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Guest Article

(From the January 11, 2010 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Rules Favorably on New Annuity Products for Defined Contribution Plans

The issue of income sufficiency and security in defined contributions plans is a front-and-center issue for both the Department of Labor and the Internal Revenue Service according to their 2010 Regulatory Agendas. Consistent with that focus, the IRS recently released a Private Letter Ruling addressing the use of a new variable annuity product in defined contribution plans. Private Letter Ruling 200951039.

Variable Annuity Contracts under Defined Contribution Plans

In the ruling, a life insurance company proposed to issue non-qualified group variable annuity contracts to qualified defined contribution plans by which plan participants would be offered an annuity form of distribution. Under the annuity form of distribution, the participant would allocate amounts from his or her account among the investment options under the group annuity, which would include a fixed account option and variable investment options. Distributions would be made to the participant based on those allocations, providing a stream of income over the lifetime of the participant (or joint lifetimes of the participant and beneficiary) through two phases.

Proposed Phase I Features

The initial phase would run for five (5) years or longer, as selected by the participant at the time the annuity option was elected. During the initial phase, each periodic payment would be calculated as the product of the account value and an annuity factor. The annuity factor would be based on the participant's age and sex, the assumed interest rate used to determine the amount of the periodic payments (which rate would be selected by the participant at the time the annuity option was elected), the frequency of the periodic payments, and the length of the initial phase. At any valuation date, the account value would be adjusted upward or downward by net investment gains or losses, and by any periodic payments that were made after the last valuation date. During the initial phase the participant would have the option to start or stop the periodic payments, to lengthen or shorten the initial phase, to pay additional premiums for the group annuity (by allocating additional portions of his or her account under the plan to the group annuity), to request a partial lump-sum withdrawal, to surrender the group annuity for its surrender value, or to change the joint annuitant. After the initial phase the participant would no longer be able to make such changes.

In the event the participant should die during the initial phase, a death benefit equal to the account value of the group annuity would be provided. The beneficiary could elect to receive the amount in a single sum or in a variety of life annuities that satisfy the IRC § 401(a)(9) minimum distribution requirements.

Proposed Phase II Features

The second phase would provide continued periodic payments in the form of contingent annuity payments (as opposed to the periodic payments in the initial phase, which would essentially be withdrawals from the account). Annuity units (based on the sub-accounts in which the account is invested) would be used to calculate the payments during the second phase. The payments might increase or decrease based on the investment return, but could not exhaust the value of the group annuity and would continue for the life of the participant (or joint lives of the participant and beneficiary).

In the event the participant should die during the second phase, continued payments would be provided in the form elected by the participant (which must satisfy the IRC § 401(a)(9) minimum distribution requirements). The group annuity would likely be used by plans to pay a qualified joint and survivor annuity during the second phase. Like the annuity payments that are otherwise paid during the second phase, payments to the surviving spouse would be based on a specified percentage of the "annuity units" that were used to calculate the payments during the joint lives of the participant and spouse, rather than a specified percentage of the dollar amount that was paid during that period.

IRS Rulings

Although narrow in scope, the IRS gave a green light with regard to three key aspects of the proposal.

MRD Requirements: The IRS agreed with the position put forth by the insurance company applicant that minimum required distributions during the initial phase would be determined under the rules applicable to defined contribution plans (i.e., Treasury Regulation § 1.401(a)(9)-5), and during the second phase would be determined under the rules applicable to defined benefit plans (i.e., Treasury Regulation § 1.401(a)(9)-6).
Election under IRC § 411(a)(11): The IRS ruled that a participant's election to take the annuity form of distribution - rather than the election to receive payments during the initial phase or the second phase - is the point at which the IRC § 411(a)(11) requirements apply (i.e., the joint and survivor annuity requirements, notice requirements, etc.). The IRS categorized an election to take the annuity form of distribution as an election to receive a future benefit in the form of a life annuity, preceded by the distribution of a benefit not in the form of a life annuity.
Qualified Joint and Survivor Annuity: In what might be viewed as a surprising conclusion, the IRS agreed with the position put forth by the insurance company applicant that the annuity payments made during the second phase could be considered payments under a qualified joint and survivor annuity - notwithstanding the fact that the payment amounts would vary with investment performance - provided that the payments otherwise satisfy the joint and survivor annuity requirements. Although the payment amount would fluctuate, the IRS observed that payments to the surviving spouse would be based on not less than one-half of the amount of the annuity units used to calculate the annuity payable during the joint lives of the participant and spouse, and that would result in an annuity that has the effect of a qualified joint and survivor annuity under IRC § 417(b).

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955.

BenefitsLink is an independent national employee benefits information provider, not formally affiliated with the firms and companies who kindly provide much of the content and advertisements published on this Web site, including the article shown above.