Tax breaks for annual investments in life insurance and annuities could be limited to $10,000 under a proposal for sweeping tax reform being advanced by a presidential advisory panel.[@@]

Members of the President’s Advisory Panel on Federal Tax Reform talked about the proposal at a hearing Tuesday, but their written report is not due until Nov. 1.

The Treasury Department may work with the White House include some or all of the proposals in President Bush’s State of the Union address in January 2006.

The report also is expected to set the stage for debate in Congress.

“With 2006 being an election, the likelihood for these proposals moving ahead are slim in the near term,” Nigel Dally, a securities analyst at Morgan Stanley, writes in a note about Tuesday’s hearing.

But the proposal “has the potential to emerge as a major new risk for the life insurance industry,” Dally warns. “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.”

If the tax-free buildup of life insurance policy and annuity contract assets were eliminated, “life insurance sales, of which 77% incorporate some savings element, could come under severe pressure,” Dally writes. “Annuity sales could also be hit, although we expect many investors now purchase these products for the protection features rather than the tax-free build-up. The impact on pension companies is more difficult to gauge without additional details.”

“This is a very, very substantial proposal, a significant event that the life insurance industry must pay close attention to,” says a life insurance industry executive who requested anonymity.

But “overt assaults on the authors and the administration will be counterproductive,” the executive says. “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.”

Observers believe the Tax Reform Panel will unveil 2 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 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.

Instead, the panel will propose 3 new types of savings accounts, including save at work retirement accounts, save for retirement individual retirement accounts, and save for families medical and education accounts.

The American Council of Life Insurers, Washington, and the National Association of Insurance and Financial Advisors, Falls Church, Va., are greeting the proposals with skepticism.

“It will be crucial for the panel to emphasize and encourage long-term savings,” says ACLI spokesman Jack Dolan. “Treating all savings the same ignores human nature and the strong desire of people to have everything now. Without strong incentives, people are just likely to consume currently, which we see in the dramatic rise in credit card debt.”

NAIFA has vehemently opposed a proposal by President Bush to create a “lifetime savings account” that would be similar to the savings accounts included in the Tax Reform Panel proposals.

If the government eliminates incentives for long-term saving, “empirical evidence shows the vast majority of people will only ‘spend and save’==or not save at all,” warns NAIFA spokesman Jim Edwards.

The Tax Reform Panel has published some general information about its thinking in the meetings section on its Web site, at http://www.taxreformpanel.gov

The Congressional Budget Office has published a report that discusses the possibility of eliminating tax breaks for annuities, life insurance policies, employer-sponsored health coverage and other products of interest to insurers at http://www.cbo.gov/ftpdocs/67xx/doc6792/10-18-Tax.pdf