Through the 1980s and 90s when tax rates were higher, variable annuities were a popular tool for tax deferral. However, since the late 1990s, the primary focus of the annuity industry has been on risk management instead, offering a series of living and death benefit features that have provided significant guarantees, but at a significant cost. When combined with tax rates that declined significantly with President Bush’s tax legislation in 2001 and 2003, the benefit of tax deferral associated with non-qualified annuities was simply no longer worth the cost.
In a significant shift, though, an emerging new generation of low cost variable annuities, combined with a significantly more progressive tax system since the American Taxpayer Relief Act of 2012, may usher in a new era for the use of variable annuities, especially when the contracts can be used strategically as an asset location vehicle to shelter high-return but tax-inefficient investments. Consequently, while not long ago it was projected to take a decade or two for the benefits of tax deferral to offset the cost, it now can take as little as a year or two for higher income clients! The end result: it may once again be time to seriously consider the cost of variable annuities as an expense worth paying to harness the value of tax deferral.