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

Apr 30

Conference

Retirement Income Summit

Join InvestmentNews at the 12th annual Retirement Income Summit - the industry's premier retirement planning conference.Much has changed - and much remains to be learned. Attend and discuss how the future is full of opportunity for ... Learn more

Featured video

Events

What's the first thing advisers should do when they get home from a conference?

After attending a financial services conference, advisers can be overwhelmed by options, choices and tools. What's the first thing they should do when they get back to their office?

Latest news & opinion

Galvin's DOL fiduciary rule enforcement triggers industry plea for court decision

Plaintiffs warned the Fifth Circuit that Massachusetts' move against Scottrade signaled that the partially implemented regulation can raise costs for financial firms.

Social Security underpaid 82% of dually entitled widows and widowers

Agency failed to tell survivors that they could switch to a higher retirement benefit later.

Is Fidelity competing with retirement plan advisers?

As the Boston-based mutual fund giant expands the products and services it brings to the retirement market, some financial advisers say the firm is encroaching on their turf.

Gun violence hits investment strategies, sparks political debates with advisers

Screening out weapons companies has limited downside.

Whistleblower said to collect $30 million in JPMorgan case

The bank did not properly disclose that it was steering asset-management customers into investments that would be profitable for JPMorgan Chase.

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