Why is this Topic Important to Wealth Managers? Today concludes chapter one of our series on “Wealth Management in Today’s Economic Environment”. The series has been designed to address the specific question many wealth managers are currently asking: “what are the best investment, retirement and financial planning tools given the current global financial position?” We have so far explored alternatives from “safe” to “risky” from “traditional” to “emerging” for the purpose of discovering and discussing the most relevant wealth management tools and techniques available today. We have so far enjoyed presenting this discussion and think you will find the information quite valuable. Please note that this series is presented in continuation starting with last week’s entries. That being said each blogticle resumes discussion from the previous day.

The economy has presented a number of issues for individual investors. Retirement savings were exhausted to a great extent in many cases caused by the financial crisis. Others lost large sums of investment capital. This series has explored a number of options available to clients and wealth managers with regards to investing in today’s economy. Today we present one option that many wealth managers are most likely aware of and can take advantage of starting immediately.  As one commentator has noted, “[o]ver the past two years, investors have been taken for a wild ride. Annuities offer a way off the roller coaster.” [1]

We discussed last month the use of annuities as a substitute/addition to traditional government retirement plans. In sum, the financial condition of Social Security is far from great. Projected long-run program costs for Social Security are generally not sustainable under currently scheduled financing. Thus, we explained, the expected shortfall of federal funds available for retirement has presented a compelling reason to provide clients with fixed income retirement products.

Moreover, as we have previously mentioned earlier in the series, the baby boom generation continues to age and the American economy continues to undergo structural change. Two factors will continue to push investors to become more responsible for their personal planning. First, defined benefit plans are becoming obsolete as the retirement plan of choice for employers. Secondly, defined contribution plans likely won’t provide enough for baby boomers to retire comfortably. One study showed the average amount for retirement available in 401(k)s was only around $64,000.[2]

What are some general considerations that should addressed by wealth managers with regards to annuities providing for retirement income to clients?

• Tax characteristics: as almost all wealth managers are aware the investment income from an annuity grows tax free. The return of capital also will not cause a taxable gain.
• Income stream: perhaps the most salient selling point of annuities is that they provide the annuitant with a guaranteed stream of income for life. The key here is to find a company that clients trust will provide safety and security so that they may rely on the company’s ability to continue to make payments.
• Timing: wealth managers and clients should almost always consider retirement age and projections when using annuity products for retirement income purposes.
• Fixed v. Variable: the client should consider the risk and reward functions available in different products. Many companies offer very advanced products these days and most advisors should be able to find something that fits well with overall planning goals.

Finally, indexed products may provide for the best of both worlds. We discussed earlier in the series the potential benefit of following stock indexes with regards to planning in today’s economy. Indexed annuities provide even further benefit to those planning for retirement as the gains in the market can be leveraged into regular payments.

We will continue this series throughout the summer. Please check back for more analysis and information regarding financial planning in today’s economy.

Next week’s blogticles will discuss tax and market issues relating to wealth management.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

Series Author: Benjamin Terner

---

[1] Ben Steverman. Annuities Offer Steady Income, Big Drawbacks. March 15, 2010. http://www.businessweek.com/investor/content/mar2010/pi20100312_316911.htm. Last Accessed 6/8/2011.

[2] AdivosrFX Advisor’s Journal. “Are Annuities Right for Your Clients?” http://advisorfx.com/articles/default.aspx?documentID=816&filename=fc060110-d.htm&action=24. Last Accessed 6/8/2011. Citing, Fidelity Investments Survey Feb. 2010.

Why is this Topic Important to Wealth Managers? This blogticle provides discussion and analysis on the tax treatment of certain annuities. The blogticle provides detailed information for those wealth managers who sell annuities and for those who have clients with or are considering annuities.

In general, earnings and gains on a deferred annuity contract are not subject to tax during the deferral period in the hands of the holder of the contract.[1] When payout commences under a deferred annuity contract, the tax treatment of amounts distributed depends on whether the amount is received as an annuity (generally, as periodic payments under contract terms) or not.

For amounts received as an annuity by an individual, an exclusion ratio is provided for determining the taxable portion of each payment.[2] The portion of each payment that is attributable to recovery of the taxpayer’s investment in the contract is not taxed. The exclusion ratio is determined as of the taxpayer’s annuity starting date. Once the taxpayer has recovered his or her investment in the contract, all further payments are included as ordinary income. If the taxpayer dies before the full investment in the contract is recovered, a deduction is allowed on the final return for the remaining investment in the contract. Generally speaking, section 72 uses the term ‘‘investment in the contract’’ in lieu of the more commonly applicable term ‘‘basis.’’ Amounts not received as an annuity generally are included as ordinary income if received on or after the annuity starting date, and are included in income to the extent allocable to income on the contract if received before the annuity starting date (i.e., as income first).[3]

Moreover, present law provides for the exchange of certain insurance contracts without recognition of gain or loss.[4] No gain or loss is recognized on the exchange of: (1) a life insurance contract for another life insurance contract or for an endowment or annuity contract or for a qualified long-term care insurance contract; or (2) an endowment contract for another endowment contract (that provides for regular payments beginning no later than under the exchanged contract) or for an annuity contract or for a qualified long-term care insurance contract; (3) an annuity contract for an annuity contract or for a qualified long-term care insurance contract; or (4) a qualified long-term care insurance contract for a qualified long-term care insurance contract. The basis of the contract received in the exchange generally is the same as the basis of the contract exchanged.[5]

In interpreting section 1035, case law holds that an exchange of a portion of an annuity contract for another annuity contract qualifies as a tax-free exchange.[6] Treasury guidance provides rules for determining whether a direct transfer of a portion of the cash surrender value of an annuity contract for a second annuity contract qualifies as a section 1035 tax-free exchange. Under the Treasury guidance, either the annuity contract received, or the contract partially exchanged, in the tax-free exchange may be annuitized without jeopardizing the tax-free exchange (or amounts withdrawn from it or received in surrender of it) after the period ending 12 months from the receipt of the premium in the exchange.[7]

Section 2113 of the Small Business Jobs Act of 2010 [8] permits a portion of an annuity, endowment, or life insurance contract to be annuitized while the balance is not annuitized, provided that the annuitization period is for 10 years or more, or is for the lives of one or more individuals.

The provision provides that if any amount is received as an annuity for a period of 10 years or more, or for the lives of one or more individuals, under any portion of an annuity, endowment, or life insurance contract, then that portion of the contract is treated as a separate contract for purposes of section 72.

The investment in the contract is allocated on a pro rata basis between each portion of the contract from which amounts are received as an annuity and the portion of the contract from which amounts are not received as an annuity. This allocation is made for purposes of applying the rules relating to the exclusion ratio, the determination of the investment in the contract, the expected return, the annuity starting date, and amounts not received as an annuity.[9] Generally, a separate annuity starting date is determined with respect to each portion of the contract from which amounts are received as an annuity.

Tomorrow’s blogticle will continue our series on tax law changes related to wealth managers in 2011.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

---

[1] IRC Sec. 72.

[2] RC Sec. 72(b).

[3] IRC Sec. 72(e).

[4] IRC Sec. 1035.

[5] RC Sec. 1031(d).

[6] Conway v. Comm’r, 111 T.C. 350 (1998), acq., 1999–2 C.B. xvi.

[7] See generally, Rev. Proc. 2008–24, 2008–13 I.R.B. 684.

[8] Public Law 111–240.

[9] Secs. 72(b), (c), and (e).

NB: All or parts of this work may have originally appeared under government publication intended for the general public.

A recent Businessweek article highlighting what it calls the “drawbacks” of annuities is the latest in a long line of articles panning the financial products. But do annuities—especially variable annuities—deserve their bad reputation, or are annuities just an easy target of the mainstream media? And, where annuities are the right choice for your clients, how can you counter the negative press to help them make the right investing decision? Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of annuities in Advisor’s Journal, see Women Are Leading Purchasers of Immediate Annuity Customers (CC 10-107), Medicaid Compliant Annuities (CC 10-78), & Indexed Annuities: Still Insurance (CC 10-42).

For in-depth analysis of variable annuities, see Advisor’s Main Library: Section 19.2 A—Amounts Received As An Annuity.

Sales of variable annuities (VA) with guaranteed living benefit (GLB) riders continue to grow exponentially, according to LIMRA’s Variable Annuity Guaranteed Living Benefit Election Tracking Survey. The Survey showed a 78 percent increase in assets of VAs with GLB riders, from $292 billion in the fourth quarter of 2008 to $521 billion in the fourth quarter of 2010.

Advisors are likely to find that the protection offered by GLB elections will remain a popular option until consumers regain confidence in other investing prospects. But with unemployment still around 9%, it could be a while before we reach that turning point. Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of guaranteed living benefit sales in Advisor’s Journal, see More Consumers Buy Guaranteed Living Benefits Riders (CC 10-70)

For in-depth analysis of the topic of the taxation of annuities, see Advisor’s Main Library: A—Amounts Received As An Annuity & B—Amounts NOT Received As Annuities

National Underwriter Offers Tax Advisors Expert Analysis of the Impact of the Recently Passed Tax Relief Act of 2010 on Their Clients

The proprietary analysis is the only practitioners’ guide in Q&A format that answers the most critical questions asked by clients on insurance, estate and gift tax law changes.  National Underwriter’s wealth management experts and report authors, Professor William H. Byrnes, Esq., LL.M, CWM and Robert Bloink, Esq., LL.M., noted, “While most media attention has focused on the Act’s retention of existing tax rates on the highest-earning Americans, tax, insurance and investment advisors are finding that the most important changes, from their perspective, are likely to be found in insurance, estate and gift tax provisions that will drive client decisions on investment strategy and wealth management priorities in 2011 and beyond.”

“This is the only guide available on the market today that gives financial planners and producers issue-specific, time-critical information in Q&A format that addresses their most important technical questions with content that can also be used directly in client presentations,” Prof. Byrnes added.

Why is this Topic Important to Wealth Managers?  This blogticle presents discussion on the recently released New York State Insurance Department’s regulations which state that annuities must be suitable for buyers and that agents and brokers are prohibited from falsely claiming expertise in serving seniors. Wealth managers who are subject to the supervision of the New York Insurance Department should be aware of the increased fiduciary standards of care.

The New York State Insurance Department issued emergency regulations last week aimed at combatting misleading practices in the sales of annuities and life insurance to senior citizens and other consumers. [1]

The two emergency regulations that have been put in place by the New York State Insurance Department: 

• Require that only a suitable annuity, based on a consumer’s financial situation and needs, be recommended to a consumer by an insurer, agent or broker.
• Prohibit insurance agents and brokers from using titles, such as “certified senior advisor”, that suggest they have special expertise on issues regarding seniors when, in fact, they have no such qualifications. [2]

The new regulations were the result of a number of cases where consumers, especially senior citizens, were convinced to buy or replace existing annuities with new annuities that are not in their best interests.

The first regulation is designed to stop the sale of unsuitable or inappropriate annuities such as: 

• Convincing a consumer to switch from one annuity to another when the benefits of the new annuity are more than offset by the high cost of surrendering the existing annuity due to the surrender charges.
• Selling an annuity with a higher investment risk or designed for a longer term investment horizon to an elderly client who is unlikely to live long enough to realize the benefits from the annuity and whose needs would be better served by some other insurance product or investment.

Agents and brokers will now be required to consider the insurance needs and financial objectives of the consumer, based on the facts disclosed by the consumer, when recommending an annuity contract for purchase or replacement.

The regulation also requires that consumers: 

• Be informed of various features of the annuity being sold such as potential surrender periods and charges; the availability of cash value; potential tax implications if the consumer sells, surrenders or annuitizes the contract; death benefits; and various fees which could be charged.
• Benefits from certain features of the annuity being sold, such as tax-deferred growth, annuitizations or death or living benefits.

The second regulation addresses the fact that some agents and brokers use misleading titles, such as “certified elder planning specialist” or a “certified senior advisor” to gain seniors’ confidence in order to sell them insurance products.  This regulation prohibits the use of these misleading titles and fraudulent marketing practices linked to the use of such titles in the solicitation, sale, or purchase of, or advice made in connection with a life insurance policy or annuity contract.

For additional information about fiduciary care see AdvisorFX: SEC Unprepared to Implement the Fiduciary Standard for Broker-Dealers.

Tomorrow’s blogticles will continue to discuss topics relating to insurance and financial planning.   

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

---

 

[1] See generally, New York State Insurance Department News Release. Consumers Buying Annuities, Life Insurance Get More Protection under New State Regulations http://www.ins.state.ny.us/press/2011/p1103081.htm.

Issued/08/2011. Last Accessed 3/14/2011.

[2] Copies of the regulations are available at http://www.ins.state.ny.us/r_emergy/pdf/re187t.pdf and http://www.ins.state.ny.us/r_emergy/pdf/re199t.pdf.