For 2015, LIMRA reported that sales of FIAs grew by 13 percent year-on-year to a record $54.4 billion. More than 60 percent of FIA sales are qualified – held in retirement plans or IRAs.
FIAs put an insurance company’s guarantee behind all principal while crediting an annual interest rate linked to a market index, up to a cap. Since clients can’t lose money, regulators generally have treated FIAs the same as fixed annuities – not as registered securities products like variable annuities. When sold in retirement plan accounts, FIAs have been subject to the same PTE 84-24 exemption as guaranteed life insurance contracts and fixed annuities.
Without notice, DOL stripped away FIAs’ PTE 84-24 exemption and replaced it with the more stringent Best Interest Contract (BIC) exemption of the new rule, putting FIAs in the same regulatory regime as variable annuities. The annuity industry was blindsided, with some companies predicting huge declines in their FIA sales, and a few threatening to exit the market.
For advisors who believe in FIAs, the situation may not be as bad as all this suggests, for three reasons.
First, even if the FIA market contracts, the product meets clients’ needs and some carriers will continue to offer attractive contracts.
Secondly, advisors who already offer qualified variable annuities (VAs) should not be greatly disadvantaged, because the same Best Interest Contracts can cover transactions in both FIAs and VAs from the same carrier.
Thirdly, clients usually don’t give up much tax benefit by holding non-qualified FIAs outside retirement plan accounts.
Non-qualified FIAs are designed as long-term, tax-deferred vehicles for retirement accumulation and income. Unlike qualified FIAs, they aren’t subject to minimum distribution requirements, and income payments aren’t fully taxable. (A portion of each payment is recovered tax-free under an exclusion ratio.)
Even if clients plan to accumulate money in an annuity for many years before income payments begin, the tax advantages of qualified FIAs aren’t always that much better.
Example: A client changes jobs at age 50 and can transfer $100,000 from a 401(k) plan to a Traditional IRA funded by a qualified FIA. In 20 years’ time, at 6 percent interest per year, the IRA hypothetically will grow to $320,714 pre-tax or $230,914 after-tax (at 28 percent).
Instead, suppose the client pays income tax on a $100,000 distribution and puts the balance ($72,000) into a non-qualified FIA. To have the same after-tax amount in 20 years, the FIA will need to earn an interest rate of 7.2 percent annually – 1.2 percent more than the qualified FIA. After age 70 ½, the client can continue to defer all taxes in the non-qualified FIA, while minimum distributions (or annuity payments) will be required annually from the Traditional IRA.
If your clients like FIAs and you don’t want to put this business under a BIC exemption, start educating them now on the benefits of non-qualified annuities.
For many, paying taxes now and investing the difference tax-deferred (for up to the rest of your life) won’t seem such a bad deal. To learn more about the tax treatment of non-qualified annuities, see IRS Publication 939.