How Tax Reform Could Impact Annuities

Image courtesy of the WSJ

Uncertainty around the Trump administration’s tax reform efforts has made it difficult to predict the kinds of effects that could be in store for a wide variety of consumers, investors and employers. It’s especially hard for annuity experts to determine what might happen to retirement spending. If consumers have more money in their pockets because of lower taxes, they may invest it in long-term savings, while fewer savings incentives might inspire them to simply spend the money somewhere else.

So how might this affect annuities? “No one has a clue,” says lawyer Mitchell Miller. The estate tax is one of the rules expected to change, but it’s unclear exactly what might happen. “We have no idea of the form estate tax reform will take: Outright elimination? Increased exemption? Will gift tax be maintained? How about the step-up in basis? What happens to annuities will depend mightily on the details.”

Here are some possibilities for how tax reform could affect annuities under different scenarios.

Changes in Capital Gains Would Help

The White House’s tax reform proposal has several different components, and it can be difficult to predict how they might affect different aspects of the economy; however, part of the proposal being discussed involves lowering corporate tax rates and possibly raising capital-gains tax rates, says William Stack, owner and founder of Stack Financial Services.

“While it remains to be seen if tax reform happens this year, it is possible that capital gains could be taxed at ordinary income rates,” Stack says. “If that occurs it would be a net positive for annuities. By removing the tax advantage of owning equities over annuities, there are fewer reasons not to own annuities. Many retirees might prefer the future income guarantees inherent in annuity policies over the uncertainty of future stock prices.”

Direct Taxation Unlikely

Annuities are seen as an attractive investment vehicle because of their lack of taxation, and that’s not likely to change, says Robert Nevarez of HN Financial Group. “Annuities are tax-deferred vehicles that shelter taxation during accumulation,” he says. “This will still provide the same advantages that they currently provide.”

Proposed reform may affect distributions from annuities if they’re taxed as ordinary income, Nevarez says. “This is where the proposed reform may have an effect with the three proposed tax brackets of 10, 25 and 35 percent,” he says. “Investors may pay less income tax in retirement. They will also potentially avoid the estate tax for annuities that are used to transfer wealth to other generations.”

Uncertainty Will Continue

Republicans are interested in performing an overhaul of the entire tax system, but that outlook seems increasingly unlikely as time goes on. Some specific proposals, such as the idea of doing away with deductions for state and local taxes, are facing opposition, including from some Republicans. Any tax proposals face a strong fight in Congress and changes from both sides before a final plan is voted on, making an already uncertain market even more unsteady.

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