A cap that President Barack Obama has proposed on the size of tax-advantaged retirement accounts is seen as potentially pushing savers to another product that limits payments to the government: life insurance.
Obama’s 2014 budget plan, unveiled April 10, includes a proposal to cap at about $3.4 million tax-preferred retirement accounts such as IRAs and 401(k)s. That would encourage wealthy savers to put more cash into insurance — whose death payouts are typically exempt from federal taxes — and annuities, where taxes are deferred, says Walter White, chief executive officer of Allianz SE’s North America life business.
“In our industry, in many ways, that could be helpful, because then you’ll start to look for tax advantages in other ways, and some of our products are geared toward that,” White says.
Wealthy investors have long included life insurance as part of a strategy to limit taxes and pass on wealth to their heirs. The cap proposed in Obama’s budget would push more assets into life insurance and annuities as investors seek to limit taxes, says Ron Rubin, the CEO of Union Square Financial Partners LLC, which advises wealthy clients on transferring their assets.
Annuities are another type of insurance product that can offer a stream of income in retirement.
“We’re going to see a massive swing over to the after-tax, tax-deferred asset classes like annuities and life insurance,” Rubin says.
Life insurance payouts at death typically aren’t subject to federal taxes. In addition, living policyholders can withdraw premium payments from some forms of permanent coverage without triggering U.S. taxes. Policyholders can take out additional cash tax-free as a loan, which can be repaid with the benefit when the person dies.
The cap on retirement savings and another proposal in the budget to require non-spouses who inherit IRAs to take taxable distributions within five years instead of over their lifespan may increase the attractiveness of life insurance. That’s because many wealthy families place life insurance policies in trusts as a way of moving money out of their estates to heirs.
Obama’s budget proposes increasing estate taxes and limiting techniques used by the wealthy to transfer assets through trusts. Insurance payouts are one way high earners can transfer assets to their heirs, says Brian Batson, the chief operating officer of Krupin Partners LLC, a Beverly Hills, California-based insurance adviser firm.
“There are substantial income and estate tax advantages to certain life insurance products,” says Jay Messing, a senior director of planning in the Northeast for the private bank unit of Wells Fargo & Co. “Any time you get tax increases, whether it’s income or estate, the efficiency of those life insurance products tends to increase in value.”
Still, the coverage is purchased with after-tax dollars, diminishing the tax benefit compared to a retirement account, Rubin says. If wealthy individuals accumulate excessive assets in life insurance, the products’ tax treatment may draw scrutiny, Batson says.
MetLife Inc. and Prudential Financial Inc. are the largest U.S. life insurers. Other top sellers of life insurance and annuities include Prudential Plc’s Jackson National and Lincoln National Corp. Allianz was the No. 10 annuity seller, according to data compiled by the National Association of Insurance Commissioners.
“We believe Americans should have every opportunity to maximize their retirement savings, as well as protect their long-term financial security,” Radnor, Pennsylvania-based Lincoln said in a statement.
The benefits for the companies may be limited because retirees often use tax-deferred accounts to fund savings products, says Caleb Callahan, senior vice president at broker- dealer ValMark Securities Inc. Many insurance companies also provide retirement plans for companies, he says.
“What you get in one hand, you give back in the other,” he says.
The retirement cap is part of a $3.8 trillion budget that leans on top-earning households for revenue to cut the deficit. The account limit is projected to raise $9 billion for the government over the next decade. The budget also caps the value of tax deductions and other breaks for top earners and imposes a minimum tax on those earning more than $1 million a year.
The limit on retirement accounts would be implemented by prohibiting taxpayers from adding more tax-free money to the accounts once the cap is reached. The cap would be set starting at $3.4 million, the amount needed to fund a $205,000 annual annuity for a 62-year-old, and would be adjusted for the cost of living. Investors could add to the accounts if investments lag.
Because the cap is tied to annuities, it could decline if interest rates rise, according to an analysis by the Employee Benefit Research Institute. Balances of Roth IRAs and the value of defined-benefit plans would count toward the cap, according to a Treasury official who briefed reporters on the condition of anonymity. Contributions are already limited by law.
“In a world where people have not prepared adequately for retirement, increasing taxation of retirement benefits would seem counterintuitive,” White says. “I would be pretty hopeful that message will break through.”
Congress should continue or expand opportunities for retirement savings, Jack Dolan, a spokesman for the American Council of Life Insurers, says.
The proposed cap is “unworkable,” adds confusion to the retirement system and would discourage savings, Investment Company Institute CEO Paul Schott Stevens, whose Washington- based trade group lobbies on behalf of mutual funds, said in an April 10 statement.
Americans have become increasingly reliant on their savings for retirement. Just 14% of workers were covered by defined-benefit, or pension, plans in 2010, compared with 32% in 1989, according to the Center for Retirement Research at Boston College. More than half of workers had no workplace retirement plan in 2010, the center’s data show.
Retirement savings gained attention during the presidential campaign last year when Republican nominee Mitt Romney disclosed that his IRA held between $18.1 million and $87.4 million, and at one time the maximum value exceeded $100 million. IRAs are retirement accounts that let people contribute money without paying income taxes up front. The money grows tax-free inside the account, and holders pay taxes at ordinary income rates when they withdraw the funds.
In 2011, about 0.1% of savers older than 60 had at least $3 million in 401(k) and IRA accounts, says EBRI. The median balance in 401(k)s for those ages 55 to 64 was $54,000 in 2010, according to an analysis of federal data by the Center for Retirement Research.
By focusing on prohibiting Romney-sized accounts, the plan diverts attention from encouraging lower-income workers to save more, says Alicia Munnell, who directs the Center for Retirement Research. Tax benefits for retirement savings should be limited for the rich, and a cap isn’t the right approach, she says.
“What does the administration think they’re solving?” she says. “I spend all my time trying to get people to save more. The only person I’ve seen who seems to have more than they need is Mitt Romney.”
The administration is seeking to encourage Americans to save as much as possible, Treasury Secretary Jacob J. Lew said at an April 11 House Ways and Means Committee hearing.
“Tax incentives have to be looked at in the context of the tradeoffs,” he said.
The cap would probably affect well-off professionals such as lawyers and doctors, while the ultra-rich would find ways to avoid it, Munnell says. Tax shelters mean that a cap devised to prohibit Romney-sized accounts may mostly end up hitting those with far fewer resources.
“What Obama is doing here is throwing the baby out with the bath water,” Rubin says. “The ultra-affluent community is very nimble.”
To contact the reporter on this story: Zachary Tracer in New York at email@example.com.
Photo: Official White House photo by Pete Souza
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