Annuitization from DC plans suffers from the lack of clarity on a number of key technical rules, which need to be resolved before such annuities can be widely implemented. The IRS has taken a major step in its issuance of PLR200951039, a complex PLR which- for the first time-defines what an annuity really is for purposes of DC annuitization, and when the annuity election election occurs. This is critical for determining which RMD rule applies, and when spousal consents will be required. It also, very importantly, recognizes the Plan Distributed Annuity (see my prior blogs) and the qualification rules which will apply to them.
Even the informed reader is likely to get lost in trying to parse through this particular PLR. Suffice it to say that there is a highly involved set of facts related to an insurance company’s specific group and individual annuity products. The relevant features are:
- It is an annuity purchased by a DC plan for distribution to participants-either from the group annuity contract held by the plan (and not being a "plan asset", by the way) or as an individual annuity contract purchased by the plan and distributed to a participant-the classic Plan Distributed Annuity.
- The contracts have account balances within them which are invested in variable separate accounts. The retirement distributions from these contracts are actually treated by the contracts as withdrawals from the account balance. Every dollar taken out reduces the account balance by the same amount.
- At the time the participant starts taking payments, the participant elects how the amount of the withdrawals will be calculated. The choice is that the payment will be equal that which would be paid under either a single life annuity or a joint and survivor annuity. This particular product gives the participant the right to actually choose the interest rate at which the annuity will be determined.
- The amount of the withdrawal is adjusted every year to reflect investment performance relative to the interest rate selected. It is also adjusted for any "extra" withdrawals taken by the participant during the year.
- At a certain age (typically age 85, but the plan can elect the age, within a range), the account balance actually disappears. All payments now come directly from the insurance company, not from the participant’s account, and that payment is guaranteed for a lifetime. This particular product has an interesting twist, called "variable annuitization." This feature actually allows the participant to elect to have their annual payment adjusted in accordance with investment performance using a sort of "phantom" set of accounts.
Here’s what the IRS has importantly said:
- Payment as an annuity/not as an annuity. Payments made from the contract after the account balance is "shutdown" IS annuitization. All payments before then are NOT considered annuitization, but systematic or periodic withdrawals (let’s call it the "access period"). Those "access period payments" are also considered RMDs, but only up to up to the calculated RMD amount. (This, by the way, means that the amounts up to the RMD cannot be rolled over, but the amounts in excess of that can be).
- Application /Timing of spousal consent rules. Spousal consent is required at the time the participants elects distribution from the annuity- even though the payments during the access period are "non-annuity" payments. Electing the form of computing the payment at the time withdrawals begin is necessary under this product to make the systematic withdrawal "match up" with the actual annuity payments, to make it resemble a guaranteed income stream that is set for life. This then makes the election the same thing as currently electing an annuity payout at age 85 (or whatever age is elected), even if the intervening periodic payments are not paid as an annuity. This means that the spousal consent must be received if the basis for computing the payment (and ultimate annuity payment at a later age) is other than (at least) 50% Joint and Survivor. Though one may quibble whether this is the right decision, we finally have a rule we can use. As a practical matter, this may cause some problems if there is an intervening divorce and remarriage during the access period.
- Spousal beneficiary. The account balance during the access period will still be subject to the spousal consent rules on the naming of the beneficiary.
- RMD. In determining the RMD, the RMD for the for payments during the access period will be determined using the account balance under the standard DC rules. AFTER the account balance disappears, the DB method of computing the RMD will apply.
Finally, it is the overall message of the PLR which bears importance: the IRS further affirms the tax treatment of an annuity that was distributed from the plan, for an annuity that meets the requirements of 404(a)(2).
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