By Chris Conklin
It’s crunch time for clients who have not yet filed their income tax returns, and some clients may be feeling the pain of seeing how much tax they are paying on their investments.
This frustration can set the stage for you to discuss how purchasing an annuity can help reduce the amount of tax they would have to pay in future years.
Your clients are accustomed to paying taxes on their existing savings vehicles every year, so they naturally expect that to be the case with annuities, too. That gives you a wonderful opportunity to be the bearer of good news: Annuities offer tax deferral. This means that an annuity isn’t taxed until a client makes a withdrawal or starts taking regular distributions. As a result, for clients who are simply letting their money grow with interest, their money can continue working for them instead of for Uncle Sam.
Since most clients are interested in learning how to pay less in taxes, you can see why annuities would be of interest to them. As you prepare for upcoming client meetings, here are a few commonly asked questions and ways to help clients understand the tax benefits an annuity can offer.
What is the advantage of owning an annuity over another type of savings vehicle?
As clients try to weigh which savings vehicle could work hardest for them, highlight the triple-compounding interest potential that an annuity can offer. With an annuity, a client can earn interest on the principal, interest on the interest, and interest on the tax savings because an annuity is not subject to income tax until a withdrawal or distribution is taken. This means 100 percent of your client’s interest can continue to compound instead of being used toward taxes.
Can I move money from my retirement plan to an annuity without getting taxed?
The simple answer is yes. If your client has money in a corporate retirement plan — such as a 401(k), 403(b) or 457 plan — or in an existing individual retirement account, those funds can be transferred tax-free into an annuity. This can be done without any tax implications, as long as the annuity is designated on the application as an IRA.
What’s more, as an annuity earns interest, that interest can remain tax-free in the annuity. However, as with all IRAs — and as with all corporate retirement plans for that matter — when your client ultimately takes withdrawals, the withdrawals will be taxed as ordinary income.
What if I have money in a Roth IRA or Roth retirement plan?
Roth funds also can be transferred tax-free into an annuity. Simply designate the annuity on the application as a Roth IRA. And, with a Roth IRA annuity, there is an additional benefit. As long as your client keeps the money in the annuity for at least five years before taking a withdrawal, and doesn’t take any withdrawals before age 59½, the withdrawals and interest credits can be completely income-tax-free.
Can I move money tax-free from my savings to an annuity?
General savings is called nonqualified money, and since general savings typically has been taxed already, this transfer can be done tax-free as well. Rolling a client’s nonqualified savings into an annuity will also create tax advantages, as interest will be credited to the annuity and not taxed until a client withdraws it.
If your client is moving nonqualified investments such as stocks or mutual funds into an annuity, then the transaction would be taxable to the extent that your client is realizing gains or losses upon the sale of their prior investment.
Will I get taxed if I touch the money early?
Yes. Clients would be taxed if they withdrew money from their annuity early. This is an important point to emphasize with clients. If any withdrawal amount is taken from an annuity prior to age 59½, it is subject to a tax penalty. This penalty is assessed on a client’s federal income tax return — not by the company that issued the annuity. As the withdrawal amount is subject to a 10 percent penalty, it’s important to counsel a client to not withdraw money from an annuity before age 59½.
The tax benefits of an annuity are among many attractive reasons for clients to purchase this type of savings vehicle. By talking to clients about these product advantages now, you can help relieve them from feeling the pain and frustration next tax season.
Chris Conklin is vice president of individual annuities at The Standard. He also is a Fellow of the Society of Actuaries. He may be contacted at [email protected].
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