Capitol Hill. AP Photo/Luis Magana

Proposals by the Obama administration to cap tax-advantaged retirement accounts at the $3 million level has some industry officials thinking that, if approved by Congress, it would merely benefit the sale of alternative products, primarily life insurance.

For example, in one reaction to the administration proposal, Walter White, CEO of Allianz SE’s North America life business, said such a cap would encourage wealthy savers to put more cash into insurance, whose death payouts are typically exempt from federal taxes, as well as annuities, where taxes are deferred. Plus, the cash value grows tax-deferred

The bad news is that veterans of the Washington lobbying wars fear what the administration proposal may portend — limiting inside buildup as part of comprehensive tax reform somewhere down the road.

The good news is that the proposal will go nowhere in a totally dysfunctional Congress. As noted by one lobbyist: “I’ll be rooting against the proposal — fortunately, Congress can’t agree on what day it is.”

The specter of limits on inside buildup has been around since 2003, when Rep. Bill Thomas, R-Calif., then-chairman of the House Ways and Means Committee, left a hearing on proposed tax cuts concerned about how inside buildup in life insurance policies could be used by deft advisors and imaginative tax practitioners to shelter huge estates from taxation. For example, the current estate tax law allows a couple to shelter up to $100 million in assets.

The couple can do this by using the provision reunifying estate and gift taxes to use the $5.25 million per person exemption to buy enough life insurance to shelter the entire estate from federal taxes.

When informed of the potential to do this during the hearing by a financial advisor, Thomas contemplated capping inside buildup at $3 million.

He returned from a weekend recess planning to do that, and it took a host of life insurance industry lobbyists assembled in a hastily convened meeting early the next week to dissuade him. Based on that hearing, Thomas engineered a compromise aimed at saving the government some revenues by separating the estate and gift taxes.

“There is the likelihood that everything will be on the table, including ‘cash value’ or inside buildup, as well as caps on contributions to retirement accounts, during discussions on comprehensive tax reform,” acknowledged one industry lawyer.

The American Council of Life Insurers (ACLI) keeps a watchful eye for any proposal that would reduce inside buildup, or, as it is sometimes stated, the “tax-preferred” status of life insurance.

In comments in December dealing with the specter that the “tax-preferred” status of life insurance might be on the table during year-end “fiscal cliff” talks, an ACLI official defended its tax status, saying that, “Cash value is crucial to a permanent policy’s functioning.”

The ACLI argued in the comments that the availability of cash value “keeps premiums steady throughout the life of the contract, and can also pay for the premiums during tough and uncertain times.

“Without cash value, life insurance would be unaffordable for many Americans as they get older or if their health deteriorates. Cash value is integral to the concept of permanent life insurance,” argued Walter Welsh, ACLI executive vice president, taxes & retirement security.

“Based on income tax principles, life insurance is taxed properly, and it would be unfair to tax it any other way,” Welsh said. “It is inaccurate to say it receives special treatment.”

At the same time, one industry lawyer says, the industry must maintain a balanced approach in supporting the continuation of current policy on inside buildup.

“The industry must put equal weight, if not predominate weight, in any marketing initiative, on the insurance benefits of life insurance as they are coupled with the appropriate tax benefit,” the lawyer said.

“Marketing materials should emphasize that life insurance is not exclusively for the rich,” the lawyer said.

“The rich have alternatives to life insurance to provide for their golden years, but the motivation to leave something for one’s heirs is a driving force for the entire population,” the lawyer cautioned.

“Marketing materials and promotional activities should be designed to appeal to the broadest possible marketplace,” the lawyer said.

For more from Arthur D. Postal, see: