Tax Benefits of Deferred Annuities

[Brian Anderson]

Forbes columnist William Baldwin railed pretty hard on the tax benefits of deferred annuities in his latest piece (link below). He presents some hypotheticals, and concludes "the tax benefit you think you're getting on a deferred annuity may not exist."

Couple of quotes and conclusions from his piece:

"I have some numbers on what this tax deferral is worth. Unpleasant surprise: Annuities can backfire. They can raise your tax bill."

"If a variable annuity is invested in stocks and incurs a typical expense burden, it's bad on a pretax basis and very bad on an aftertax basis."

"If a variable annuity is invested in bonds, has a minute expense ratio and is held for 20 years, then it's a buy. But not much of one."

Variable Annuities -- What's the Tax Deferral Worth? - Forbes

Please check out the article and post here regarding the validity of his arguments.

 

[DHK]

He's talking about NQDA... versus selling annuities to fund qualified plan money. That's what I primarily do - rollover qualified money into annuities for the annuity's other benefits for the preservation and growth of those funds.

I have yet to recommend a NQDA to someone... unless it's part of distributing assets over a period of years - maybe a 72q distribution to fund a PUA rider on a life policy? But yeah, sometimes the capital gains on a brokerage account are better to pay per year... than to continue to defer the taxes into a larger lump-sum to withdraw 1st (LIFO). Of course, that's when you're supposed to sell the Immediate annuity and spread out the taxable income burden over your life expectancy.

I think I'd rather recommend a SPWL instead of a NQDA. Same taxation, and you can increase the death benefit... as long as the client qualifies.

 

[scagnt83]

The first issue I have with the articles numbers are that they include expenses on the VA, but no expenses on the brokerage account. They used 1.5% for the VA, but 0% for a brokerage account holding single stocks.... for a $100k portfolio they would easily pay a manager 1%-2% fees for that portfolio... which totally throws off their calculations showing the portfolio outpacing the VA.

Second, they only calculated capital gains at age 65. Which means they held the same stocks and made no changes at all for 15 years. Anyone who manages money knows how unrealistic that scenario is if they are using a professional manager.

Third, they used an 18% capital gains rate, which only gives a 3% state capital gains tax. Most states use the regular state income tax as the capital gains tax. Here in SC its 8%, so that would put you at 23%, not 18%. NY, CA, and many others are even more.

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I have yet to recommend a NQDA to someone... unless it's part of distributing assets over a period of years - maybe a 72q distribution to fund a PUA rider on a life policy? But yeah, sometimes the capital gains on a brokerage account are better to pay per year... than to continue to defer the taxes into a larger lump-sum to withdraw 1st (LIFO). Of course, that's when you're supposed to sell the Immediate annuity and spread out the taxable income burden over your life expectancy.

I think I'd rather recommend a SPWL instead of a NQDA. Same taxation, and you can increase the death benefit... as long as the client qualifies.

I cant totally agree. The typical brokerage account is full of mutual funds which are taxed each year (unless you pick a tax strategy based fund that focuses on long term gains).

The real advantage of the brokerage account is the step up in basis. But the higher RoR on the VA could easily negate the step-up depending on the time line... but like everything else in this industry there is never one single answer for all situations.

 

[walthamny]

The article misses several points, however, I am happy that the author sees benefits with corporate bonds. Here are some of its misses.

The non qualified annuity is even better with state income taxes. You can be in NY state and you will never pay any state income tax on the deferred annuity earnings and then retire in Florida and you will again pay no state income tax on the earnings as they come out. It does not change the Federal taxation but this is a hidden benefit.

The deferred annuity is probate free, a mutual fund account is not. This may be an issue for some. Sometimes a deferred annuity is useful as it provides liquidity to an estate.

Deferred annuity is mostly protected from creditors in most states, a mutual fund account is not. You can also protect the brokerage account from creditors through this takes time and money. OJ Simpson is a good example of putting his earnings in a variable deferred annuity and his payments are protected from the Goldman's.

If you invest 1 million in a non qualified annuity and the market drops 30%,(ie 2008 crash), you can cash the annuity pay the surrender charge and then deduct 300,000 against ordinary income on your taxes immediately.The same in a mutual fund would result in a 300,000 loss to be deducted 3000 a year for the next 100 years. Losses on non qualified annuities are not limited by the 3000 capital gain loss deduction as long as the whole annuity is surrendered.

You can portfolio allocations inside of a deferred annuity and pay no capital taxes. In a brokerage account any portfolio allocation has to be examined against the potential for short term and long term capital gains taxes. It is hard to quantify this benefit but it will add up over time.

For charitable purposes, if you are young and start investing in a brokerage account , you will pay taxes over the years on earnings and the you can donate the stock and get a full deduction for market value and pay no taxes on the gains. However taxes you paid over the years are just gone. In a non qualified annuity over a long period of time you never pay any taxes and then you get to deduct the full account value.

If you invest with Mutual Company A for 10 years and get pissed at them, sell pay taxes and move to Mutual Company B for 20 years and then sell pay taxes again and move to Mutual Company C. The same situation with deferred annuity would be after 10 years you do a tax free exchange using the 1035 exchange and you wont pay any taxes on the gains, your cost basis would carry over to a new annuity. You can keep doing this as long as the surrender charge period has ended. There are no tax consequences for a 1035 exchange

I dont advise putting all into a deferred annuity but they clearly have their place with pros and cons.