Proposals being advanced by a presidential advisory panel would come down hard on insurance products with tax-free inside buildup.
In one proposal, the tax-free inside buildup in life insurance and annuity products would be eliminated entirely. In the other, annual investments in life insurance and annuities would be limited to $10,000 in premiums per person.
The proposal was unveiled orally by the President’s Advisory Panel on Federal Tax Reform Oct. 18 and will be included in the panel’s written report, due Nov. 1.
It will then be evaluated by the White House and the Treasury Department, which will prepare proposals likely to be unveiled in the President’s State of the Union address before Congress in January. Then, Congress will have a stab at it. As Morgan Stanley insurance analyst Nigel Daily said in an investor’s note Oct. 19 raising alarm at the proposal, “with 2006 being an election, the likelihood for these proposals moving ahead are slim in the near term.”
The latest assault on inside buildup is being greeted with alarm by the insurance industry and analysts. Daily said in his note that the proposal “has the potential to emerge as a major new risk for the life insurance industry.
“While any action is unlikely until 2007, at the earliest, these proposals could have far-reaching repercussions for life and annuity companies, including significant reductions in the amount of life insurance sold,” he said.
Daily projected that if the tax-free buildup were eliminated, “life insurance sales, of which 77% incorporate some savings element, could come under severe pressure.”
Daily said “annuity sales could also be hit, although we expect many investors now purchase these products for the protection features rather than the tax-free buildup. The impact on pension companies is more difficult to gauge without additional details.”
The American Council of Life Insurers says it sees the advisory panel’s recommendations as “an opportunity to debate the importance of insurance protection and retirement security.”
But a top executive of a major life insurance company who has been following the issue closely for months had a different take.
First, the official said, “I am very skeptical that it will survive the process, the scrutiny of the Bush administration and then the Congress.”
However, at the same time, the official said, “This is a very, very substantial proposal, a significant event that the life insurance industry must pay close attention to.”
He also cautioned, “Overt assaults on the authors and the administration will be counterproductive. The industry must give the Treasury Department and the White House, to which the proposals will now go, the latitude to move away from this quietly.”
Specifically, the advisory panel will unveil on Nov. 1 two tax reform packages that will include one proposal to eliminate tax-free buildup in life and annuity products, and another to limit investments in these products to $10,000 in premiums annually.
One proposal will call for the government to create a “simplified income tax” system that would eliminate many tax breaks, kill the alternative minimum tax, and reduce the number of tax brackets to 3, from the current 6.
The other proposal, for a “progressive” consumption tax,” would make sweeping changes to the U.S. tax system. If the progressive consumption tax system proposal were adopted, individuals, families and sole proprietors would pay taxes only on wages and would not have to pay taxes on investment income or gains. Businesses could write off investments on equipment immediately and pay taxes mainly on cash flow.
Adoption of the proposals might eliminate many of the retirement plans, health plans and other plans now on the market, such as 401(k) plans, 529 college savings plans and the new health savings accounts.
The tax panel also wants to replace the current deduction for mortgage interest with a 15% tax credit for any mortgage interest paid. The panelists would limit eligibility for the credit to mortgages that fall within the maximum Federal Housing Administration loan limit of about $310,000.