Beware state premium taxes on annuities

Under-the-radar taxes pose big planning challenges for financial advisers

Jun 18, 2014 @ 12:01 am

By Darla Mercado

Don't be alarmed, but did you know that a handful of states slap premium taxes on carriers for annuities — and that some of that expense is being passed onto clients?

The practice has been ongoing for years, but it's largely been taking place under clients' noses. It's modeled into the quote investors receive.

It's not all that different from the tax nearly all states currently levy on life insurance premiums — and that's been going on since the 1800s, according to Leonard Wright, a certified public accountant and personal finance specialist.

There are currently eight jurisdictions that apply state premium taxes to clients' deposits into annuity contracts: California, Florida, Maine, Nevada, Puerto Rico, South Dakota, West Virginia and Wyoming. The tax applies based on the residence of the buyer.

“Life insurers aren't taxed on net income but on the gross premiums in each state,” said Jim Hall, regional vice president at the American Council of Life Insurers, an industry advocacy group. “The annuity tax works like a premium tax on the gross amount received.”

(Don't miss: New annuities offer exposure to equities and downside protection)

Naturally, life insurance and annuities are priced with the expectation that the state in which the client resides will take its slice of the premium dollars. This way, the company pays the tax and the expense is subsequently deducted from the client.

Rates for non-qualified annuities, according to the ACLI, include: California: 2.35%; Florida: 1%; Maine: 2%; Nevada 3.5%; Puerto Rico: 1%; South Dakota: 1.25%; West Virginia 1% and Wyoming: 1%.

For qualified annuities, California taxes insurers at a 0.5% rate. In Florida, Puerto Rico and West Virginia, they are taxed at 1%. The remaining jurisdictions — Maine, Nevada, South Dakota and Wyoming — do not tax qualified annuities.

In Florida, insurers are exempt from the annuity premium tax if they can show that they've passed the savings onto the policyholders in that state.

The extent to which an insurer passes the expense tied to the premium tax to the client varies from one insurer to another. Some companies pass on the full tax amount to the client.

“It's a matter of competition,” Mr. Hall said. “Some companies may incorporate it more. Others, less so.”

The timing of when the insurer passes on the expense can also vary. Insurance law statutes in California, Nevada and West Virginia permit the carrier to remit the tax to the state either when the client makes the deposit or when the contract is annuitized. In the remaining states, however, the carrier pays the tax on the front end, according to Mr. Hall.

When a company decides to assess the tax expense on the customer is generally up to the carrier, however. “A company may be required to pay the tax on the front end, but they might assess it [to the customer] after annuitization,” Mr. Hall said.

But there are real planning implications for annuity purchasers in the eight jurisdictions. Mr. Wright specializes in the tax as it applies to contracts for residents in California and Nevada. What advisers need to bear in mind is whether the annuity is being held in a qualified account or in a non-qualified account.

The tax impact can be huge. In California, an annuity in a qualified account will be taxed at a rate of 0.50%. But if it's in a non-qualified account, the levy climbs to 2.35%.

“It forces you into a decision: Where should the annuity be held in the first place?” asked Mr. Wright. “Is it in a qualified plan where your distributions are considered ordinary income?”

Another factor to weigh, particularly with clients who may retire outside of states that tack on high levies: Should you hold off on the annuity purchase until you've relocated, since the annuity premium tax is based on residency? “If you want to move to Texas from Nevada, you'll pay less in taxes if you wait a year,” said Mr. Wright.

Regardless of how a client decides to proceed, it's important that advisers ensure that the annuity decision is the right call for the investor in the first place. The application of the annuity premium tax is just one consideration.

“If it is the right decision, don't let the tax tail wag the dog,” Mr. Wright added.

0
Comments

What do you think?

View comments

Recommended for you

Sponsored financial news

Upcoming Event

May 02

Conference

Women Adviser Summit

The InvestmentNews Women Adviser Summit, a one-day workshop now held in four cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Featured video

INTV

Why broker-dealers are on a roll

Deputy editor Bob Hordt and senior columnist Bruce Kelly discuss last year's bounce-back for IBDs.

Latest news & opinion

Top 10 IBDs ranked by revenue

These independent broker dealers generated the most revenues in 2017.

8 podcasts advisers listen to when they aren't working

Listening to podcasts for the fun of it.

UBS continues to cut loans to recruits, while increasing compensation to brokers

The wirehouse reduced recruitment loans 20% and increased bonus loans 68% in the first quarter.

Things are looking up: IBDs soared in 2017

With revenue up, interest rates rising and regulation easing, IBDs are soaring.

SEC advice rule may give RIAs leg up over broker-dealers

Experts say advisers will be able to point to their role as fiduciaries as a differentiator in the advice market.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print