferred status of annuities would not necessarily increase the tax revenue generated by the products, especially among middle income investors," the report concluded. "Yet, it might very well result in reduced use of annuities, and most likely among the population that has come to rely on them the most."

Register or login for access to this item and much more

All Bank Investment Consultant content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access