Variable Annuities Miss Out On Tax Cut Benefits In US

by Mike Godfrey, Tax-News.com, Washington

18 June 2003

As investors look forward to receiving a larger slice of their stock profits as a result of lower rates of dividend and capital gains tax, it is becoming clear that not all investment vehicles, such as REITS and variable annuities, will benefit from the recently enacted tax cuts, leading to speculation on the future worth of these instruments.

The reason for this is that REITs (Real Estate Investment Trusts) were excluded from the $350 billion tax cut because, unlike ordinary companies which issue shares, they have not already paid corporate tax and instead are required to pay 90% of their taxable income in dividends. Therefore, REITs are not subject to the 'double taxation' that the tax cut plan was geared to eliminating, or at least reducing. This means that taxation rates will be as much as 35% on a REIT whereas a mutual fund enjoys the new 15% rate on dividends and capital gains.

Similarly variable annuities, which are part retirement investment, part insurance policy, are also excluded from the new tax benefits, as gains from these vehicles are classed as ordinary income and are also subject to tax at a rate of up to 35%. Some analysts fear that this will inevitably mean demand for such investments will dwindle, as investors are attracted back to mutual funds.

Whilst variable annuities have the flexibility to defer tax liability until the investment matures, many experts believe that investing in a mutual fund over the same length of time will lead to significantly greater tax advantages in the long run.

As Brent Brodeski, managing director of Savant Capital Management told CBS recently: "Your tax cost on the dividend along the way is significantly less than the (expenses) on even the lowest-cost annuity, let alone the higher-cost annuities which are typically at 2 percent or higher," although with a mutual fund, "the maximum capital gain, even if you're Bill Gates, is still going to be 15 percent." However, Bradeski pointed out that with an annuity "what could have been capital gain now gets converted to tax-nastier ordinary income, which is taxed at up to a 35 percent rate."

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