Just two weeks after Standard and Poor’s (S&P) downgraded the U.S. government’s credit rating to AA+, the New York Times reported that the Justice Department is investigating S&P’s ratings of mortgage securities in the lead up to the recent mortgage crisis.

Despite the timing of the news, we know that the investigation isn’t retribution for the downgrade since the investigation precedes the downgrade by months. But the rating agency’s downgrade of US treasuries certainly didn’t help its case, and is construed by many as an effort at establishing S&P independence.

The investigation began with the Securities and Exchange Commission (SEC) looking into whether S&P and Moody’s Investors Service turned a blind eye to problems with sub-prime mortgage bonds that it rated prior to the recent financial crisis. The Justice Department joined the SEC’s investigation in recent months.

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 the debt crisis and U.S. downgrade in Advisor’s Journal, see What Does the U.S. Downgrade Mean for Clients? (CC 11-159), Debt Limit Deal Leaves Unfinished Business (CC 11-154), & Democrats Call Debt Limit Unconstitutional (CC 11-134).

The rich are protected like “spotted owls” and other “endangered species,” wrote Warren Buffett in a recent New York Times op-ed piece. And despite Republican assurances that they will not approve any tax increases, they may be inevitable.

Buffett says that his effective tax rate is far lower than anyone else’s in his office. Citing the sacrifice of the poor and middle class who fight for the US in Afghanistan and who are struggling during the halting post-recession recovery, Buffett says that Washington spared him and his billionaire friends when it called for “shared sacrifice” in the recent debt limit discussion.

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 reverse mortgages in Advisor’s Journal, see Report Slams Reverse Mortgages (CC 10-121).

Why is This Topic Important to Wealth Managers? Our discussion today is focused on Annuities. There has been a lot of talk recently in the major media about the use of Annuities to meet certain financial planning objectives. We thus continue this discussion which focuses on how wealth managers can take advantage of the situation.

Earlier this week, Advisor’s Journal presented an article discussing a recent Securities Litigation & Consulting Group white paper which captures the sentiments of the anti-annuity press, commenting that, “[a]nnuities stand out as the investment most likely to be unsuitable since in virtually every instance, the investor would have been better served by mutual fund or a portfolio of individual stocks.” See AMAFX: Annuities: They Get No Respect. [1] But the bad press may be unwarranted.

National Underwriter reports variable annuities in 2010 were bullish by virtually all measures. 2010 new sales totaled $136.6 billion, an increase of 10.3% over 2009 sales of $123.9 billion. [2]

New sales surged in the 4th quarter of 2010, reaching $37.1 billion which represents a two-year quarterly high and posting a 17.4% increase over 4th quarter 2009 new sales of $31.6 billion.

Furthermore, year-end assets under management reached a milestone of just over $1.50 trillion, an 11.2% increase over year-end 2009 assets of $1.35 trillion and the highest recorded in almost 20 years of variable annuity asset tracking. This also represents a return to pre-financial crisis asset levels as the previous high water mark of $1.49 trillion was reached in the third quarter of 2007.

Not since 2006 has the change in year-over-year net flow been more positive than the change in sales, and at 15.7% the ratio of net flow to new sales was the highest since 2007; both measures point to improvement in terms of new money vs. exchange fueled sales.

Advisor’s Journal also reported earlier this year that 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. See Advanced Markets Advisor FX: Guaranteed Living Benefit Riders Breathe Life into Variable Annuity Sales [3]

As Sterling noted earlier this week, the case studies too represent a positive outlook. He cites to an article by Professor Richard H. Thaler, a University of Chicago professor, which explores one example showing the value through stability and security to the average individual planning for retirement. [4]

The Professor asks readers to assess the financial challenges of identical twins approaching retirement. One twin has a pension that will pay him $4,000 a month for the rest of his life. In contrast, his brother will sustain his retirement income by withdrawals from self-directed accounts. Financial projections confirm this brother has enough assets to fund his retirement through age eighty-five—an age he has a 30 percent chance of reaching. This assumes financial conditions based on historical averages; hardly a fair representation of events during the past decade.

Professor Thaler surmises that, when given the choice between the two retirement options, “nearly everyone” would prefer the guaranteed pension to the uncertainty of self-managed investments.  In sum, according to the Professor, annuities purchasers generally end up with more post-retirement income than their peers.

Tomorrow’s blogticle will present discussion on issues surrounding the wealth management practice.

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

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[1] Citing Craig McCann  & Kaye Thomas. Securities Litigation and Consulting Group. Annuities. http://www.slcg.com/pdf/workingpapers/Annuities.pdf. Last Accessed 6/20/2011.

[2] Frank O’Connor A Year to Remember. National Underwriter Life & Health. April 4, 2011. http://www.lifeandhealthinsurancenews.com/Issues/2011/April-4th-2011/Pages/A-Year-to-Remember.aspx?page=2. Last Accessed 6/20/2011.

[3] Citing LIMRA. Assets of Variable Annuity with Guaranteed Living Benefit Riders Improve By Almost 80 Percent in Two Years, LIMRA Reports. March 8, 2011. http://www.limra.com/newscenter/NewsArchive/ArchiveDetails.aspx?prid=170. Last Accessed 6/20/2011.

[4] Citing Richard H. Thaler. The Annuity Puzzle. New York Times. June 4, 2011. http://www.nytimes.com/2011/06/05/business/economy/05view.html?_r=2&adxnnl=1&emc=eta1&adxnnlx=1307963257-8N4qBWZGH3BH8+ydWXq9TQ. Last Accessed 6/20/2011.

Why is this Topic Important to Wealth Managers? This blogticle provides an overview of a recently rule promulgation as part of the Affordable Care Act. Wealth managers providing health insurance should generally be aware of the current regulations as they apply to client planning.

Yesterday, the Department of Health and Human Services (HHS), working in partnership with the States, issued a final regulation which is designed to scrutinize large health insurance premium increases, and to provide consumers with access to clear information about those increases.

Under the final regulation:

• Starting September 1, 2011, insurers seeking rate increases of 10 percent or more for non-grandfathered plans in the individual and small group markets are required to publicly disclose the proposed increases and the justification for them. Such increases will be reviewed by either State or Federal experts to determine whether they are unreasonable.

• An easy-to-access, consumer-friendly disclosure form explaining the proposed increases will also be made publicly available through HHS, State and/or insurer websites.

• Starting September 1, 2012, the 10-percent threshold will be replaced with a State-specific threshold, using data that reflect insurance and health care cost trends particular to that State. The final rule clarifies that HHS will work with States in developing these thresholds.

• States with effective rate review systems will conduct the reviews, but if a State lacks the resources or authority to conduct actuarial reviews, HHS would conduct them. HHS expects that the vast majority of States will conduct these reviews, and will make this determination by July 1. HHS will continue to make resources available to States to strengthen their rate review processes.

Publication of the final rule under the Act was prompted in part since the rise in health insurance premium over the last decade. Since 1999, the cost of coverage for a family of four has climbed 131 percent. [1] Moreover the rule comes as health insurance companies have reported some of their highest profits in years.[2]

The regulation issued today finalizes proposed rules issued in December 2010. The final rule has several additions to the proposed rule, including a requirement that states provide an opportunity for public input in the evaluation of rate increases subject to review.

The Affordable Care Act brings an unprecedented level of scrutiny to health insurance rate increases. The new rate review regulation works in conjunction with earlier rules requiring insurers to spend at least 80 percent of premium dollars on direct medical care or work to improve the quality of care for patients or provide a rebate to their enrollees. The “medical loss ratio” regulation was released on November 22, 2010. The medical loss ratio regulation is designed to ensure that premiums are being spent on health care and quality-related costs, not excessive administrative costs and executive salaries.

The New York Times reports that since “Federal officials acknowledged that they did not have the authority to block rates that were found to be unjustified” the feds provided other support in the form of $250 million. The Times reports that a few states have turned downed the funding because they are generally opposed to the federal health care law.[3]. HHS has already awarded $44 million in Affordable Care Act in connection with state oversight capability funding.

Next week’s blogticle will present discussion on topics related to planning with life insurance.

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

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[1] The Kaiser Family Foundation and Health Research Educational Trust. “Employer Health Benefits 2010 Annual Survey”. http://ehbs.kff.org/pdf/2010/8085.pdf. Last Accessed 5/19/2011.

[2] See generally New York Times, “Health Insurers Making Record Profits as Many Postpone Care.” May 13, 2011.http://www.nytimes.com/2011/05/14/business/14health.html.  “The nation’s major health insurers are barreling into a third year of record profits…”

[3] Robert Pear. “Insurers Told to Justify Rate Increases Over 10 Percent.” New York Times. Published: May 19, 2011. http://www.nytimes.com/2011/05/20/us/politics/20health.html. Last Accessed May 19, 2011.

Why is this Topic Important to Wealth Managers? Presents discussion on Federal corporate income tax reform as noted in the President’s State of the Union address.  Provides an overview of the current corporate tax situation from a macroeconomic level. 

President Obama recently targeted corporate tax rates in his State of the Union address.  “It makes no sense, and it has to change”. “Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years — without adding to our deficit. It can be done.”

Here’s why some politicians in Washington are calling for reform:

Although America has one of the highest maximum corporate tax rates throughout industrialized nations, many large corporations pay only a fraction of the maximum rate.  In a study by a New York University Professor, the data shows that a great number of public companies are paying around half, or even less, than the maximum corporate rate. 

Below is a chart adapted from the study showing just how low the effective tax rates are for some major corporations (information compiled from over 7000 publicly traded companies): [1]

Industry                                    No of Companies         Effective Federal Rate

 

Electric Utilities                         24                                 33.8%

Retail Automotive                       15                                 32.7

Trucking                                    33                                 30.9

Railroad                                    15                                 27.4

Tobacco                                    12                                 26

Securities brokerage                  30                                 20.5

Banking                                    481                               17.5

Petroleum producing                  198                               11.3

Medical supplies                        264                               11.2

Computer software/services        333                               10.1

Internet                                     239                               5.9

Drug                                         337                               5.6

Biotechnology                            121                               4.5

Further evidence of low corporate taxes actually paid is shown rates paid by companies compiling the Standard & Poor’s 500 stock index.  Of the 500 companies, “115 paid a total corporate tax rate — both federal and otherwise — of less than 20 percent over the last five years”, according to an analysis by The New York Times. [2]   “Thirty-nine of those companies paid a rate less than 10 percent.”   

The Times also recently spotlighted Carnival Cruises as paying a mere 1.1% total tax over the last five years on $11.3 billion in profits. [3]   The Publication cites other low tax paying corporations including, Boeing which paid a total tax rate of just 4.5 percent over the last 5 years;  Southwest Airlines paid 6.3 percent; Yahoo 7 percent; Prudential Financial, 7.6 percent; General Electric, 14.3 percent. [4]

Some tax professionals attribute the significant tax breaks to companies who have operations offshore in low tax jurisdictions or make heavy tax deductible expenditures.  Other companies however, “simply seems to have become expert at avoiding taxes.”   

The Times notes, “G.E. is so good at avoiding taxes that some people consider its tax department to be the best in the world, even better than any law firm’s”. [5]

Tomorrow’s blogticle will continue our discussion on additional changes and hot topics in 2011. 

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

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[1] Professor Aswath Damodaran. NYU.  http://www.nytimes.com/imagepages/2011/01/28/us/politics/28tax-graphic.html?ref=politics. 

[2]David Leonhardt.  The Paradox of Corporate Taxes.  New York Times.  2/1/2011.  http://www.nytimes.com/2011/02/02/business/economy/02leonhardt.html?src=me.  Last Accessed 2/1/2011. 

[3] Id. 

[4] Id.

[5] Id.

Why is this Topic Important to Wealth Managers? Provides a brief discussion on the difference between tax avoidance versus evasion, the former earns wealth managers checks and the latter can send them to jail.  Knowing the difference, when to spot it, and how to “avoid evasion” is essential to any wealth manager’s tool kit.

Tax avoidance is “The act of taking advantage of legally available tax-planning opportunities in order to minimize one’s tax liability.” [1] On the other hand, tax evasion is the “willful attempt to defeat or circumvent the tax law in order to illegally reduce one’s tax liability. [2]

From the above definitions, and the function of the tax code itself, the line becomes blurred between taking advantage of legally available planning opportunities and a willful attempt to circumvent the tax law.  A well known quote often attributed to Will Rogers speaks to this point.  “The income tax has made more liars out of the American people than golf has. Even when you make a tax form out on the level, you don’t know when it’s through if you are a crook or a martyr.” [3]

Today’s advanced transactions are even more difficult to understand in regards to an ever expanding tax code.  Even over 50 years ago, (well before the Revised 1983 Code) it was said by one of the world’s most famous scientists, Albert Einstein, “The hardest thing in the world to understand is the income tax.” [4] So if Einstein had trouble with calculation of income tax liability, in the 30s-40s what can wealth managers do to not only keep their clients safe, but also maximize every opportunity?

• Stay Informed – A plan that may have been okay last year may be under attack currently.  Some forms of retirement plans were the classic example of this.
• Ask an Attorney and/or Accountant– If a wealth manager is planning a transaction that he/she is not absolutely sure of the consequences, in other words willing to risk licensing and professional liability, then it would be prudent to seek tax and/or legal advice for the client.  A small amount of billable time now can go a long way later, even if to just confirm initial conclusions.
• Don’t Stay too Limited – If a wealth manager hears of a beneficial concept for a client that makes sense, it may be worth exploring.  As we continue further into a global economic climate, many more international opportunities are becoming available.  Just with any other investment opportunity, risk levels vary based on various factors.
• Don’t Cheat – Know the rules of the game, and play the game the best it can be played within those rules.  Take for example, the recent “Father & Son” Cohen tax evasion case in South Florida.  The Times reported [5], “Prosecutors said the Cohens used offshore companies, friends and family posing as owners, and forged documents to cheat on their taxes. They said the Cohens should have declared income from their use of mansions and luxury cars that the father and son said were owned by corporations.”

Whomever was advising the Cohens, based on the information provided, was not doing a good job.  The Cohens were convicted at trial of “hiding a $33 million hotel sale from federal tax authorities while living a lavish lifestyle.”

It should be quite clear from the above example that forged documents are obviously illegal and wealth managers should make every attempt to avoid participating with anyone who has an intent to defraud.  There is always a line in the law, and although what the line is, or where it lies is not always clear, wealth managers should be able to distinguish clearly illicit activity.  With that in mind, it has long been the reasoning of the High Courts that for the reason and in favor of the “astuteness of taxpayers in ordering their affairs so as to minimize taxes we have said that ‘the very meaning of a line in the law is that you intentionally may go as close to it as you can if you do not pass it.’ ” [6]

Tomorrow’s blogiticle will discuss tax advantageous solutions such as bonds.

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

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[1] Black’s Law Dictionary (8th ed. 2004), tax avoidance.

[2] Black’s Law Dictionary (8th ed. 2004), tax evasion.

[3] See generally, Charlie Kelliher, PhD.  Associate Professor, Dixon School of Accounting – University of Central Florida.   http://www.bus.ucf.edu/ckelliher/tax_5015/examples/tax_quotes.htm.  Last Accessed 10/6/10.

[4] Id.

[5] “Father and Son Found Guilty of Tax Evasion.” New York Times crediting Bloomberg News.   http://www.nytimes.com/2010/10/07/business/07tax.html?_r=1&src=busln.  Published: October 6, 2010.  Last Accessed 10/6/10.

[6] Atlantic Coast Line R. Co. v. Phillips 332 U.S. 168, 172-173, 67 S.Ct. 1584, 1587 (U.S. 1947) citing,  Superior Oil Co. v. State of Mississippi, 280 U.S. 390, 395, 396, 50 S.Ct. 169, 170, 74 L.Ed. 504.