Underlying all conversations about annuities is the issue of tax deferral and the marginal tax bracket for most investors.   This calculation of the value of tax deferral,  plus the acknowledgement of the exclusionary ratio (the percentage of annuitized withdrawals credited as principal or interest) represent the two key tax advantages annuities provide American savers.

This is true for fixed annuities.  In the case of variable annuities, and to a lesser extent fixed annuities, a potential annuity consumer needs to analyze the current preferences for either dividends or capital gains.  Low marginal tax brackets and high tax preferences for capital gains results in variable annuities becoming more competitive from purely tax perspective.  Elimination of these preferences for dividends and raising of the marginal tax brackets makes fixed annuities and variable annuities more competitive.

There is a nationwide debate emerging over the extension of the tax cuts initiated under President George W. Bush early last decade.   Marginal income tax rates as well as the preferences for capital gains and dividends were lowered.   Today there is a public policy debate over spending, taxation and the long-term deficit.

A side portion of this debate focuses on the core structural design of our tax system.  A recent proposal for tax reform that has gained an incredible amount of support is the fair tax. The fair tax is a major consumption tax that seeks to replace the major existing tax structures—namely, income, property, estate, and capital gains.  Historically, policies like the “Fair Tax” and the “Flat Tax” have emanated from the political right.  I don’t know whether there is a real groundswell for this change, but the last decade of public policy decisions; our two wars, the Medicare prescription drug benefit, the Bush era tax cuts, and now the twin problems of the recession—lower receipts and stimulus spending—are creating greater discussion.


Robert Longley of About.Com elaborates,

“In place of all current federal taxes, the Fair Tax would place a 23 percent tax on the final sale of all goods and services. Exports and business inputs (i.e. intermediate sales) would not be taxed. Individuals would file no tax return at all. Businesses would only need to deal with sales tax returns. The IRS and all 20,000 pages of IRS regulations would be abolished. Under the Fair Tax, no federal taxes would be withheld from employees’ paychecks. Social Security and Medicare would be funded by sales tax revenue.”