Bushs Tax And Saving Vehicles: Bad Public Policy
By David F. Woods
Something has been missing in reports by the media and other industry analysts on President Bushs tax proposals. These reports have concentrated on the effect the proposals could have on sales of annuities and retirement plans. And while this is correct as far as it goes, it is dangerously incomplete since it overlooks an equally major threat to permanent life insurance.
There is little question the Bush administrations proposed savings vehicles would adversely affect current savings and retirement vehicles as well as threaten long-term savings for retirement. But they would also have a devastating impact on the sale of permanent life insurance. The result would be that millions of people, who, because of the new vehicles, bought term insurance and invested the difference in the new Lifetime Savings Accounts (LSAs), would be without the insurance they need and want as they enter their senior years.
Heres the problem. With an LSA anyone can save or invest up to $7,500 per year with the assurance that dividends and capital gains, as well as any distributions, are tax-free and can be used at any time for any purpose.
In other words, the LSAs have all the advantages of permanent life insuranceplus one. When a permanent life insurance policy is surrendered any excess of cash surrender value over premiums paid is taxable as ordinary income. This is not true in an LSA. Distributions are tax-free. The LSAs offer more favorable tax treatment than permanent life insurance.
This represents an historic reversal of Congressional intent. The “inside buildup” of a permanent life insurance policy has always received favorable tax treatment because Congress wants to encourage people to provide their families with lifelong protection, even into their later years. The LSA proposal is a virtual mandate to “buy term and invest the difference” in an LSA.
So what happens later in life when the term insurance becomes too expensive? People will drop it whether they want to or not because they cant afford it. In my 42 years of experience, I have seen very few people who wanted to get rid of their life insurance as they got older. Those who still had term insurance usually were forced to do so because of cost. Those with permanent insurance most often had relatively low premiums or premiums that could be reduced or fully paid by dividends.
Additionally, only very infrequently did the “buy term and invest the difference” folks have enough invested to take care of their families the way they wanted.
And what happens to the “difference” invested in an LSA? Human nature being what it is, an individuals LSA over the years would almost certainly be treated as a tax-free spending account for new cars, vacations, etc. Very little of it would be around at retirement time. This is very bad public policy.
In the uncertain times in which we live, our countrys leaders should consider those policies that encourage Americans to think about, and implement, long-term, insurance-based financial plans. The Presidents proposals appear to do just the opposite, jeopardizing the financial security of Americas families and small businesses.
Furthermore, they spell potential disaster for the long-term financial health of Americas life insurance companies, as millions of Americans stop buying permanent life insurance and begin massive surrenders of the policies they already own. Why would I not begin the systematic transfer of my cash values, up to $7,500 per year plus a like amount for my spouse and each of my children, into a Lifetime Savings Account? I can buy some cheap term on the side to cover my insurance needs.
The potential run on the companies would be devastating, even after they exercise their right to delay distribution of policy loans for six months.
It appears the President has moved this proposal down his priority list and some of the leaders in Congress have proclaimed it “dead on arrival.” But it is not off the Presidents agenda. He has shown a remarkable ability to get the things he wants out of Congress.
I think we ignore this “shot across the bow” at our peril. These proposals are a serious threat to the long-term financial and retirement security of the American people. They are lying in wait for the right political moment. I believe it is up to us to be sure that moment never arrives.
David F. Woods, CLU, ChFC, is Chief Executive Officer of the National Association of Insurance and Financial Advisors. He can be reached via e-mail at [email protected].
Reproduced from National Underwriter Edition, March 17, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.