Tax deferral benefits take center stage for VAs

The insurance industry predicts a new boom in variable annuities as tax deferral takes the spotlight in the near future, but financial advisers and broker-dealers aren’t convinced that this will help products fly off the shelves again.

“Historically, variable annuities are sold best when markets do well,” said Scott Stolz, president of Planning Corporation of America, Raymond James Financial Inc.’s insurance agency.

“The markets have done well over the last five or six months, but that’s not enough to get clients’ money off the sidelines,” he said. “The reality is that people don’t buy variable annuities until they’re confident that the market has recovered.”

In better days, insurers counted on rich living benefits, including guaranteed-income and withdrawal riders, to attract advisers and clients. Post-crisis, however, insurers emerged with “derisked” variable annuities and living benefits that aren’t as generous.

Accordingly, the VA industry has also begun to move its focus to the appeal of tax-deferred growth.

“I think in the past eight or nine years, people focused on the guarantees as a reason to put annuities into the portfolio,” said Cathy Weatherford, president and chief executive of the Insured Retirement Institute. “Going forward, once people start thinking of tax advantages, that will be a reason to move into the product.”

VAs will become more attractive because clients who hold them will be able to have their investments grow over time without a yearly tax bite from capital gains and dividends, said John Koehler, vice president of Jackson National Life Insurance Co.

An increase in capital gains and dividend taxes would hit those with mutual funds. Withdrawals from an annuity would still receive income tax treatment, though.

“The appreciation in the variable annuity is working from a higher-water mark,” Mr. Koehler added. “You’re ahead of the game because the money you didn’t pay in taxes is working for you.”

But some advisers are already pushing back against that theme. Some have reported a slide in VA sales, and they say that they plan to use other products to mitigate the effects of the expected tax hikes.

For Gregory L. Olsen, a partner at Lenox Advisors Inc., the concern of higher income taxes in the future outweighs the benefits of a deferral on capital gains and dividend taxes, so he has turned to municipal bonds and other investments instead.

MUNICIPAL BONDS

Municipal bonds with short-to-medium-term maturities are among his vehicles of choice, he said.

Muni bonds not only provide an attractive rate of return, but there is a possibility for capital appreciation due to supply and demand, Mr. Olsen said.

Still, not many people are talking about muni bonds as a strategy, perhaps because they think that inflation is on the horizon and interest rates will increase, he added.

Others, such as Mike Mills, a managing principal at Mike Mills Wealth Management LLC, think that with higher taxes on the horizon, indexed-universal-life insurance will be more interesting to clients.

“We’re not really selling variable annuities as much as we used to, but we’re selling a lot of life insurance,” he said. Wealthier clients with cash that they won’t need immediately can use that money toward the purchase of indexed-universal-life insurance.

“We think volatility will be high, and if we have this environment where interest rates are low and it stays that way for two or three years, then that’s not very productive if your money is in a certificate of deposit,” Mr. Mills said. Many indexed-universal-life products, however, accrue at least 2% in interest, which is attractive when CDs provide less than that.

On the broker-dealer side, firms say that interest in VAs is slowly picking up among advisers who didn’t use the products much before the crisis.

But how much of that interest stems from tax advantages is still up in the air.

“In the last three to four months, we saw a spike in variable annuity sales,” said Vere Reynolds-Hale, senior vice president of the Financial Services Group at First Allied.

“It wasn’t necessarily driven by tax deferral over the next year or so but rather by the underlying benefits of the variable annuity through the income and death benefits,” he said.

The products that generate the most interest are those that have managed to keep their products and benefits fairly consistent since the crisis, Mr. Reynolds-Hale said.

STILL RESONATING

The latest sales theme from insurers has centered on converting traditional individual retirement accounts to Roth IRAs and using a variable annuity in tandem, he said.

At Edward D. Jones & Co. LP, Merry Mosbacher, a principal in the insurance marketing unit, said that the firm never stopped promoting VAs for tax-deferral purposes and that the message of guaranteed income continues to resonate among advisers.

“A more balanced message has allowed us to stay true to the benefit that the annuity can provide,” she said.

“The impact of the pricing changes in February did hurt sales — there’s some sticker shock, and the contract isn’t as good as it was,” Ms. Mosbacher said. “But we have advisers who recognize variable annuities at the current value still provide value when they’re made part of a diversified portfolio.”

Although insurers aren’t completely abandoning their message of predictable guaranteed income, they think that a combination of annuity-friendly public policy and increased emphasis on individual retirement planning will help VA sales skyrocket in the next few years.

“I believe that if we do this right, the $180 billion high-water mark we hit in 2007 will pale compared to what we can build this industry to,” said Robert DeChellis, a senior vice president of distribution for Allianz Life Insurance Company of North America.

“Tax deferral is the phoenix from the ashes,” he said. “It’s hard not to imagine a scenario where tax rates will be higher in approaching years.”

E-mail Darla Mercado at [email protected].