At press time the Senate was poised to vote on–and approve–tax cut legislation that the House passed on May 10 by a 244-185 vote.
The legislation includes incentives for wealthy taxpayers to convert to Roth IRAs by removing the modified adjusted gross income limitations on rollovers from an IRA to a Roth IRA. Some analysts are concerned that the provision would have an impact on the sale of annuities, although industry officials discount such an impact.
The $70 billion tax cut legislation left up in the air whether legislators will ultimately enact a provision proposed by Senate tax writers last year that would impose punitive taxes on investor-owned life insurance transactions, including those involving charities.
The life industry’s concern is that so-called “trailer tax cut legislation” the Republican congressional leadership is committed to passing may include the IOLI provision as a revenue raiser.
Republican leaders in Congress have made a commitment to Sen. Charles Grassley, R-Iowa, that the second tax cut bill will be attached to must-pass pension reform legislation now being drafted by a House-Senate legislative reconciliation panel.
And it was Grassley who added to the Senate bill last November the provision imposing punitive taxes on IOLI.
In the Roth IRA provision, tax writers removed the modified adjusted gross income limitations on rollovers from an IRA to a Roth IRA.
Under the provision, taxpayers can elect to pay tax on amounts converted in 2010 in equal installments in 2011 and 2012.
While Democrats oppose the bill, through arcane rules regarding budget legislation, it needed only a simple majority in the Senate to win passage and thus could not be stopped by a filibuster.
Such an expansion of Roth IRAs would reduce annuity sales to wealthier individuals who are currently not eligible for Roth IRAs, according to tax experts at Washington Analysis, a securities research firm that caters to buy-side clients such as pension and hedge funds.
Withdrawals from Roth IRAs after age 59 1/2 are not taxable, while withdrawals from annuities are taxed at the regular income tax rate.
According to Washington Analysis and American Council of Life Insurers’ tax experts, under current law, single taxpayers with annual incomes in excess of $110,000 and married filers with incomes of more than $160,000 are ineligible for the Roth IRA.
Removing these limits would prompt additional transfers of money into tax-advantaged Roth IRAs at the expense of traditional IRAs and, at the same time, generate billions in tax revenue as assets in the traditional IRAs are taxed for the first time.
Such a shift of money into Roth IRAs would be a positive for mutual fund companies but a negative for annuity writers, analysts said.
Whit Cornman, a spokesman for the ACLI, said, “Given the fact that the provision only applies to rollovers from traditional IRAs to Roth IRAs, we do not see any significant effect on annuities.”
The primary purpose of the bill is to extend tax cuts enacted in 2001 and scheduled to expire in 2008 an additional two years.
But Mike Kerley, senior vice president, federal government relations at the National Association of Insurance and Financial Advisors, did voice concern.
He said the Roth IRA provision is consistent with the Bush administration policy “that all savings should be tax-deferred and which does not distinguish between long-term savings as provided by life insurance and annuities, and short-term savings as provided by such vehicles as a lifetime savings account.”
To the administration and its supporters in Congress, “all saving is good and should be tax-preferred,” Kerley said.
“We, of course, disagree,” he said. “We believe that tax preferences should be used to encourage people to save for their long-term family and retirement security. But we have not taken a public position on the tax reconciliation.”
Kerley said the Roth IRA provision represents a “fire-sale type of mentality where people would be encouraged to roll over their traditional IRAs into Roth IRAs. The resulting tax that would be paid on the rollover of the traditional IRA is simply being used as a gimmick to pay for other provisions in the tax reconciliation bill.”
Kerley warned that “long term, those provisions will lead to higher deficits years from now unless steps are taken to stop that from happening.
“Trading a current tax revenue windfall for later deficits translates into instant gratification but long-term fiscal pain,” he said.
The main purpose of the bill was to extend tax cuts enacted in the first years of the Bush administration.
Under current law, capital gains and dividend income are taxed at a maximum rate of 15% through 2008. For taxpayers in the 10% and 15% tax brackets, the tax rate is 5% through 2007 and zero in 2008. The bill extends the rates effective in 2008 through 2010. Without action, these rates would have increased after 2008.
The bill also raises the Alternative Minimum Tax (AMT) exemption levels through the end of 2006 to a higher level than in 2005. The new exemption levels for 2006 are $62,550 for joint filers and $42,500 for single filers.
But the “trailer legislation,” which the Republican leadership promised would be acted on shortly, constitutes the greater concern for the industry.
Grassley had been holding off on finalizing the main measure to preserve negotiating leverage on the second bill, which is to contain a number of widely backed tax breaks.
They include a popular education tuition tax deduction, a tax break for teachers who buy their own school supplies, and a research and development tax credit for businesses. That measure also would preserve tax deductions for state and local sales taxes.
The thinking is that Republicans will seek to attach these provisions to pension reform legislation now being negotiated by House-Senate conferees.
The insurance industry is concerned that the IOLI provision may be added to that in order to raise revenue.
An industry lobbyist, who asked not to be identified, said that view is the industry’s thinking. “Revenue will be a key consideration,” the lobbyist said. “The IOLI provision raises $267 million over five years and is supported by the administration and Grassley.
“So, while it appears to be out of tax reconciliation, it may not be gone for good,” the lobbyist cautioned.
The ACLI agreed. Cornman said, “We are pleased that the IOLI provision was not included in the tax reconciliation bill. We are closely monitoring discussion of the extenders bill, but it is not clear what this bill will include.
“We look forward to working with the tax writing committees to ensure that if a provision is enacted, that it completely addresses inappropriate uses of life insurance without affecting legitimate transactions,” Cornman added.
Kerley said NAIFA and its sister organization, the Association for Advanced Life Underwriting, favor delaying action for the immediate future on the IOLI provision.
“We believe that the way the IOLI provision is written is not acceptable,” Kerley said. “It causes harm to legitimate insurance sales situations. So, we’re hoping that the Senate sponsors of this legislation will agree to fix it down the road but in the meantime, take it out.”
Advanced life underwriters say the issue in the IOLI provision that is still up in the air and most concerns them deals with instances where the tax would be triggered if the insured gets a loan secured by his interest in the policy.
In a note to members when the provision passed the Senate last November, AALU officials said its interpretation is that whenever there is a loan secured by an insurance policy the excise tax would be triggered.
In its note, AALU lawyers gave two examples where the tax would be inadvertently triggered. One is a case where the insured borrows money to purchase a life insurance policy (borrowing secured by policy) and makes a family member the beneficiary for 90% of the proceeds and a charity the beneficiary for the other 10%.
The other is a case where the insured borrows money to purchase a life insurance policy (borrowing secured by policy) that is needed for purely personal reasons. “Years later, the insured no longer needs the policy for the original personal reasons and gifts the policy to a charity,” the AALU officials said, thereby triggering the tax.