changes insure, as Congress intended, that annuities will be used for long-term savings and retirement.

The administration has presented no evidence that additional changes are needed at this time. They have argued instead that taxing the inside buildup on annuities and life insurance contracts is necessary in order to insure that such contracts are not accorded more favorable tax treatment than savings instruments with other financial intermediaries. Mr. Chairman, the premise of the administration's line of reasoning, that annuities are essentially no different from bank savings account, is entirely faulty. In contrast with savings deposited in a bank, the purchase of an annuity confers on the policyholder the guarantee that at retirement these savings will be returned in the form of a stream of payments that will continue for the balance of his life.

In addition, the administration has totally failed to analyze the role that deferred annuities play in individual retirement planning. There is no doubt that annuities serve a valuable social function in insuring that individuals have adequate income during their retirement years.

While IRA's are an important vehicle for saving for retirement, they do not nor can they meet everyone's individual needs. And, as I have already pointed out, because annuities are purchased with tax-paid rather than tax-deductible dollars, existing tax treatment of annuities is far less favorable than that accorded to IRA's. Indeed, it is a very modest incentive to individuals who are genuinely concerned about the adequacy of their retirement income.

In conclusion, the Committee of Annuity Insurers urges this committee to reject the administration's proposal to tax the inside buildup on annuity contracts. The current basic tax treatment of deferred annuity contracts is grounded in sound tax policy and social policy. The annuity contract must be allowed to survive. Thank you, Mr. Chairman.

[The prepared statement follows:]

STATEMENT OF THOMAS R. ANDERSON, ON Behalf of the Committee of ANNUITY

INSURERS

Mr. Chairman and other distinguished members of the Committee, my name is Thomas R. Anderson, and I am Chief Executive Officer of Kemper Investors Life Insurance Company. Our home office is in Chicago, Illinois. I appreciate this opportunity to appear before you today to present the views of the Committee of Annuity Insurers on the President's "Tax Proposals to the Congress for Fairness, Growth, and Simplicity" (the "Administration Proposals") and, in particular, on the Administration's Proposal to alter the tax treatment of nonqualified deferred annuity contracts.

The Committee of Annuity Insurers, a coalition of 25 of the leading annuity writers in the country, was formed in 1981 for the purpose of monitoring legislative and regulatory issues at the Federal level that affect annuity policyholders and annuity writers. In 1984, member companies of the group accounted for almost 3 of the total annuity premium volume in the United States. A list of the member companies of our coalition is attached.

Mr. Chairman, while I deeply appreciate the opportunity to present to you the comments of the Annuity Group, in all candor, I am surprised that the need for my appearance here today has followed so closely on the heels of my last appearance before this Committee two years ago on the same subject-the taxation of life insurance companies and life insurance products. That hearing in May of 1983, marked the beginning of what proved to be a long, complex and arduous process, during which this Committee, and in particular, the Select Revenue Measures Subcommittee, fashioned a wholesale reform-and I must emphasize the word reform, for it

was genuinely that-of the provisions of the Internal Revenue Code relating to the taxation of insurance companies and life insurance products, including nonqualified annuities. As respects deferred annuities, a combination of the 1984 Deficit Reduction Act and related provisions of the Tax Equity and Fiscal Responsiblity Act of 1982 significantly altered the applicable tax rules, in ways that ensure that nonqualified annuity contracts in fact are used to provide retirement income.

Now, fewer than six months after many of the annuity reform provisions included in the Deficit Reduction Act became effective, the Administration is proposing further changes in the taxation of annuity products and annuity companies. Many of these changes were specifically considered, and rejected, by the Congress just last year. While we support the Administration's overall goal of tax reform and tax simplification, we believe that, even in the context of overall tax reform, additional changes in the taxation of insurance companies and insurance products are not needed. In general, we share the concerns expressed in the statement of the American Council on Life Insurance on the insurance provisions in the Administration Proposals. However, we wish to limit our comments to one aspect of the Administration Proposals-the proposal to tax the so-called “inside build-up” on deferred annuity contracts.

Under the Administration Proposals, an annuity policyholder would be taxed currently on the interest credited to his or her annuity contract (the so-called "inside build-up") even though the policyholder has not received these amounts either directly or constructively. Thus, under the Proposal, the policyholder would be put in the position of paying a tax on income he cannot effectively receive-assuming he wants to retain the basic benefits he acquired with the purchase of his annuity. The policyholder would incur ongoing negative cash flow (because of the tax he would pay) for the privilege of purchasing the annuity. Not only does this Proposal represent a fundamental change in the taxation of insurance products, it is contrary to both sound tax policy and sound social policy. If enacted, it would very likely tax out of existence one of the best retirement products that is presently available to the American public. The reasons advanced by the Administration in support of its Proposal are neither compelling nor convincing. In 1978, and again in 1983-1984, Congress had before it similar proposals to tax the inside build-up on annuity contracts. Both times these proposals were rejected. This Congress should do likewise. To comprehend fully the Proposal currently being advanced by the Administration, it is essential that we clearly understand the present state of the tax law regarding nonqualified annuity contracts and how we arrived at the current tax treatment. First of all, the annuity contract is not a tax avoidance device. The premiums for a nonqualified annuity are paid in after-tax dollars, that is, such premiums are not deductible from gross income. Furthermore, current law does not allow interest on annuities to escape tax-it only permits a deferral of tax. All income credited to the contract is eventually taxed at ordinary income tax rates when money is actually received by the policyholder. Ordinary income tax rates apply even though, in the case of variable annuities, a portion of that income may have been generated from long-term capital gains.

In 1982 and 1984, Congress, after exhaustive review, made substantial changes to the tax treatment of annuities in order to ensure that such contracts are utilized for long-term investment and retirement purposes. As a result of these changes, if a policyholder makes a premature withdrawal from an annuity contract, the amount withdrawn is considered to come first from gain that has accrued under the contract, until all such gain has been taxed. In addition, with limited exceptions, a penalty tax of five percent is imposed on withdrawals from a deferred annuity that occurs before the holder has reached age 59%. For these purposes, a loan against, or pledge of, the annuity contract is treated as a taxable distribution. Furthermore, to curb any potential for continuing deferral of tax after the death of the annuity policyholder, a provision was added in 1984 requiring (except in the case of a transfer to a surviving spouse) that distributions under the contract, which operate to terminate any tax deferral, be commenced at the time of the policyholder's death. In addition, the Technical Corrections Act of 1985, which is currently pending before this Committee, would expand these "forced distribution" rules to include transfers by gift as well as by reason of death.

Our experience has shown that the changes enacted in 1982 and 1984 ensure, as the Congress intended, that annuities will be used for their basic purpose-to provide for the long-term retirement needs of the American people. Hence, the fundamental objection to deferred annuities raised by the Administration in its tax reform proposal-that they can be used like a bank savings account to shelter shortterm savings-has already been addressed by Congress. The Administration, which

supported the 1982 and 1984 revisions, has presented no evidence that additional changes are needed at this time.

In support of its Proposal, the Administration does argue that such taxation is necessary to ensure that annuity contracts are not accorded more favorable tax treatment than "savings" instruments with other financial intermediaries. Otherwise, according to this line of argument, the flow of "savings" dollars will be directed to life insurance companies and away from other financial intermediaries.

Mr. Chairman, the premise of the Administration's line of reasoning-that annuity contracts are essentially no different from bank savings accounts-is entirely faulty. In contrast with savings deposited in financial institutions, the purchase of a deferred annuity also confers on the policyholder a guarantee that, at retirement, these savings, plus interest, will be returned to the policyholder in the form of a stream of payments that will continue for the balance of his or her life. The decision by Congress to impose a penalty tax on pre-retirement withdrawals from a deferred annuity operates to ensure that annuity contracts will in fact be held until the time of retirement. These considerations operate as a deterrent to the purchase of annuities for purposes other than retirement, and significantly undermines the Administration's unsupported apprehension that preservation of the existing tax treatment of annuities will divert non-retirement savings to annuity companies from other financial intermediaries. Indeed, the Administration has offered no convincing argument to the contrary and has not presented any evidence demonstrating that other financial intermediaries have experienced a decline in deposits due to annuity sales. In its Proposal, the Administration has also argued that the current tax treatment of annuities favors wealthy individuals, since such individuals have more disposable income available for savings. Such "reasoning", however, totally ignores the fact that wealthy individuals can achieve much greater rates of return and tax preferences from other "investments", such as, for example, municipal bonds.

Finally, the Administration has totally failed to anaylze the role that deferred annuities play in individual retirement planning. In this connection, the Proposal is especially noteworthy for what it fails to say. There is no doubt that annuities serve a valuable social function in ensuring that individuals have adequate income during their retirement years. Mr. Chairman, one of the greatest fears expressed by our customers-both old and young alike-is the real or anticipated inability of social security (1) to keep pace with inflation for those already retired, and (2) to provide any benefits at all for those whose current contributions are being counted on to carry the system. As recent events have shown, a financially sound social security system alone cannot ensure that an individual's retirement years will be free from financial worry. It is critical, then, to support savings programs which bridge the gap between social security benefits and an adequate retirement income.

While Individual Retirement Accounts ("IRSs") offer an important supplement to personal savings for retirement, they do not, nor can they, meet every individual's needs. For example, during their early working years and their family-rearing years, many middle income individuals are just not financially able to set aside $2,000 each year in an IRA. As a result, the funds they ultimately contribute to an IRA, beginning at age 45 or 50, will not provide sufficient retirement income. That same individual could, however, purchase an annuity contract at age 50 and still be assured that he or she will have adequate retirement income. With an annuity, an individual is guaranteed that he or she can receive periodic payments for life, thereby offering a way of eliminating the risk, and the fear, of out-living one's resources. The reason that only with an annuity can an individual be guaranteed lifetime income is that such a guarantee involves the assumption by the insurance company of substantial mortality risks for years into the future. While banks may guarantee specified interest rates, they cannot make lifetime guarantees. Because of this, the annuity has been characterized as the most certain, convenient, and complete protection against dependency available to an individual today. And, as we already have pointed out, because annuities are purchased with tax-paid, rather than taxdeductible, dollars, existing tax treatment of annuities is far less favorable than that accorded IRAs. Indeed, the tax deferral present in a deferred annuity is a very modest incentive to individuals who are genuinely concerned about the adequacy of their retirement income.

Rather than discouraging savings through annuity contracts by adopting the Administration's Proposal, Congress should act to preserve the incentive to retirement saving through such socially desirable arrangements. This is especially appropriate since, like other life insurance products, annuities play an important role in our nation's economy as a source of investment capital. Through the end of 1983, for example, life insurance companies had invested over $150 billion in all forms of investment, thereby placing life insurance companies fourth among all private domestic

institutional sources of funds. Taxing the inside build-up on annuity contracts would curtail the availability of such funds for long-term investment and would significantly impede capital formation.

CONCLUSION

The Committee of Annuity Insurers urges this Committee to reject the Administration's Proposal to tax the inside build-up on annuity contracts. The current basic tax treatment of deferred annuity contracts-which has prevailed since 1913-is grounded in sound tax and social policy. A policyholder should not be taxed currently on income he or she has not received, either directly or constructively. As a matter of social policy, the reasons for the traditional taxation of annuities have not diminished with time. In fact, today more than ever we as a Nation need to encourage individuals to provide for their own security in their retirement years. For many, the annuity provides an essential supplement to public and private pension plans. For others, it provides the only source of retirement income outside of social security. The annuity contract must be allowed to survive.

COMMITTEE OF ANNUITY INSURERS

Aetna Life and Casualty Insurance Company.

American General Life.

American International Group.

Anchor National Life.

Capitol Holding Corporation.

Capital Life Insurance Company.

Charter Insurance Group, Inc.

Church Life Insurance Corporation.

CIGNA Corporation.

Equitable Life Assurance Society of the United States.

Family Life Insurance Company.

Fireman's Fura Insurance Company.

Guardian Life Insurance Company of America.

Hartford Life Insurance Company.

IDS Life Insurance Company.

Integrated Resources Life Companies.

Kemper Life Insurance Companies.

Keystone Provident Life Insurance Company.

Life Insurance Company of the Southwest.
National Benefit Life Insurance Company.
Nationwide Life Insurance Company.
New York Life Insurance Company.

Northwestern National Life Insurance Company.
Sun Life of Canada.

Travelers Insurance Companies.

Mr. STARK. Thank you, Tom, very much.
Mr. Deer.

STATEMENT OF JAMES A. DEER, VICE PRESIDENT, ANCHOR NATIONAL LIFE INSURANCE CO.

Mr. DEER. My name is James Deer. I am vice president and associate general counsel for Anchor National Life Insurance Co. I would like to express my appreciation to the members of this committee for the opportunity to appear before you today. Anchor fully supports the statements of the Committee of Annuity Insurers, and of the ACLI, of which it is a member. Anchor opposes the adoption. of the administration's proposals to tax the internal buildup on deferred annuities.

Our comments today will focus on five basic reasons why the internal buildup in annuities should not be taxed until it is received by the contract holder. First taxation of inside buildup in deferred annuities conflicts with the goal of encouraging individuals to save for their own retirement.

Second, contrary to its stated purpose the proposals would not ensure a level playing field among comparable financial insitutions and products due to the fundamental differences in function and product design and the disparity in Federal and State regulations of the various types of financial institutions and products.

Third, taxation of inside buildup in annuities would inhibit capital formation and economic growth.

Fourth, taxation of inside buildup before it is received by the contract holder is contrary to the longstanding and simplifying tax principle of constructive receipt, that tax should not be imposed on amounts that cannot be received without sacrificing substantial rights and benefits.

Fifth, Congress has examined taxation of annuities twice in the last 3 years and has already made substantial changes to discourage the use of annuities as short-term investment vehicles.

TEFRA and the 1984 act made extensive changes in the taxation of deferred annuities. The uncertainties inherent in these changes, as well as changes in other areas of the life insurance tax laws, caused Congress to mandate a Treasury study of the functioning of the act, including its effect on insurance products. Interim reports were provided as well as a final report due January 11, 1989. The required studies have not been undertaken, the reports have not yet been made, yet Treasury would now have this committee legislate again without any knowledge of the effects of the prior legislation. We submit that action at this time is premature.

If the Treasury study were conducted today, it might show some interesting things. For instance, it would show that at Anchor National, the average value for a fixed annuity account issued by Anchor was approximately $11,500. The cumulative premium for the same account was $8,100. The average age of annuity purchasers, as determined by a special study which I conducted of our products for the month of June 1985, was 51.7 years. This tells us that the average annuity purchaser is a person of relatively modest means using this program in their later years to create additional funds before retirement.

If these trends are confirmed on a broader basis, the reform provisions of the 1982 and 1984 legislation will have accomplished their goal.

Finally, I want to say a few words about the level playing field concept. Because of the differences in function and purpose it is our view that level playing field argument is really an attempt to compare apples and oranges.

Treasury cannot seriously want us in the business of checking, demand deposits, or consumer loans. We don't think a life insurance company will be improved by these additional lines of busi

ness.

Our products are essentially different. Savings deposits and CD's are short-term and very flexible instruments with finite risks limited to the value of the account.

An annuity is a long-term arrangement with life contingencies to supply an income that the holder cannot outlive. We have no special expertise in auto and consumer loans. The banks have none in long-range life contingencies.