Inasmuch as they typically have no cash value, provide limited investment return, and have as their predominant purpose assuring that the annuitant will not outlive his or her benefits, Congress could well find that the goals achieved by immediate annuities warrant favorable tax benefits without regard to dollar limits.
Certainly the potential to abuse the favorable tax aspects of such annuities seems minimal, since the annuitant is taxed as benefits are received, and benefits are not available until they are received.
If the limit is too low, however, it should presumably be raised for all retirement savings, not just for annuities. There does not appear to be any reason for more restrictively limiting the amount of dollar contributions to nondeductible IRAs and after-tax contributions to qualified plans, and not limiting the amount of dollar contribution to deferred annuities.
The specific limitations that should be imposed on annuities obviously are a topic for political debate. What should be beyond debate, however, is that the government should refrain from imposing new and unjustifiable restrictions on annuities out of a vague sense that all annuities are abusive, and that taxpayers should recognize that they cannot have the favorable tax benefits accorded to a retirement program without accepting the restrictions imposed on these programs.
For purposes of this article, the term "annuity" will refer only to nonqualified annuities, which are annuities not issued as part of a qualified plan or individual retirement arrangement. A discussion of the tax treatment of qualified annuities is beyond the scope of this article. Return to text Pub. Return to text See 1 J. Weinstein ed. Return to text The tax law has, at all times, permitted the holder of an annuity contract to defer taxation on any increases in the annuity value until the surrender of the annuity or annuitization, although the method of taxing the annuity proceeds has varied.
Prior to the enactment of the RevenueAct of , ch. Beginning with the Revenue Act, the law was changed to require the taxation of some portion of each annuity payment as it was received.
The Internal Revenue Code of adopted a third method of taxation, which remains in effect today under the Internal Revenue Code of Under this method, a portion of each annuity payment is tax-free and the remaining amount is taxable. In the case of an annuity for a life or lives, the expected return is the amount of each payment times the number of payments which can be expected, given the life expectancy of the annuitant s.
Return to text In the case of annuities other than variable annuities, state laws are generally modeled after the Standard Valuation Law of the National Association of Insurance Commissioners, which requires that insurance companies set aside reserves equal to the present value of future benefits.
Until recently, highly conservative interest assumptions were utilized to obtain the present value. As an example, the applicable state law could require that an insurance company utilize a rate of interest no greater than 5.
Recent changes in the Standard Valuation Law have lessened this problem, but the changes have not eliminated the reserve problems of guaranteed annuities. An insurance company that issues variable annuities, by contrast, would not assume any investment risk. Return to text Investment Company Act of , ch. Return to text U. Return to text See supra note 4 discussing method of taxation adopted by the Code. Return to text See I. Return to text Section , as in effect prior to , subjected life insurance companies to very favorable taxation provisions.
The term "life insurance company" was defined to include companies which were "engaged in the business of issuing … annuity contracts" and which met certain other tests. Return to text I.
Until , this definition was contained in Section From through , different deductions or exclusions from income based on reserves were available in computing taxable investment income I. This deduction now is contained in Section a 2.
Effective August 13, with respect to contracts purchased after this date which were not purchased under qualified plans, partial withdrawals are fully taxable to the extent the cash value immediately before the withdrawal exceeds the investment in the contract. Special transitional rules are provided by TEFRA for contracts to which amounts had been added both on or before and after August 14, Return to text Regs. Return to text Frankel, supra note 5, at 1. Return to text Section 4 of the Investment Company Act of divides registered companies into face-amount certificate companies, unit investment trusts, and management companies.
Since face-amount certificate companies have specified purposes incompatible with treatment as segregated asset accounts and closed-end companies are unsuitable if the issuer of the variable annuity intends to continue selling variable annuities, unit investment trusts or open-end companies mutual funds are the logical ways of structuring segregated asset accounts. Return to text Unit investment trusts UITs may not make substitutions of underlying securities without Securities and Exchange Commission approval.
To escape the operational problems caused by this restriction, UITs generally invest through mutual funds. Return to text Investment Annuity, Inc. Blumenthal , F. Return to text Rev. In Revenue Ruling , theService held that no part of the accounts maintained under the investment annuity contracts was taxable to the issuing insurance company as a segregated asset account under I. The sole issue was how the policyholders should be taxed.
See , e. Indeed, one private letter ruling was issued and revoked during the pendency of litigation concerning the validity of Revenue Ruling See I. Letter Ruling , August 29, revoked by I. Letter Ruling , September 13, Return to text Id. The Act prohibits pre-enforcement review of most service actions. Return to text 28 U. Return to text F. Thus, the plaintiffs in a suit challenging the validity of Revenue Ruling should have been policyholders.
All existing policyholders, however, had been granted relief under section b. Decisions by the Insurance Commissioner of the Commonwealth of Pennsylvania and the Securities and Exchange Commission based on Revenue Ruling prevented the sale of any future investment annuities.
Without any aggrieved policyholders to file suit in the district court, Tax Court, or Court of Claims, the insurance companies had to file suit and challenge the validity of Revenue Ruling In doing so, the insurance companies opened themselves up to a challenge under the Anti-Injunction Act, I.
Return to text E. The NAIC Annuity Disclosure Model Regulation establishes standards for the disclosure of certain information about annuity contracts to protect consumers and foster consumer education.
The NAIC Annuity Disclosure A Working Group is working on finalizing draft revisions to Model to allow for the illustration, under certain circumstances, of indices that have been in existence for fewer than 10 years. The current model prohibits such illustrations. The Task Force is charged with keeping reserve, reporting, and other actuarial-related requirements current including the Valuation Manual and actuarial guidelines. The VM A Subgroup has exposed an American Academy of Actuaries proposal for modernizing the valuation process for all non-variable annuities.
Among the considerations for that valuation process are the determination of a standard projection amount and review of the mortality assumption for pension risk transfer business. Annuities Issue Brief. Search NAIC. Annuities can be classified as either immediate or deferred. Immediate annuities are purchased with a one-time contribution and provide income payments to the annuitant within one year of purchasing the contract.
The Romans made a few major mistakes, but they got it right when it came to annuities and lifetime income planning. Annuities have been around since the Roman Empire, and I have always tried to envision the first annuity lunch seminar with some guy in a toga talking about a too good to be true product as other people in toga's gorge themselves on a free Roman buffet.
Most agree that the Roman's were first to the annuity party, but some financial archaeologists argue that annuities actually existed in Egypt from to B. In Rome, annuity solutions for Roman citizens were simple lifetime income strategies that became the genesis for today's Single Premium Immediate Annuity structure.
It's kind of interesting to look back at a time line of annuity growth after the Roman's started it all. Early individual annuities were called "tontines. These early annuities provided lifetime income payments to the soldiers and their families. No, they weren't inappropriately called "hybrids" back then! However, I do think this could be the start of the bad annuity lunch seminar. For the annuity buying Romans, the Latin word "annua" actually meant annual payments.
The first fixed indexed annuity was developed in by a Canadian company, Keyport Life , to provide their clients with interest credited above their standard minimum guarantee by buying call options on an equity index. In this way, the annuity was hedging its guaranteed interest rates paid to subscribers with a product that had potential for paying out even higher interest rates.
At a time when the bond market was producing negative gains, banking institutions were providing lackluster interest guarantees, and the markets were experiencing wild swings, the FIA with its guaranteed principal and guaranteed interest plus the potential for further growth potential made sense to many investors. Annuities themselves are not new.
Archeological evidence suggests that the Ancient Egyptians had an annuity for one of their princes. Further evidence of the concept of paying out dividends or a stream of income to an individual or a group of people has been found in the Roman Empire as well. The first fixed annuity was offered in the U. At the time, annuities were vehicles of the wealthy and were slow to grow into the massive market they now represent. Yet with the stock market crash in , these were seen as safe havens for Americans and their savings against volatile stocks.
Their growth continues to this day. A new annuity variant, indexed annuities , sprang into existence to take advantage of a very specific solution to an issue investors were having as a result of the interest rate hikes in As the bond market crashed and returns were very poor, investors were looking for a better product that could offer the same security.
Because the value of variable annuities is tied to the performance of mutual funds that invest in stocks, bonds and money markets, the performance of variable annuities suffer in rocky stock market environments. As variable annuities experienced negative returns, with stock funds in the same situation, investors began looking for another option.
With fixed annuities interest rates experiencing a long downward slump, the market was ripe for a new annuity product and the Indexed Annuity was born.
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