Cost of Owning Annuities

The costs associated with owning annuities can be substantial and are generally broken down into four areas:  (1) disclosed costs, (2) built-in costs, (3) opportunity costs, and (4) tax costs. Let’s look at each one individually.

Disclosed costs are typically the annual fees, the fees associated with mutual funds in the annuity and other riders (guarantees, growth) that you can purchase. Built-in fees include underlying fund fees, annuity provider fees, sales commissions and surrender fees. Opportunity costs refer to the addition fees you pay for guarantees on income and growth. Tax costs include the tax code in general; LIFO rules and IRA rules (NEVER own an annuity within an IRA!).

As you can see, there is overlap among the various costs, but the bottom line is that they add up and eat into your actual returns.

What Defines Middle Class?

Who is the middle class? That’s the $64,000 question. Politicians and pundits use the term to describe and support their own political and economic agendas. As we learned last week, the best way to determine who is or isn’t middle class is to look at their median income (current median income in the U.S. is $51,000).

The top and bottom median income states—Maryland and Mississippi respectively—are over $28,000 apart. The differences are even greater if you break the numbers down to the county level. Because these differences are so stark, it’s almost impossible (and a little bit dangerous) to label someone as middle class, especially if you are writing public policy. Probably the best example of this is the current tax code.

Tax Code Compounds Discontent for IRS

The complexity obscures the understanding of the tax code and creates a sense of distance between the taxpayers and government resulting in lower rates of voluntary compliance. In fact, once you get past W-2 filers, compliance drops dramatically either through misunderstanding of the code or by willful disobedience.

Another result of the complexity is a lack of trust among taxpayers in the equity of the tax collecting process. In other words, the poor think the rich take advantage of loopholes to avoid paying enough tax; the wealthy think the poor pay nothing; and the middle class feel like they have to make up the difference for both.

This mistrust in the IRS also has to do with greater taxpayer affinity with local tax collection. In other words, local taxes make more sense to taxpayers. For example, taxpayers see the results of paying local taxes in the form of school spending, road repairs, etc., while tax dollars sent to DC seem to vanish in thin air.

The final piece of the complexity puzzle lies with the IRS itself. The truth is, the code is so complex that the IRS doesn’t have the ability to administer it properly. With only 90,000 full-time employees, the organization can’t keep up with the millions of phone calls and letters it receives each year. Also, misinterpretation of the code by IRS staff means that taxpayers get as many different answers to tax questions as there are questions themselves.

Introducing the Taxpayer Advocate

The Taxpayer Advocate is a division of the IRS that represents U.S. taxpayers on matters before the agency. Nina Olson, the current Advocate, heads up this independent unit of the Federal tax collector. The Advocate also presents a twice-annual report to Congress about the state of the IRS.

According to Ms. Olson, the number one problem facing taxpayers is the complexity of the tax code. In her report, she has several suggestions on how to simplify and improve the code which would result in better service for taxpayers and more revenue for the Treasury.

Complexity of the Tax Code

The complexity of the tax code causes average taxpayers to spend excessive time and bear a significant monetary cost on compliance, usually in the form of hiring a tax preparer. The code also obscures comprehension so that taxpayers have no idea what they actually pay. It also facilitates tax avoidance by enabling sophisticated taxpayers to minimize the amount of tax they owe.

The IRS’s Taxpayer Advocate

The Taxpayer Advocate Service (TAS) is an independent organization of the Internal Revenue Service (IRS). The purpose of TAS is to help taxpayers resolve issues with the IRS; and recommend changes to IRS policies and procedures that will prevent the issues in the future. Nina Olson, the current National Taxpayer Advocate, oversees approximately 2,000 local advocates across the country.

In her role as the National Taxpayer Advocate, Ms. Olson is required by statute to submit an annual report to Congress about the state of the IRS. In her December 2012 report, Ms. Olson told Congress that the number one problem facing taxpayers—and the IRS—is the complexity of the tax code. In her report, she has several suggestions on how to simplify and improve the code which would result in better service for taxpayers and more revenue for the Treasury.

How to Simplify the Tax Code

In her 2012 report to Congress, IRS Taxpayer Advocate, Nina Olson, pointed out that the number one taxpayer complaint is the complexity of the tax code and offered ways to fix the problem. Specifically, she suggested getting rid of all deductions, exemptions, credits etc. (zero-based budgeting), and generally simplifying the tax code.

Apple Slices Its Share of the Tax Pie

David discusses Apple and its creative use of the tax code to avoid large tax liabilities.

Don’t Forget About These Taxable Items!

David identifies taxable items and events that many taxpayers may not be aware of including unemployment benefits, alimony and forgiven debt.

President Obama’s Budget Proposal Taxes Our Patience

David begins a discussion of President Obama’s proposed changes to the tax code and how they will have unintended consequences for working class Americans.

What Fair Share with Taxes?

David looks at changes to the tax code proposed by President Obama and how they will have unintended consequences for working class Americans.

Evaluating Investment Performance Reporting

David discusses how money managers promote their investment performance and what you need to know when evaluating it.

Taxes 2010: Plan First, Then Comply

David talks about the importance of tax planning vs. simply complying with the tax code.

Deciphering the Tax Code 2010: Obamacare Department

David walks viewers through the myriad changes to the tax code due to the new healthcare legislation.

Tax Changes for 2010

David describes temporary provisions in the tax code for 2010 including sales tax deduction, classroom supply deduction, tax-free IRA charitable contributions and self-employment tax.