Variable annuities have been an effective long-term financial planning tool for U.S. investors for more than 40 years. Total assets invested in annuities in the United States are now estimated at over 5400 billion.
The variable annuity concept is simple - an investor places funds in a variable annuity contract with an insurance company. The funds are then placed under the direction of an Investment Manager and invested in securities, with the value of the annuity contract fluctuating with the value of the underlying investments. The variable annuity account is required by law to be segregated from the general assets of the insurance company, and while it is not a trust account, it is similar to a trust in that it is protected from the claims of creditors of the insurance company, Accordingly, even if the insurance company fails, the assets can only be used to satisfy the obligations to the variable annuity holders.
ADVANTAGES OF TAX DEFERRAL
By far the most attractive feature of a variable annuity contract is that of tax deferral; earnings in the annuity account accumulate and compound tax-free until the investor elects to begin to withdraw the funds from the account (which may be done in hole or in part in accordance with the desires of the investor). Any balance remaining in the account continues to compound tax free.
Tax savings can be substantial depending upon the rate of return earned on the annuity's underlying investments. The annuity can be most advantageous when the investment strategy used is one that would generate short-term gains and /or interest income rather than long-term capital gains. The length of time that an investor holds the annuity is also key: the longer, the better.
The tax deferral feature also allows investments to be made in offshore funds that otherwise would be unavailable to the investor because of punitive U.S. tax rules that can apply to such investments.
WHY USE A FOREIGN INSURANCE COMPANY
There is no tax advantage per se in an annuity issued by a foreign insurance company versus one issued by a company in the U.S: the same tax rules apply to both. When property structured, however, a variable annuity issued by a foreign insurance company can provide almost unlimited flexibility in selecting managers and investment styles. This is due primarily to the elimination of the state regulation that applies to insurance companies that engage in business in the United States. The principal advantage from this flexibility is the ability to use hedge fund managers and other private managers who employ leverage, short selling and other techniques that generally are not permitted for annuity investments sold through U.S. insurance companies.
Use of a foreign variable annuity also allows easier access to foreign securities that may not be for sale in the United States, permits the investor to access offshore money managers who are not generally available to U.S. invesstors, and allows an investor who is concerned about the U.S. Dollar to denominate all or a portion of the contract in other currencies.
A foreign annuity may also open up certain long-term estate planning opportunities through the use of foreign trusts. Because of recent changes in U.S. tax law relating to foreign trusts, a variable annuity from a foreign insurance company can he especially useful to non-U.S. persons who are expecting to move to the U.S. and become U.S. taxpayers. In addition, the annuities can be coupled with other estate planning devices such as charitable remainder trust to provide additional tax deferral and estate tax benefits.
Under federal law, there is a one-time, 1% excise tax on the premium paid on a variable annuity contract issued by a foreign insurance company with respect to a U.S. person. This tax can be withheld and paid by the foreign insurance company.
To ensure that no violation of the insurance laws of any state occurs when purchasing a variable annuity from a foreign insurance company, the contact must be negotiated and entered into outside the United States.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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