Revisiting Annuity Tax Benefits

Not just an important part of your job… It’s good for business

by Daniel Herr

With today’s economy continuing to remain uncertain, there is a driving desire among investors for financial products with tax benefits. In fact, according to a new study by Lincoln Financial Group, nearly half of U.S. adults say they’ve grown more concerned about the impact of taxes on their retirement savings as a result of the current market, and one in three say it is now more of a priority to invest in financial products that provide tax benefits. This opens the door for advisors to strengthen their relationships by supporting clients’ tax focused concerns.

Satisfy Clients With Tax Education

Educating clients on the impact of taxes isn’t just an important part of the job, it’s good for business. Clients who’ve discussed ways to minimize exposure to taxes with their financial professional are nearly two times more likely to be very satisfied with their experience. Simply put, advisors looking to keep clients happy should spend more time talking about financial products that also provide tax advantages.

An important first step in tackling these conversations, alongside being well-versed in clients’ retirement goals, is to understand their baseline knowledge of tax advantaged solutions. For many, this knowledge may be more surface level than you might think. A 2022 study revealed that less than half of U.S. adults had knowledge that retirement savings accounts (401k, 403b, 457) and Individuals Retirement Savings Accounts (IRA, Roth IRA) provide tax benefits. Furthermore, only 18% of people knew that Educational Savings Accounts (529, ESA) and Life Insurance policies have tax advantages, and a mere 13% said that annuities have tax advantages.

Among advised consumers the results weren’t much better. While overall knowledge of tax benefits for each product was slightly higher among individuals working with an advisor, only 2% of advised consumers correctly identified all of them. Seeing as annuity products were associated with the least amount of people aware of their tax advantages, annuities provide a great opportunity for advisors to engage current and prospective clients in conversations about taxes. This is especially true today when annuity products address some of investors’ biggest concerns surrounding retirement like inflation, market volatility, and control of assets.

AnnuitiesOfferThe Protection Investors Are Looking For:

• Longevity Protection

Only social security, a pension and an annuity can provide the protection of a monthly income that is guaranteed to last your client’s lifetime. An often-sought-after benefit of these retirement solutions is the predictability and stability associated with an income that continues for as long as they live. As factors like inflation and volatility continue to be a concern for investors, products that provide longevity protection may help manage concerns that they may outlive their retirement assets.

An additional benefit of having a lifetime income guarantee, is that it leaves control in the hands of the investor. If life events change, having a predictable and stable monthly income for life allows them to tap other savings as necessary without the concern of reducing that monthly income.

• Inflation Protection

While having a monthly income that will last your clients’ lifetime removes the longevity risk, there remains the risk of inflation and declining purchasing power of their retirement dollars. The impact of inflation was recently highlighted in a 2022 study analyzing retirees’ experiences versus their expectations. They found that nearly half of all U.S. retirees said normal daily living expenses, travel, medical insurance, out of pocket medical costs and home or auto repairs were all more expensive than they expected.

With costs continuing to increase, it is more important than ever to educate clients on the benefits that having access to the capital markets offers. This is where annuities can offer personalization and protection. Many annuity products offer a wide range of investment choices that may help power a rising income over many years of retirement. In good market conditions, your clients may have the opportunity to grow their retirement income with the ability to lock in at a new, higher minimum. This upside potential can offer some assurance as consumers of all ages are worried about the impact inflation will have on their retirement.

• Market Protection

While having a monthly income that will last a lifetime with the opportunity to rise in up markets helps to combat the risk of inflation, it comes at the risk of markets declining. Given the uncertainty and market volatility of the last few years, investors are seeking protection on their terms to ensure the financial futures they’ve worked so hard to achieve.

Annuities offer features that bring a wide range of protection options to ensure investors are provided a minimum income guarantee on their lifetime income regardless of market conditions. With this protection, even when markets are declining, an investor can rely on the predictability of a monthly lifetime income that won’t drop below a guaranteed minimum.

• Access To Assets And Death Benefit

Planning for retirement also includes planning for their legacy. Something we often hear is the need for access and control for beneficiaries. Annuities can help fill the need for both. Unlike a pension or social security, investing in an annuity allows the investor to retain access and control over the principal investment.

Your client can maintain control over how their savings is invested and can also maintain control over accessing the investment in addition to receiving the monthly lifetime income. Additionally, clients have an opportunity to pass down a protected income stream for their loved ones in conjunction with legacy planning and special needs and other trusts. Beneficiaries can manage the taxes on the contract growth, giving them the ability to stretch the payment of the gains in the contract, keeping better control over the tax impact.

Protections And Tax Advantages

When non-qualified assets are placed inside an annuity, investors benefit from all the protections previously discussed, while also receiving under the tax-code similar tax-deferred benefits of qualified assets like those in an IRA, meaning clients won’t have to pay taxes on the growth in their retirement savings that they aren’t using yet. Instead, taxes on the investment income aren’t paid until the money is withdrawn. This is a win-win for investors because gains earned on the principal remains invested instead of being immediately taxable, and since most people are in a lower tax bracket during retirement, this means potentially paying less in taxes overall. Unlike an IRA, however, annuity owners are not faced with taxable required minimum distributions.

Arguably, the most sought after tax-advantage for a non-qualified investment in an annuity is the tax-exclusion treatment. Non-qualified annuities provide a wide range of options for investors who receive monthly lifetime income to take advantage of the tax-exclusion treatment. In this instance, clients are returned a slice of their original after-tax investment in each income payment — effectively reducing the amount of taxable income received and helping to ease the tax impact. In these cases, if additional withdrawals are allowed, they too may be part non-taxable return of principal and part taxable gain.

Lastly, when it comes to estate planning, some annuities offer options to stretch the tax benefits to the next generation. With some annuities, beneficiaries can manage the taxes on the contract growth, giving them the ability to take out any remaining cost basis, or nontaxable principal, in a lump sum after the death of the annuitant. Beneficiaries can then stretch the payment of the gains in the contract, keeping better control over the tax impact.

Discussing tax advantages with clients can have a big impact not only on the success of their overall retirement portfolio, but also on your long-term relationship. By educating clients on ways annuity protections align with tax-advantage strategies, you’ll be able to help suppress concerns about inflation and volatility and instill a sense of security and stability in retirement.

Lincoln Financial Group^® affiliates, their distributors, and their respective employees, representatives and/or insurance agents do not provide tax, accounting or legal advice. Please consult an independent professional as to any tax, accounting or legal statements made herein.

Annuities are long-term investment products designed for retirement purposes and are subject to market fluctuation, investment risk, and possible loss of principal. Optional features are available for an additional charge. The annuity’s value fluctuates with the market value of the underlying investment options, and all assets accumulate tax-deferred. Withdrawals of earnings are taxable as ordinary income and, if taken prior to age 59½, may be subject to an additional 10% federal tax. Withdrawals will reduce the death benefit and cash surrender value.

Lincoln Financial Group is the marketing name for Lincoln National Corporation and its affiliates. Affiliates are separately responsible for their own financial and contractual obligations.