Use Annuities As A Tax Shield: CPA

By Linda Koco InsuranceNewsNet

Time was, before the era of the feature festival in annuities, agents and advisors used to present annuity options based on the client’s tax needs.

According to Jeffrey Levine, certified public accountant, this may be the time to return to that strategy. Anytime there is an increase in taxes, “we’ve got to look at re-evaluating our tax strategy,” he told a workshop at the recent annual meeting of National Association of Insurance and Financial Advisors (NAIFA) in San Diego.

A lot of people do not realize it, but many Americans could see higher taxes in 2013, said the individual retirement account technical consultant with Ed Slott and Co. That is due to changes in the tax code that are going into effect this year.

Annuities as a tax play

Tax increases might be the incentive that advisors need to go back to using annuities “strictly as a tax play,” instead of just for the benefits and riders, which Levine said has become more of the norm in recent years.

In 2013, he explained, there will be four income calculations that wealthier clients will need to make. Depending on the outcome of those calculations, a client could be facing higher taxes than expected.

Advisors will need not only to calculate client income in various ways but also to factor in three different income thresholds, Levine said.

Advisors will need to do that “to determine how much it will cost a client for one more dollar of income,” he said.

“If you don’t think that puts a premium on tax planning, you’re crazy!” he declared. “If that’s complicated for you, think about what it is like for a client!”

In brief, the four calculations Levine mentioned are:

1) Taxable income. Clients could be subject to the 39.6 percent top income tax rates after doing the calculation for taxable income, he said. That top income tax rate kicks in if the client’s taxable income is more than $400,000 for single filers, or more than $450,000 for marrieds filing jointly.

The taxable income is the amount that remains after taking out itemized deductions and personal exemptions, both above and below the line, the CPA said. A client could have gross income of $600,000 but after calculating deductions and exemptions, the taxable income could be much lower.

2) Adjusted gross income. In 2013, Levine said, personal exemptions and itemized deductions will begin to phase out. The phase-out will be based on adjusted gross income (AGI), not taxable income, he pointed out, noting that this calculation does allow for deductions of things like IRAs and student loans but not for itemized deductions. In addition, the threshold for phase-out begins at $250,000 for single filers or $300,000 for marrieds filing jointly, so it’s different than for the taxable income calculation. The calculation for this needs to be done separately, he said.

3) and 4) Health care surtaxes. The threshold for two health-related surtax calculations is the same as for the AGI calculation ($250,000 for single filers or $300,000 for marrieds filing jointly). “But you have to calculate income in two different ways to get there,” the CPA said.

A 3.8 percent surtax (related to Medicare)applies to people who have a modified adjusted gross income (MAGI) above the threshold; for most clients, the MAGI will be the same as the AGI, he said. A 0.9 percent surtax, also related to Medicare, has the same income threshold as the AGI calculation but “you need to calculate this based on earned income,” Levine said, pointing to use of W-2 income tax amount and self-employment income—not AGI or MAGI.

Most clients are clueless

Most clients have no idea about the thresholds and other taxes that are coming in this year, Levine said.

“They don’t realize that adding just one dollar of income might equate not just to putting them into a higher tax bracket; it might also cost them their deductions and exemptions, and it might throw them into a 3.8 percent health care surtax.”

The great thing for advisors is that they have many tools at their disposal to help clients, Levine said. The tools include wealth conversion and annuities.

Advisors who work with annuities can use the products to smooth out a client’s income, he said. For instance, advisors can use the products to “shield” from taxes not only the income that would otherwise be subject every year to taxes on interest, dividends or capital gains, but also from taxes related to the 3.8 percent surtax.

Non-qualified annuity distributions are subject to the surtax, he added, but that doesn’t happen until the client takes the money out. And that usually doesn’t happen until retirement, when the client’s income might be lower, he said.

Hence the incentive to consider using annuities for tax planning, Levine said.

In discussing another tax strategy, having to do with estate planning, Levine urged advisors need to keep up with the changing tax environment. “You can give advice that blows up because you don’t know all the rules,” he cautioned.

Linda Koco, MBA, is a contributing editor to AnnuityNews, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].

Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].