The capital gains tax reduction that made such a splash in last week's budget deal could feel like a bucket of cold water on the heads of bankers who sell variable annuities.
Experts say variables-which are basically mutual funds in an insurance wrapper that allows tax-deferred growth-will be less attractive in a world with lower tax rates on long-term capital gains.
As a result, investors could go for mutual funds instead.
Banks "will undoubtedly sell more mutual funds," said Kenneth Kehrer, a consultant in Princeton, N.J. "The problem they face is that mutual funds pay a lot lower commission. They'll have to sell three mutual funds to replace every two variable annuities."
Bankers and third-party marketers say they're not worried.
"If a change in legislation makes one product not as competitive, our breadth of services can satisfy the needs of our clients," said Jack Kopnisky, chief executive and president of KeyCorp's investment unit. "We've always taken the view that we don't sell products, we sell solutions to customer needs."
He added, though, that banks relying heavily on variable annuities to the exclusion of mutual funds-generally smaller banks-could be hurt.
Porter Morgan, a senior vice president at Liberty Financial Cos., which controls Independent Financial Marketing Group, disagreed.
Independent Financial, a third-party marketer, has a big stake in the variable annuity business. It sells variables through at least 100 banks.
Mr. Morgan said that attractive features of the products are unaffected by the tax law. Their owners get a guaranteed death benefit, payout flexibility, and the ability to move money among funds without being taxed.
The National Association of Variable Annuities, not surprisingly, agrees with Mr. Porter.
"It is too simplistic to say that variable annuity sales will suffer due to a cut in the capital gains tax rate," said Mark Mackey, the trade group's president, in a statement fired off to the media last Wednesday, the day after President Clinton signed the tax bill.
Financial planners don't necessarily agree.
"They were marginally appropriate at best under the old tax law," said Harold Evensky of Evensky, Brown, Katz & Levitt in Coral Gables, Fla. "They're even worse now."
Mutual funds have always had a lower top tax rate than variables, but the incentive of tax-deferred growth made variables more attractive long- term investments, despite the higher fees.
Now that long-term capital gains taxes applied to mutual fund earnings are even lower, the scales have tipped toward the funds.
The compounding power of variables can still outweigh the advantages of mutuals, but only if investors are willing to keep their money tied up for 20 years or more, said Mr. Evensky.
Sales of variable annuities totaled $72.5 billion last year, nearly 60% more than in 1992. First-quarter sales this year came to $19.8 billion, a record.
Banks are relatively small distributors of variables. Of last year's $72.5 billion total, just $6.6 billion was sold through banks.
Mr. Evensky said he thinks variables will continue to sell well, simply because there is so much marketing muscle behind them.
Asked if variables will be relegated to the investment product scrap heap, he replied: "They should be, but they won't."
