Although 2008 probably won't be a year for any significant tax changes, the insurance industry is preparing for 2009 and 2010, when tax increases appear likely.
Although 2008 probably won't be a year for any significant tax changes, the insurance industry is preparing for 2009 and 2010, when tax increases appear likely.
"Every new president puts a major tax bill through Congress," said Joseph McKeever III, an attorney at Washington-based Davis & Harman LLP. "We're going to see a great likelihood of that happening with whoever is in the White House."
Mr. McKeever made his comments while hosting a panel on such legislative changes at the 2008 NAVA Marketing Conference in La Quinta, Calif., last week.
SERIES OF TAX CUTS
A series of tax cuts are expiring in the next few years, setting the stage for a massive tax hike in 2011 unless new legislation is put in place in 2009 or 2010, he said. Among them are the ordinary income tax rate, which is set to spike to a maximum of 39.6%, from 35%, and taxes on capital gains and dividends, which will rise to 20%, from 15%.
Without legislative intervention, the estate tax will leap to 55% plus surtax, following a year without estate taxes in 2010, Mr. McKeever added.
Meanwhile, the cost of maintaining the Bush administration's tax cuts will run more than $2 trillion over the next 10 years, Mr. McKeever said.
"We need to revisit the tax code," he said. "We can expect more government, and we'll be paying more for it."
That is especially true if a Democrat wins the White House this year, as the Democratic Party is more likely to question the advantages of recent tax cuts.
"This has been reflected in Hillary Clinton's and Barack Obama's platforms with respect to taxes that the cuts be kept in place for people who are earning less than $250,000 a year," Mr. McKeever said.
Scrutiny will fall upon the financial services industry overall in the coming years, and those on the mutual fund and insurance sides will have to prove that their products can benefit all Americans rather than just the upper middle class, he said.
Although fellow trade groups, including the American Council of Life Insurers of Washington and the National Association of Insurance and Financial Advisors of Falls Church, Va., anticipate greater scrutiny of tax deferral and who really benefits from it, the expectation remains grim: Affordability of financial services products likely will remain out of reach for those at the lower end of the economic spectrum, according to Michael Kerley, senior vice president of federal government relations for NAIFA.
"Congress grants those preferences in the hopes that everybody, including the lower middle class, can take advantage of them. But the harsh reality is that only a [small] segment of the workers will have enough income to take advantage of the incentives," Mr. Kerley said.
Nevertheless, the groups have considered how variable annuities would be treated depending on the tax environment of the future.
Rising income and capital gains tax rates would make variable annuities seem more favorable, compared with other products, said Mark Mackey, the departing president and chief executive of Reston, Va.-based NAVA.
While living benefits are the annuity's main selling points now, in a high-tax environment, clients may turn their focus to the investment aspect.
"At the present time, it's not being sold on the tax-deferral basis but rather the insurance aspect," Mr. Mackey said. "If the laws change, the investment aspect of the product could be more attractive when compared to other alternatives out there, such as mutual funds."
NO REPLACEMENT
However, the investment portion of the annuity will never replace the insurance concept of the product, Mr. Mackey added.
NAVA continues to promote the guarantees and living benefits of variable annuities and has turned its lobbying efforts toward the Retirement Security for Life Act of 2007, which provides tax benefits for annuitization.
Maintenance of the tax-deferred buildup inside insurance products, including annuities, is on the industry's radar, according to Mr. McKeever.
"We can't just do away with the inside buildup of annuities, but it costs money to do tax deferral," he said. "We need to be prepared in 2009 and 2010."
However, the opinions are different in the trenches.
"I think it'll come up, but the taxation won't change," said Pasquale J. Sacchetta, president of CFIG Wealth Management in Westport, Conn.
"At least once every two years, someone — whether it's the Senate or the House — will look at life insurance buildup from the taxation standpoint," he said. "It's the Holy Grail of taxation."
As for the windfall of taxes, Mr. Sacchetta predicted that Roth IRA conversions will push tax revenue in 2010 as investors will be permitted to convert their individual retirement accounts to Roth IRAs and distribute taxes over the following two years.
Despite the specter of higher taxes, he doesn't expect advisers to redirect their sale efforts for insurance and annuity products as investments — even if the capital gains tax rises.
"It would be appealing if you don't take out the interest; if you don't take it out, it's tax-free, but if you do, it's income-taxable," Mr. Sacchetta said. "It puts the annuity on the same footing as an investment, but no one would honestly say that it's better than other investments."
E-mail Darla Mercado at dmercado@investmentnews.com.
