2013: A Senior's Odyssey

No question the market has been challenging for the providers of annuities with living benefits because of the equity market volatility and the extremely low interest rate environment. Some companies have exited the business or made massive changes. We will see more companies scaling back in 2013. On the flip side, companies will focus more on the guaranteed income products that are not tied to the equity markets, like single premium immediate annuities or deferred income annuities. The risk associated with income annuities and deferred income annuities is much more aligned with traditional life insurers.

These solutions need to be provided because there is a great need for living benefit products. But the economic conditions of the country don't allow for the solution to be provided in the same format as before. Therefore, the format will shift from a product that has the upside potential of equity market exposure to one that is focused more on pure income. One thing I'm certain of, if you can't provide your client with solutions to the retirement income problem, you will lose your clients.

"The public is not as averse to the annuity word as they used to be, and advisors need to stop being ashamed to use the word annuity."

 Capitol Hill: Everything is on the table

Kristi Mathisen, CPA, PFS
Managing Director of Tax and Financial Planning
Laird Norton Tyee

There are several expired popular tax provisions that I expected would have been extended for 2012 by now. This late in the legislative year, the so called "extenders" are now included in all the controversy surrounding the Fiscal Cliff. Many of our senior clients utilized the tax-free charitable IRA distribution provision to make charitable contributions from their IRA accounts that satisfied the minimum distribution requirements without impacting their adjusted gross incomes. This provision, available only to individuals age 70-and-a-half and over, was often used by charitably inclined middle-income individuals who wanted to minimize adjusted gross income (AGI). Benefits of minimizing AGI include possibly limiting the taxability of Social Security (50 percent inclusion instead of 85 percent inclusion) and increasing the amount of deductible medical and investment expenses both of which are subject to "floors" based on a percentage (currently 7.5 percent and 2 percent, respectively) of AGI. The deduction was also popular with individuals who do not have sufficient deductions to itemize for tax purposes but do want a tax benefit from charitable contributions they make.

An upcoming "sleeper" deduction limitation that impacts seniors and lower income taxpayers: Beginning in 2013, the "floor" for deducting medical expenses for tax purposes increases from 7.5 percent to 10 percent of adjusted gross income. The effect of this change is that less of an individual's or family's medical expenses will be deductible. This translates to higher taxable income and, unless tax rates decrease, higher taxes. The change originated with the 2010 health-care act but had a deferred effective date. A special transition rule allows taxpayers who are age 65 and over to continue using the 7.5 percent floor through 2016. This change has a disproportionate impact on lower income households. In 2007, taxpayers with AGI of $50,000 and less accounted for 52 percent of the 7 percent of U.S. tax returns that reported the deduction for medical expenses. The change will also have a significant effect on seniors after 2016. Seniors tend to have higher medical expenses than younger taxpayers because most seniors pay their own health insurance through Medicare premiums and supplemental insurance while many younger families have employer-paid health insurance.

An example of the impact: A family has AGI of $100,000. Their medical expenses are $11,000. They can deduct $3,500 ($11,000 minus $7,500) of those expenses in 2012. In 2013, they can deduct only $1,000, because 10 percent of $100,000 is $10,000. If the family's marginal tax rate is 25 percent, losing this deduction increases taxes by $62.

"There are several expired popular tax provisions that I expected would have been extended for 2012 by now."

Michael C. Foltz, JD, CPA, CFP
Balasa Dinverno Foltz, LLC

Estate- and income-tax planning was at center stage in 2012 given the convergence of the expiring Bush tax cuts, estate provisions that will change in 2013 and the new tax increases proposed by the current administration. The estate and gift tax exemption is set at $5,120,000 for 2012, but will automatically decrease to $1 million on January 1 unless Congress passes new legislation, which is not assured.

In 2010, most experts hoped for a long-term solution to the state of flux in estate tax laws, but Congress and President Obama provided only a short-term fix. Many hoped that legislation would be passed in 2012, but with it being an election year, any hopes for a long-term solution were nothing but wishful thinking. So now, we are at where most expected us to be—major legislation is needed at the eleventh hour with no apparent Congressional consensus.

It is possible that Congress will come up with an agreement on a framework for new legislation and agree to extend current tax provisions until early next year when permanent legislation can be passed. In 2013, look for increased taxes and decreased deductions on those with adjusted gross incomes above $250,000. Also, it is likely that the per person estate tax exemption with be in the range of $3.5 million. It is likely that the 3.8 percent Medicare surtax on investment income of high earners will remain law. The Obama administration will likely push for limits on or elimination of tax-favored strategies like grantor trusts and GRATs (grantor retained annuity trusts) and family limited partnerships. Time is still available to plan for optimizing income tax strategies between 2012 and 2013 and utilization of the $5,120,000 estate tax exemption that may not be available in 2013.

"Time is still available to plan for optimizing income tax strategies between 2012 and 2013 and utilization of the $5,120,000 estate tax exemption that may not be available in 2013."

Judi Carsrud
Director of Federal Government Relations
NAIFA

The primary challenge for annuities and other life insurance products is the need to balance the budget, reduce the deficit, manage the debt ceiling and undertake major tax reform. At least from the [legislative] staffers we talk to, everything is on the table. In other words, any tax expenditure of any type is going to be reviewed to see if it's a necessary component to our society or if it is money that could be used to solve the deficit. And annuities, with the tax deferral nature of the growth and the way income is paid from an annuity, puts them, not in the top 10, but on the list of things that could be changed by the time tax reform is completed.

I can't say what the chances are at this point. It might be too soon for that. We do know it is being discussed and it was discussed in the past and it was decided to leave it the way it is currently taxed. But because they are so desperate for money and because they are looking at other things that are even more cornerstone to our tax code and how we grow an economy, it certainly is a possibility.

Both Democrats and Republicans are saying they want to try to make a grand bargain, compromise and solve the Fiscal Cliff and do some tax reform. But right now they are still busy posturing and positioning in their initial negotiating positions. If we get through the lame duck [Congress] and they resolve some part of the Fiscal Cliff and they get onto tax reform, we might be able to make a better estimate in the spring.

If there are changes, the impact will be dramatic. It is the deferred nature of annuities and life insurance that makes them attractive and affordable over a long period of time, and if we lose that treatment I think that the amount of interest at the consumer level will dwindle and therefore, the number of agents making a living in the industry will dwindle and the way the insurance companies price their products will change to still make them profitable. It would have a ridiculously dramatic effect and be very negative to the economy and jobs and growth, which is what we are hoping Congress will recognize before they do any cutting.

A cap on tax deductions is also being discussed quite a lot right now as a way of theoretically resolving some of the economic issues without having to change every tax code section separately. If there is a deduction limit that includes exclusions and deferrals that could negatively impact life and annuity sales by virtue of a consumer choosing to keep his mortgage interest deduction first, for instance, and running out of deductions or hitting the cap. Then, life insurance and annuity products would then fall outside of that cap and become a taxable issue. That would be a clear threat to the industry.

"The primary challenge for annuities and other life insurance products is the need to balance the budget, reduce the deficit, manage the debt ceiling and undertake major tax reform."