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Help Your Clients With Our Tax Tools

T. Rowe Price

Executive Summary

With a prolonged low interest rate environment and a theme of reducing guarantees among variable annuity (VA) providers, many investors may begin to consider tax-aware strategies.

With the increased focus on tax-aware investing, a trend of accumulation only or Investment Only Variable Annuity (IOVA) products and platforms is emerging in the broader VA competitive landscape. This kit will assist training efforts around this new trend with one-pagers highlighting:

  • Taxable vs. tax-deferred
  • Overview of current income tax brackets
  • How each state treats Social Security income
  • Equity performance in periods of rising interest rates

Taxable vs. Tax-Deferred

With the current trend of variable annuity providers reducing guarantees, tax-aware strategies may become more of a focus for investors.

Variable Annuities offer investors a long-term, tax-deferred investment vehicle designed for retirement purposes.

Many investors are focusing on planning for retirement, in part due to the continuing rise in healthcare costs and an increase in the life expectancy for investors.

The increase in age to receive full Social Security benefits and the decline in traditional pension plan income are also factors leading to investors focusing on retirement planning. Considering these current trends, a variable annuity may be an investment option providing tax-deferred accumulation while offering pension-like income.

  • Tax-deferred growth offers potential for a larger after-tax retirement nest egg for investors as illustrated by the chart on the front page.
  • Investing in a tax-deferred account can lower taxable income.
  • Compounding is a powerful investment tool, it allows you to generate earnings on an asset's reinvested earnings.
  • The effects of compounding can be even more powerful in a tax-deferred account as all of your earning can be reinvested.

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Taxable vs. Tax-Deferred

Taxable vs. Tax-Deferred

Illustrative data and perspective on the potential impacts of tax-deferred investing, and analysis of tax benefits.

Overview of Current Income Tax Brackets

Lowering taxable income may be a priority for some investors given the 2013 increase in tax rate for the highest income bracket. Those investors falling in the highest tax bracket also saw an increase in the rate for capital gains and dividends.

Given these changes to income tax rates, investors may seek additional tax-deferred growth strategies.

A tax-deferred variable annuity offers investors one possible solution to assist in lowering taxable income. A tax-deferred vehicle allows investors to lower taxable income by deferring taxes until money is withdrawn from the account.

  • The tax rate for the highest income bracket is 39.6%.*
  • Those paying 39.6% in income taxes also pay 20% on their long-term capital gains and dividends.*
  • Tax-deferred accumulation strategies such as a variable annuity may play an important role in investment planning for those investors falling in the higher income tax brackets.
  • Scenario 1 on the back page illustrates a couple who currently holds all of their investments in taxable accounts.
  • Scenario 2 illustrates how the same couple could lower their taxable income by investing a portion of their money in a tax-deferred annuity.
  • In addition to lowering taxable income, note the lowered tax liabililty for the couple in scenario 2.
* For 2016 Federal Tax Brackets

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Changing Income Tax Rates

With changes to the income tax rates, tax deferment is more important than ever.

How Each State Treats Social Security Income

When to take Social Security benefits is a major decision that clients are facing as these benefits are an important source of retirement income.

A lot of time is spent crunching numbers and analyzing different scenarios in order to assist clients with this important decision, trying to determine the optimal age to begin claiming Social Security benefits.

Another aspect to consider regarding Social Security benefits is the taxation of these benefits. Some clients will not have to pay taxes on this income, but you should consider up to 85% of your Social Security may be included in your taxable income. However at least 15% of your benefits are always income tax-free federally.

Taking taxation a step further, it is important to understand how each state treats Social Security Income. This varies from state-to-state, with some states imposing full taxation, other states offer preferential tax treatment, and there are states where this income is tax-free. Direct client’s attention to the chart on the back page of this piece. Emphasize that each state treats social security income differently.

  • Only 13 states impose tax on Social Security income, either taxing to the same extent that the federal government does or providing tax breaks for certain individuals.
  • Six states including: Minnesota, Nebraska, New Mexico, North Dakota, Rhode Island, and Vermont impose full taxation on Social Security income.
  • Seven states including: Colorado, Connecticut, Kansas, Missouri, Montana, Utah, and West Virginia offer preferential tax treatment of Social Security income.

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Social Security Taxation Map

Social Security Taxation Map

Examining how each state treats taxation of Social Security income may influence clients' decisions.

Equity Performance in Periods of Rising Interest Rates

With the possibility of increased rates, many are quick to focus on the fixed income market as rising rates can cut into a bond’s total return.

We would like to examine what impact rising rates have on equities. Based on historical data, we see that equities performed well during periods of rising interest rates.

Another important consideration for investors is the location of their assets. There are many investment vehicles to choose from, each having their own benefits and detractors.

Many investors overlook the potential for taxes to impact the long-term performance of their taxable investment portfolios. One of the benefits of investing in a tax-deferred account is that it will reduce clients’ taxable income. Tax-deferred accounts may also be appropriate for investments with high interest income, high dividend production, or high capital gains.

  • The tax rate for the highest income bracket is 39.6%.*
  • Those paying 39.6% in income taxes also pay 20% on their long-term capital gains and dividends.*
  • Tax-deferred accumulations strategies such as a variable annuity may play an important role in investment planning for those investors falling in the high income tax brackets.

* For 2016 Federal Tax Brackets

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Equities and Rising Rates

Rising Rates Image

Equities performed well in periods of rising interest rates.

Important Information

Variable annuities are long-term investment vehicles designed for retirement purposes. They contain underlying investment portfolios that are subject to investment risk, including possible loss of principal. Like most investments, variable annuities include certain fees and expenses, such as administrative fees, sales charges, and mortality risk expense charges. Withdrawing taxable amounts is subject to ordinary income tax, and if made before age 59½, it may be subject to a 10% IRS penalty. Withdrawals may reduce the benefits and contract value and may be subject to withdrawal charges. Annuity benefits and features vary, so you should carefully consider if a product is right for you. Some benefits may incur additional costs. Any guarantee associated with an annuity is subject to the claims-paying ability of the issuing life insurance company.

T. Rowe Price does not offer variable annuities. Call or visit your financial professional to request a variable annuity prospectus that includes investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing. Information in this piece does not pertain to any T. Rowe Price product and is not a solicitation for any product.

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