How much will clients pay in taxes next year? What will they owe five years from now? Financial advisers who are unsure aren't alone. With a fight on tax policy brewing inside the Beltway, uncertainty abounds. But whatever happens, the battle will have broad repercussions for the insured-retirement industry.
As policymakers debate new revenue to close the deficit, negotiate raising the debt ceiling and consider sweeping reforms to the tax code, all the chips and all the cards are on the table, including the tax-deferred status of the inside buildup of annuities and other retirement savings vehicles.
At a time when the burden of saving for retirement — as well as the risks inherent to the task — is falling squarely on the shoulders of individuals, it may seem difficult to believe that any serious tax reform proposal could include reducing or eliminating deferrals. But negotiations in Washington can be thorny, and we can't afford to risk it.
We need to be vigilant and armed with information to protect the incentives that are helping Americans attain financial freedom and peace of mind in retirement. Fortunately, ours is a good story to tell, and the facts are on our side.
Take, for instance, a report from the Insured Retirement Institute and Cogent Research LLC, “The Evolution of the Annuity Industry 2012.”
It found that consumers increasingly consider annuities vital to a retirement strategy. The report also found that 71% of advisers have had a client request to buy an annuity during the past year and that tax deferral is one of the reasons for annuities' increased use in retirement planning.
INCENTIVE TO SAVE
More than half the advisers surveyed identified tax-deferred growth as a very or extremely important factor when evaluating and selecting a variable annuity, and nearly 30% think that deferral will take on added importance during the next five years. Perhaps more important, consumers cited tax-deferred growth as one of the primary reasons to purchase an annuity — just behind guaranteed income and adviser recommendation.
The tax-deferred growth of annuities is intended to provide an incentive to help Americans save for retirement, and no segment has used it more than middle-income consumers. More than three in four middle-income baby boomers place importance on tax deferral when selecting a retirement investment.
Eight in 10 buyers of nonqualified annuity contracts have annual household income of less than $100,000; that includes 64% who earn less than $75,000. The IRI's study on middle-income boomers indicates that about one-quarter would be less likely to save for retirement if deferral were reduced or eliminated.
Although reducing or eliminating this important incentive would diminish retirement savings, a change wouldn't necessarily increase tax revenue. The tax-deferred status of annuity earnings doesn't translate to tax-free earnings.
The federal government collects revenue when distributions are taken from annuities. In fact, tax deferral actually may increase revenue flows over time.
A study by the Congressional Budget Office on the long-term revenue effects of tax deferral concluded that federal revenue rises modestly as a percentage of gross domestic product over the long term as a result of tax-deferred growth.
Overall, reducing or eliminating tax-deferred growth of annuity earnings promises no real benefit. It would serve only to cut a powerful tool that is helping people save for retirement and build their financial security.
IRI research has found that annuity owners have more confidence in their expectations, with nine in 10 baby boomer annuity owners believing that they are doing a good job preparing for retirement. The role of tax deferral in leading many to attain financial security through lifetime income coverage can't be underscored enough.
With many Americans still struggling to recover from the recession, it isn't the time to deprive them of this valuable tool. We must work to protect tax deferral and other incentives that help people secure their financial future.
Cathy Weatherford is president and chief executive of the Insured Retirement Institute.