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Annuities and the Shifting Sands of Income Tax Rates

In December, the political compromise between President Obama and Congressional Republicans to extend the Bush tax cuts for two more years was truly a stunning 11th-hour deal. It even took the IRS by surprise. On December 23, the IRS announced that it will not have its tax processing systems ready to handle some of the extended provisions until sometime in late February – well into tax return filing season.

In such an unpredictable environment, some clients may be reluctant to undertake long-term strategies that can reduce their income tax burdens, but even with the uncertainty, a number of strategies can still work very well.

Strategies for...
Upper Income Clients Middle Income Clients Retired Clients
  • Roth IRA Conversion
  • Traditional IRA for immediate tax deduction
  • Non-qualified annuity for tax deferral
  • Non-qualified annuity for tax deferral and possibly to lower taxes on Social Security benefits

For example, the long-term prospect for upper income earners is quite likely for the tax rates that they pay to increase. At some point, the federal government is going to have to take significant steps to attack the budget deficit. Thus, upper income earners might want to seriously consider putting together a plan to convert their IRA’s to Roth IRA’s. The rationale for doing a conversion is that upper income earners may prefer paying taxes now to avoid paying taxes in later years, when they expect that tax rates may be higher.

For middle income clients with modest amounts of retirement savings, the tax deferral offered by annuities still makes a lot of sense. Even if tax rates increase, most clients will likely be paying lower tax rates after they retire than they are paying today because their income will probably be lower. Thus, contributing to an annuity that is designated as a traditional IRA gives your clients an immediate tax deduction, plus it could easily turn out to be a good long-term bargain. Clients have through April 15 to make an IRA contribution for 2010, thus creating a savings on the tax return they send in by April 15, and they can make a contribution for 2011 as well, which will save them money on their tax return next year.

Putting non-qualified money into an annuity makes sense because middle income clients will quite likely benefit from tax deferral over the long run. That’s because they not only earn interest on their principal and interest on their interest, but also interest on the amount they would otherwise have paid in taxes. Plus, many middle income clients pay income taxes in their working years but owe no income taxes when they are retired. If that’s the case, tax deferral becomes tax elimination.

Last but not least, for clients who are retired and are paying taxes on their Social Security benefits, annuities can be used as part of a strategy to both delay the taxes they are paying on their interest income and reduce the taxes they are paying on their Social Security benefits.

Thus, the tax deferral offered by annuities is very attractive for clients, even in today’s uncertain tax environment.

Article Date: 
2011 January