Tax reform proposals that would strip away many of the tax advantages of life and health products are being greeted with dismay by industry officials.
Life and health insurance groups voiced skepticism that the President’s Advisory Panel on Federal Tax Reform’s sweeping proposals would provide consumers with an incentive to increase their savings. And they vowed to lobby against them with vigor.
At the same time, the panel avoided another hot-button issue for the insurance industry, the estate tax, which was set for congressional debate this fall until Hurricane Katrina and other pressing issues moved it back on the congressional calendar. At the press conference unveiling the proposals, former Florida Senator Connie Mack said the panel had avoided the estate tax issue because President Bush asked them instead to focus solely on income tax issues.
“I don’t remember when the industry has faced as big a challenge as this,” said David Woods, CEO of the National Association of Insurance and Financial Advisors.
Several life insurance groups, including the American Council of Life Insurers, the Association for Advanced Life Underwriting, NAIFA and the National Association of Independent Life Brokerage Agencies, issued a joint statement cautioning policymakers against tampering with the investment benefits of life insurance products.
“Congress has long recognized the important role life insurance and annuities play in financially protecting American families,” the groups said. “The options offered to the U.S. Treasury Department by the advisory panel would, for the first time, impose taxes on these products–taxes that would discourage people from securing the lifetime protection they need.”
In a note to members obtained by National Underwriter that was far more dramatic than the joint industry statement, the AALU said, “AALU and other representatives of the life insurance community view the panel’s report with no less than intense alarm.”
In its note, AALU said, “The panel has overlooked the critically important role that life insurance and annuities provide for American society. By proposing to take away the tax benefits that support these products, the proposal would undermine the financial security of American families. Vigorous opposition to this aspect of the report will certainly be made.”
Joe Stenken, assistant editor in the tax and financial planning department for The National Underwriter Company, noted that the panel did not submit its proposals in any sort of legislative language, meaning that they are “relying on the Treasury, or maybe the White House or a member of Congress” to formulate a specific proposal.
However, he added that what can be seen in the proposal definitely runs counter to the life industry’s interests.
“Assuming that anything is passed,” he said, noting that the odds of that happening seem unlikely, “It’s not a very positive thing for the insurance industry in general.”
Under the proposals, defined contribution plans, such as 401(k)s, would be consolidated into a Save at Work plan that has simple rules and an AutoSave program that would automatically enroll an employee in a savings plan and gradually but steadily increase their contribution. A Save for Retirement account would, according to the panel report, “replace existing IRAs, Roth IRAs, Nondeductible IRAs, deferred executive compensation plans, and tax-free ‘inside buildup’ of the cash value of life insurance and annuities.” Annual premiums toward inside buildup would be limited to $10,000.
The panel submitted its recommendations to the Treasury Department on Nov. 1.
The administration said it will review the proposals and make its own recommendations to the President. Treasury Secretary John Snow said when the detailed proposals were presented that he hoped “we’d be in a position to do that by the end of the year.”
Despite industry anxiety about the plan, one Washington investment group said that enactment by Congress is unlikely. In a note on the proposals, Tim Vandenberg and Joe Lieber of Washington Analysis note that the concerns over the proposals may be unnecessary. The odds of a fundamental tax reform bill being passed next year “are well under 50%, and even beyond 2006 the odds remain long,” they said.
“A confluence of political rancor on Capitol Hill, procedural barriers in the Senate, a weakened administration and a lack of agreement on offsets sets a very high bar for enacting sweeping tax reforms,” they said. “We expect these same factors will also impede less ambitious, incremental tax reform proposals that will likely arise if broader reform proposals falter.”
However, NAIFA’s Woods cautioned that “the threat is very real” from the reforms, noting that lawmakers facing re-election next year may seize upon tax reform as a “unifying issue” to lure voters. Additionally, he noted that “the barriers have been broken down” by the proposal, which touches on areas where other lawmakers have been reluctant to tread, such as the inside buildup issue.
The report from the tax reform panel includes two proposals, which were designed to simplify the tax code. They could involve eliminating or capping several major tax breaks and create in their place savings vehicles designed to help individuals pay for their health coverage, mortgage and education, and retirement.
The Simplified Income Tax Plan would create four tax brackets of 15%, 25%, 30% and 33%, while the Growth and Investment Tax Plan, which has some additional features focused on savings and business taxation, features only the 15%, 25% and 30% brackets.
The savings vehicles would be known as Save at Work plans for work-based retirement savings, Save for Retirement Accounts for personal retirement savings, and Save for Family Accounts for medical, housing and education expenses. Although these accounts were designed to simplify the vast array of savings and investment products on the market, they do so by “leveling the playing field” and removing the unique tax benefits of individual products.
In an interview, NAIFA’s Woods explained that the life insurance industry serves “as an alternative to government.
“Without insurance, as individuals grew older, their financial security would depend on the kindness of neighbors or the federal government,” he said. “The federal government does not want that responsibility, and it can’t afford it; it can’t afford to keep the promises it has already made.”
If these reforms are enacted “life insurance might well dry up,” Woods said, because “individuals would have no incentive to buy anything beyond term insurance, which provides no opportunities for savings.”
The Save for Family Accounts, which are designed to replace current education and health savings plans, would also have an annual contribution limit of $10,000.
The American Society of Pension Professionals & Actuaries predicted that enactment of the reform proposals would devastate millions of workers’ retirement security by eliminating most of the immediate tax incentives used to promote long-term saving and by taking away the personal incentives owners of small businesses now have to offer retirement plans.
“Without the upfront tax deduction [for 401(k) contributions], we believe many workers currently saving in their 401(k) will choose not to save,” said ASPPA Executive Director Brian Graff.
The tax panel itself says in its report that it was able to finance lower tax rates on taxpayers with the highest incomes by eliminating the pre-tax deduction for retirement plan contributions, ASPPA said.
“ASPPA believes that it is totally unacceptable to lower tax rates for higher income individuals by sacrificing the savings tax incentives for American workers,” Graff said.
For health care coverage, the proposals both allow all taxpayers to use pre-tax dollars to purchase health insurance coverage but with a limit of the amount of the average premium, which the panel estimated at $5,000 for individuals and $11,500 for families. These limits, according to panel vice-chairman and former Louisiana Senator John Breaux, were a positive “in the sense of connecting people with the costs of their health plans,” which are typically borne by employers.
Mack, the panel’s chairman, said the limits would serve not as an impediment to health care plans but as a “tax on excessive health plans” that can cost $15,000 to $16,000 annually.
The panel noted in its report that capping the health insurance deduction at $8,400, slightly less than 75% of the recommended $11,500, would have allowed for a 3% reduction in the overall average income tax rate and that eliminating the deduction would allow a 14% rate reduction.
However, it concluded that “an immediate elimination of the tax incentives for health insurance would adversely affect many Americans who currently receive health care coverage through their employer.” Additionally, the report noted that “several members of the panel felt that some incentive for health insurance should be provided through the tax code.”
Stenken noted that the panel also proposed that the government eliminate all tax breaks for group life insurance, employer-sponsored child care benefits and other fringe benefits.
Although fringe benefit tax breaks serve a worthwhile goal of encouraging employers to provide benefits, “the practical effect is favored treatment for some workers at the expense of higher rates for all taxpayers, including those who do not receive benefits at work,” the panel said in the report.
James Klein, president of the American Benefits Council, issued a cautious statement expressing the council’s fears about the tax reform proposals.
“We are concerned that taxing health benefits will lead many workers to drop coverage or demand much higher wages to offset the additional tax burden,” Klein says. “The panel’s proposals for retirement savings are intriguing but unproven as to whether they would result in greater savings.”
Both proposals would eliminate alternative minimum tax, which was one of the goals from the outset for the panel. They would also limit the tax deduction for home mortgage interest payments, allowing for a credit equal to 15% of mortgage interest paid instead of the current allowance for all interest paid up to $1.1 million. This provision could become a major roadblock to the proposals moving through Congress, where a reduction in the mortgage interest deduction has been labeled as a non-starter with lawmakers.
The Major Changes
==Annual premiums toward inside buildup would be limited to $10,000.
==Defined contribution plans would be consolidated into a Save at Work plan.
==A Save for Retirement account would replace existing IRAs, Roth IRAs, deferred executive compensation plans and tax-free inside buildup of the cash value of life insurance and annuities.
==A Save for Family account would replace current education and health savings plans and would have an annual contribution limit of $10,000.
==For health care coverage, all taxpayers could use pre-tax dollars to pay for health insurance, but the average premium would be limited to $5,000 for individuals and $11,500 for families.