RMD Rules for Longevity Annuities Finalized

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By W. Mark Smith, Esq.,

 Joanna G. Myers, Esq., and

 Carol T. McClarnon, Esq.

Sutherland Asbill & Brennan LLP, Washington, DC

Longevity annuities are contracts that provide life annuity
payments typically commencing at age 80 or 85; in many (but not
all) cases, that is the only benefit the contract provides. As
such, these contracts may offer cost-effective "tail risk"
protection for a retirement plan participant's decumulation
strategy. However, that contract design - in particular, the
economic value of the future annuity payments that are not
available for distribution prior to the specified age, and the
possibility of a "doughnut hole" in distributions if a plan
participant's other plan balances are exhausted prior to that age -
raises questions under the required minimum distribution (RMD)
rules for account balance plans, which mandate that the RMD be
based on the entire account balance.

Regulations (T.D. 9673, 79 Fed. Reg. 37633 (July 2, 2014)),
finalizing a February 2012 proposal (REG-115809-11, 77 Fed. Reg.
5433 (Feb. 3, 2012)) and effective immediately, provide a method
for compliance with the RMD requirements applicable to qualified
defined contribution plans, individual retirement accounts (IRAs),
and §403(b) and governmental §457(b) arrangements for "qualifying
longevity annuity contracts" (QLACs). Under the regulations, the
value of QLACs are excluded from the account balances used to
determine RMDs, and QLAC distributions would be treated as meeting
the RMD requirements. The final regulations substantially follow
the approach of the proposed regulations, with a number of helpful
refinements and clarifications provided in response to comments on
the proposal.

QLAC definition. Generally to constitute a QLAC under
the regulations:

  • The amount of premiums paid for the contract may not exceed the lesser
    of $125,000 or 25% of the employee's account balance on the date of
  • The specified annuity starting date (ASD) must be no later than the
    first day of the month next following the employee's attainment of
    age 85 (subject to any adjustments published from time to time by
    the Internal Revenue Service (IRS) for changes in mortality). After
    the ASD, the contract distributions must satisfy the RMD rules.
  • The death benefit must be a life annuity.
  • The QLAC may not be a variable contract, equity-indexed contract or
    similar contract, although the IRS is authorized to publish in the
    future guidance providing an exception to this limitation, and a
    contract providing for either dividends or cost-of-living
    adjustments as described in the RMD regulations is permissible.
  • The QLAC may not provide a commutation benefit, cash surrender value or
    similar right, except as noted below.
  • The QLAC must state in the contract form or in a rider or endorsement
    or in a group certificate, when issued, that it is intended to be a
    QLAC, except that contracts issued before 2016 have until December
    31, 2016, to incorporate this language.
  • The issuer of the QLAC must satisfy certain disclosure and annual
    reporting requirements.

Limitation on premiums. The 25% limit applies
separately to each plan, including §403(b) plans, except that for
IRAs it applies across all of the taxpayer's IRAs (other than Roth
IRAs). A QLAC may be held in any of the taxpayer's permissible
IRAs. Annuities purchased under a Roth IRA will not constitute a
QLAC because Roth IRAs are not subject to the RMD requirements
applicable prior to an employee's death.

The $125,000 limit applies to all plans and is reduced by any
premium payments an employee has previously made for the same
contract or for any other contract under any other plan that is
intended to be a QLAC.

For purposes of determining whether premiums exceed the dollar
or percentage limitation, an IRA provider may generally rely on an
IRA owner's representation, unless the issuer has actual knowledge
to the contrary.

Maximum age at commencement. The regulations allow a
participant to elect an earlier ASD than age 85 if the QLAC
provides such an option.  However, QLACs are not required to
permit commencement prior to age 85.

Permissible benefits after the death of the employee.
As in the proposed regulationsl, the final regulations permit a
QLAC to provide a life annuity after the employee's death. Thus, a
contract that permits payment in the form of a life annuity with a
period certain upon death would not be a QLAC.

If the sole beneficiary under the QLAC is the employee's
surviving spouse, the only benefit permitted to be paid after death
is a life annuity payable to the surviving spouse that does not
exceed 100% of the annuity payment payable to the employee. The
regulations provide an exception that will apply when necessary to
comply with the qualified preretirement survivor annuity rules.

In the case of a non-spouse beneficiary, to satisfy the minimum
distribution incidental benefit requirements under §401(a)(9)(G),
the regulations provide that the life annuity upon death is not
permitted to exceed an applicable percentage of the annuity payment
payable to the employee.  The applicable percentage is
determined under one of two tables - the percentage described in
the existing table in Reg. §1.401(a)(9)-6, A-2(c) or a new table
set forth in the final regulations. The first table is only
available if no death benefits are payable to a non-spouse
beneficiary in any case in which the employee selects an ASD that
is earlier than the specified ASD and dies less than 90 days after
making that election, even if the employee's death occurs after the
selected ASD. The new table under the regulations is available when
the contract provides a pre-annuity-starting-date death benefit to
a designated non-spouse beneficiary.

In addition, in response to comments, the final regulations also

permit a QLAC to provide, either before or after the ASD, a return
of premium benefit (premiums paid less QLAC distributions) on the
death of the employee in a single life QLAC or, if coverage is also
provided for a surviving spouse, on the death of both the employee
and the spouse.  This death benefit must be paid in a single
sum no later than the end of the calendar year after the calendar
year of the employee's and/or spouse's death as applicable. This
payment is not eligible for rollover.

Disclosure and annual reporting requirements. The final
regulation omits the initial disclosure of the proposed regulation,
in light of otherwise applicable disclosure requirements under
state and federal law, but retains the requirement of an annual
report to the employee (by January 31 of the following year) and
the IRS (by a filing date to be specified by the IRS) under
§6047(d) including at least:

  • A statement that the contract is intended to be a QLAC;
  • Identifying information about the contract issuer;
  • Identifying information about the contract owner;
  • If the QLAC is purchased pursuant to a plan, identifying information
    about the plan;
  • If payments have not commenced, the ASD, the amount of the periodic
    annuity payable on that date, and whether that date may be
  • The date and amount of premiums paid during the calendar year;
  • The total premiums paid for the contract through the end of the
    calendar year;
  • The fair market value of the QLAC as of the end of the calendar year;
  • Other information that the IRS may require.

The IRS will prescribe a form for this purpose. Reports must be
filed starting with the first calendar year for which a premium is
paid and ending with year in which the employee attains age 85 (or
other adjusted age) or dies, except that if the surviving spouse is
the sole beneficiary, reporting must continue until the surviving
spouse starts receiving payments or dies.

Defined benefit plans. Treasury requested further
commentary on the possible replication of the QLAC structure in
defined benefit plans, including as an alternative to a lump-sum
distribution, and deferred consideration of those issues for
potential future guidance.

For more information, in the Tax Management Portfolios, see
Bosley and Hutzelman, 370 T.M.
, Qualified Plans - Taxation of
Distributions, Kennedy, 367 T.M., IRAs and in Tax
Practice Series, see ¶5520, Plan Qualification

© 2014 Sutherland Asbill & Brennan LLP.

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