A Way to Avoid the Dreaded 1099 Conversation With Clients

What You Need to Know

Some of your clients might owe capital gains taxes despite seeing negative returns.
Variable annuities are not subject to capital gains taxes, even when rebalancing assets among subaccounts.
VA gains will be taxed as income when withdrawn.

Tax season is here, and so are the difficult 1099 talks with clients. Having to explain to a client that they have to pay capital gains taxes despite staring at -20% returns is never a fun conversation.

“Let me see if I have this straight: My investment in XYZ fund has gone from $1 million to $800,000, but I have to pay $25,000 in taxes? In what alternate reality does that make sense?” Not fun at all.

Let me offer a potential solution to this problem. What if a meaningful percentage of your client’s investable assets outside of qualified retirement plans was held within a variable annuity?

I’ve had the same variable annuity for 32 years now, and do you know what I’ve never received? A 1099 for income taxes due. Not once. No taxes of any kind in 32 years and counting.

Yes, I will eventually pay taxes on what are now pretty substantial earnings. And yes, those taxes will be paid at the ordinary income tax rate rather than the long-term capital gains rate. But how much extra money will I have because every penny I would have had to pay in taxes over the years is still sitting in my account, compounding away?

I’m sure some of you reading this article are saying, “I have an even better idea. Rather than put my clients in mutual funds, I use ETFs. They aren’t required to distribute capital gains each year, so they are a much more tax-efficient solution.”

That would, of course, be a true statement. But is it a better solution? How many of your clients in 2022 sold some of their equity ETFs to reduce the volatility of their portfolio? How did they fare with capital gains?