As ever, the turning of the year means tax season is just ahead. When it comes to the taxation of annuities the devil is inevitably in the details. Advisors can demonstrate value here by showing understanding of the complexities of tax liability on the different types of annuities from numerous insurance companies. Annuities are sold as tax-advantaged, so the best advice at distribution time will be critical for your clients and promises that need to be kept.
The current popularity of annuities has meant CPAs and banks are not shy about pitching annuities to their clients. This means the dice are somewhat loaded. To compete with other financial professionals, insurance agents need to out-shine their counterparts with excellent product knowledge, illustrations and customer service.
The tax complexity with annuities mostly revolves around benefit riders, income riders, withdrawals and annuitization. Generally speaking, withdrawals and accumulation benefits do not require annuitization whereas some income benefits can. With non-qualified annuities, typical penalty-free withdrawals use a last-in-first-out system for tax purposes, while taxation on annuitization will be calculated using an exclusion ratio. With exclusion ratios related to annuitization, a portion of each withdrawal (or payment to the policyholder) is excluded from taxes. There can be variance between issuing carriers so it is critical to understand and apply specifics to your client’s situation.
If an advisor feels confident in tax rules outside of the product and wants to provide a value-add it should be framed tax efficient planning rather than advice. Always stay in the lane of existing tax rules and avoid interpretation or the temptation to make recommendations on new tax rules where boundaries are not yet clear. For example, an advisor might give general, factual information on tax law, or maybe explain the tax implications of a Roth IRA. The fundamental here is to keep it broad and factual—and definitely within the bounds of your E&O insurance!
It can be advantageous to collaborate with the client’s tax preparer. This will give the client peace of mind and will lend the advisor legitimacy. Any specific tax advice given to the client, however, must ultimately come from that tax-preparer
Always be clear that the client understands that any tax-efficient product you suggest, or factual IRS information you share with them is not meant to represent formal tax advice.
As complex as taxes can be, any in-depth conversation with a client is an opportunity. A meeting at tax time will invariably involve risk-tolerance, long-term goals, legacy plans, etc. These exchanges can open the door for you to offer other tax-advantageous products that might suit your client.
Every January your clients will be looking to complete their return for the previous year, but the advisor’s job is to keep them focused on a tax-efficient future, and how to get them there.