AnnuityAdvisors - Where advisors go for advice
by Margaret Kruse

The President’s 2004 budget makes 2 important proposals, which could greatly affect the annuities market. I STRESS THAT THESE ARE PROPOSALS! THEY ARE NOT LAW NOW, AND THEY MAY NEVER BE LAW!

The first proposal allows shareholders to exclude double-taxation on corporate earnings (which occur at the corporate level and the shareholder level.) If a corporation retained earnings, rather than distribution them as dividends, shareholders would get to increase the bases of their stock accordingly, which would reduce their future capital gains on sale of stock.

This dividend exclusion as proposed would change many of the tax assumptions people use in planning their personal finance. Tax-free dividends would now be more desirable than interest income and even capital gains. Stocks would compete for funds of high-bracket taxpayers now going into mutual bonds. And tax-free dividends would make merely tax-deferred products such as annuities less desirable. However, the ripple effect of the dividend exclusion and the perception that it favors wealthy investors makes this proposal a difficult sell. The proposal seems unlikely to pass in its current form.

The second budget proposal replaces IRAs with Lifetime Savings Accounts (LSAs) and retirement Savings Accounts (RSAs); and replaces elective-deferral-style employer plans with Employer Retirement Savings Accounts (ERSAs). All three of these accounts can be funded with nontransferable annuities.

The Lifetime Savings Account will no doubt be the most popular of the 3 new accounts if it becomes law as proposed. An LSA would be available to anyone regardless of income, earnings or age. Each person could contribute $7,500 annually. Although the contribution would not be deductible (similar to Roth IRA), you could withdraw the funds and their earnings tax-and penalty-free at any time and for any reason. LSAs would take a bite out of the 529 college plan market (for the first $7,500 per child per year, anyway) because they are much more flexible about investments and distributions.

The Retirement Savings Account looks like a Roth IRA with a few adjustments. Each year you could contribute up to $7,500, or all earnings, whichever is less. You could also deposit up to $7,500 for a non-working spouse if you have enough earnings. Contributions would not be deductible. Funds distributed after age 58 would not be taxed or penalized. People would probably fund their LSA before contributing to their RSA.

A treasury press release likens both LSAs and RSAs to Roth IRAs. From that it seems likely that the death benefit on any annuity held under the LSA or RSA tax shelter would be tax free, as it is with a Roth IRA.

The Employer Retirement Savings Account is an employer plan which would replace 401(k)s, 403(b)s and 457 elective deferral plans. Like a 401(k), employees could defer up to $13,000 of income, plus a $3,000 catch up contribution for ages 50 and over (in 2004). Employers could make matching contributions and profit–sharing contributions. Between elective deferrals, matching contributions and profit-sharing contributions no more than $40,000 could be credited to an employee’s account each year. The contributions are deducted from the employee’s income (unlike LSAs/RSAs). The distribution rules are similar to current 401(k)s-most distributions would be taxable. Premature distributions would also be penalized. ERSAs could also allow post-tax contributions, which would also be penalized. The switch to ERAs would have little effect on 401(k) plans for self-employed people (the so-called solo 401(k) or individual 401(k) other than a change of name.

An employee would still be able to roll his plan balance out of an ERSA to an IRA tax-free when he retires. This will allow people to use annuities for guaranteed income and death benefits for a large portion of their retirement funds. IRA holders can also shop for a provider who will do an extended or stretch IRA to maximize tax deferral for the next generation, an option that an employer might not provide in an ERSA.

The savings account proposals also face an uphill battle. Some argue that the new savings accounts will actually decrease retirement savings, as people will put their first dollars into the LSA, which will be spent, which will be spent before retirement. Also, a small business owner might not be incented to offer the ERSA if she were satisfied with the $30,000 annual contribution into LSAs and RSAs for herself and spouse. Without the ERSA benefits of pre-tax contribution, company matches and direct deposit, employees might not have the desire or discipline to save for their retirement.

If you want more details, please call Margaret Kruse
Product Tax Counsel, 502-582-7945
Integrity Life Insurance Company

Last Updated: 3/7/2003 2:56:00 PM