InsuranceNewsNet Magazine February 2012 : 24
FEATuRE | BEWARE THE TAx MOnsTER FOCuS ON INCOmE, NOT TAXES If you believe that future income tax rates will be higher than current marginal rates, then suggesting that clients use a tax strategy based on tax deferral in annuities will be “problematic,” predicts John Olsen, principal of Olsen Financial Group, St. Louis, Mo. That’s because growth in a non-qualified annuity is taxed as ordinary income when the owner takes the money out. If income tax rates have gone up during the annuity’s accumulation years, a client could wind up in a higher tax bracket than originally projected and therefore could end up paying more taxes on withdrawals than planned in the original tax strategy. In general, Olsen says, annuities are a “terrible” device to use to pass wealth on to the next generation on a tax-efficient basis. For instance, the products are subject to federal estate taxes (on amounts over the federal estate tax exemption amount, which is scheduled to drop to $1 million in 2013 but which Congress may decide to handle differently). In addition, there are income-in-respect-of-the-decedent considerations to factor in. He urges advisors not to base an annuity recommendation on tax considerations, because there are so many variables in what could happen with taxation and different kinds of taxes. “You have to guess.” Instead, Olsen suggests looking at the purpose the client is buying a product. “What is the job the darn thing is supposed to do? If it’s to produce a guaranteed income, consider an annuity. If the person is not trying to do that, why buy an annuity? Annuities are all about income. If the person doesn’t need income, it might not be the product to offer.” tax bracket, particularly if you were suc-cessful in the working years and retire with a lot of money lying around.” 5. Behavioral Issues. Having an understanding of buyer behavioral ten-dencies can help advisors work with a client who is concerned about all the tax uncertainty or that taxes will go up, explains Victor Ricciardi, assistant professor of financial management at Goucher College. Not knowing what will happen with taxes or the economy affects buyer behavior and decision making, Ricciardi says. “That is a major issue for advisors, because the uncertainty leads to a ‘status quo bias’ that causes inertia and paraly-sis in decision-making. As a result, many customers won’t do anything.” However, the professor predicts that this should resolve after the November elections, “assuming that we get long-term tax treatment from Congress, not another temporary measure.” But if Con-gress doesn’t resolve the uncertainty, 24 InsuranceNewsNet Magazine February 2012 chances are that the markets will resolve it themselves and that major inflation and other problems could result. Ricciardi thinks it’s better for every-one if Congress passes a permanent tax agreement, because then people can plan. Later on, new administrations can come in and make changes, as needed. His advice to advisors is to con-sider offering clients not only tradi-tional products and strategies, but also alternatives. And if a customer has money searching for a retirement sav-ings home right now, perhaps suggest dividing it into chunks and investing it gradually over the next year or two in tax-qualified retirement accounts, not all at once. “Also think about using a combination of accounts—Roth IRAs, traditional IRAs, 401(k) s, etc.—plus tax planning.” Many consumers today are “anchor-ing,” he points out. That means they are setting a reference point or focus based on what happened in the past, whether it was a positive or negative experience or a bull or bear market. When that happens, behaviorists find that people let their anchors guide their decision-making in the present. But since no one really knows what will happen with taxes in the future, that anchoring ten-dency could lead to some bad tax deci-sions, Ricciardi cautions. Advisors will need to guide clients to make their deci-sions with that awareness in mind. In general, the message from the experts boils down to this: “No one knows for sure what will happen with taxes, but it does seem likely that some taxes will go up. So, let’s plan with what we know now and the products and strategies we have now. But let’s stay diversified and also keep our options open.” Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, an-nuities and income planning. Linda can be reached at Linda.Koco@innfeedback.com.