How Annuities Have Evolved
The concept of annuities can be tracked back to the 18th century when a company offered the first annuity to ministers and their families. The first qualified variable annuity was issued in the early 1950’s by TIAA-CREF. In the 1960’s, Variable Annuity Life Insurance Company issued the first non-qualified variable annuity.
In the 1970’s, Investment Annuities surfaced which allowed people to buy certificates of deposit wrapped inside of an annuity policy. The product had tax-deferred accumulation, tax-free withdrawals up to cost basis, and a stepped up cost basis at death. In essence, income taxes were only paid after principal had been withdrawn with no excise tax penalty for earnings withdrawn prior to age 59.5.
Surprisingly, annuity sales were surprisingly low in the 1950’s-70’s. Why? 1) Often, products need to evolve before a product can gain wide public acceptance 2) sales practices also had to evolve and 3) tax legislation halted new sales of the Investment Annuity. Understandably, the government did not think that people should be able to buy Certificates of Deposit inside of an annuity and receive all of those tax advantages previously described.
In the early 1980’s, the tax-deferred annuity, (referred to today as the Pre-TEFRA annuity) had tax-deferred accumulation, principal could again be withdrawn first income tax free, no excise tax penalty and the death benefit, while taxable, could be very easily deferred by the use of the contingent annuitant provision. It was not uncommon for an annuity owner to make a $100,000 premium, earn 10% interest (15.75% was the highest rate we had available), withdraw $10,000 a year for 10 consecutive years and not pay one penny of income tax during the entire 10 years.
Many Pre-TEFRA annuities were consumer driven and certainly tax-advantaged but, surprisingly, annuity sales were low compared to today’s current sales environment. Why? 1) Often, products need to evolve before a product can gain public acceptance 2) sales practices also had to evolve and 3) tax legislation amended the tax code for new annuity sales. This tax legislation was titled the Tax Equity and Fiscal Responsibility Act of 1982(TEFRA).
TEFRA reminded all of us what we already knew or should have known. A tax-deferred annuity is a long-term retirement vehicle. This piece of tax legislation is interesting since it introduced LIFO accounting, which meant that now interest came out first instead of principal. Also, a 5% excise tax penalty was introduced for withdrawals during the first 10 years of holding an annuity or prior to attainment of age 59.5. Naturally, the next piece of tax legislation, The Deficit Reduction Act of 1984, which came right on the heels of TEFRA replaced the 10-year holding period with just the attainment of age 59.5 and introduced Distribution at Death Rules so that a non-spousal beneficiary could not defer income taxes indefinitely.
However, the 80’s also gave us the Tax Reform Act of 1986 (TRA) and The Technical Miscellaneous Reform Act of 1988 (TAMRA). TRA prevented corporations from receiving tax-deferred accumulation and increased the federal tax penalty from 5% to 10%. TAMRA discouraged the use of multiple annuity policies (aggregation) purchased with one company in the same year.
The 1990’s gave us The Omnibus Reconciliation Act of 1990 where it became clear the multiple policy rules (aggregation) did not apply to immediate annuities.
