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Tax Cuts Could Undermine Annuity Industry


PHOENIX, Ariz. - Insurance industry products and variable annuities in particular have always been targets for government revenue-raising measures due to their tax-preferred treatment, according to Stephen Zimmerman, a partner at Dykema Gossett PLLC of Washington D.C. As the new administration settles in, a panel of lawyers discussed legislative issues likely to arise that could affect the annuity industry at the National Association for Variable Annuities marketing conference held here last month.

In 1998, the Clinton administration tried unsuccessfully to initiate a tax on transfers within annuities, Zimmerman said. While the new administration is unlikely to propose a similar bill, the 2002 elections will decide which party controls Congress and that in turn will affect how large the tax cuts proposed by the Bush administration will actually be. The tax-cut legislation is not likely to pass for another two years, according to Joe McKeever, a partner at Davis & Harman LLP of Washington, D.C. While the full $1.6 trillion tax cut is unlikely, there will be some reductions, which does not bode well for the annuity industry, said McKeever.

"From the annuity perspective, the primary advantage of an annuity is tax deferral, so at a lowered tax rate, it is less of a benefit," McKeever said. "The capital gains rate could be reduced to 15 percent, which has an impact on variable annuities."

The newly-formed House Committee on Financial Services, which will handle banking and insurance issues, will have a critical

influence on policy matters such as the lifetime annuity payout or LAP proposal, Zimmerman said. The proposal seeks to have non-qualified annuity payments taxed at the capital gains rate rather than at the ordinary income tax rate. The American Council of Life Insurers, the Committee of Annuity Insurers and NAVA have formed a coalition to lobby for the proposal. The coalition is trying to get members of Congress to co-sponsor the bill, which will be introduced in Congress sometime this month, according to Zimmerman. But, it may not pass this year, he said. However, its chances would be improved if it were tied to major tax legislation, said Mark Mackey, president of NAVA. If passed, more people would be likely to annuitize their contracts, McKeever said.

Other potential legislation includes the Portman-Cardin Bill which would expand pensions. Although not an initiative of President Bush this year, the bill received bipartisan support and was passed in the House last year. It will increase the maximum contributions that can be made to IRAs from $2000 to $5000 a year over a three-year period and increase maximum contributions to 401(k) plans from $10,000 to $15,000 over a five-year period.

"This will mean a lot more money will be invested in pension plans and annuity products," said McKeever. "People fund their IRAs and pension plans with annuities, so any time there is an increase in retirement plan contribution limits, more money will be put into annuities. People will also invest in mutual funds and securities, but the pie would be getting bigger and annuities are one piece of that pie." The annuity industry is also interested in estate tax repeal, said McKeever.

"It is not certain if it will be repealed and if so, over what period of time, but there are likely to be very dramatic, substantial changes if not an outright repeal this year," said McKeever. "It is one of the centerpieces of the president's proposal and it is clearly a priority for the administration and for many members of Congress. If the estate tax is repealed and the step-up in basis rule for other investments is eliminated, it will level the playing field for annuities, he said.