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Variable Annuities Not Meeting 415 Requirements


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A good number of DB Plan customers want to offer variable annuities as a distribution option to retiring plan participants but they are raising 415 limit concerns with me because the annuity payout is based primarily on a stock index and a rising stock market could cause a 415 limit violation in any given year. Pursuant to 415(b) the annual benefit for 415 purposes is a straight life annuity with equal installment payments. Pursuant to the 1.415(b)-1 regulations, there must be an adjustment to a variable annuity so that it is the actuarial equivalent of a straight life annuity beginning at the same time. Further, the regs. address a payout with an "automatic benefit increase feature", where certain complex annual limitation requirements must still be met, and it seems that a variable annuity which automatically adjusts the annuity payout based on the performance of a stock index could be an automatic benefit feature. Then there is example 10 of 1.415(b)-1(c) which seems to address a variable annuity and states that 417(e)(3) does not apply and that to determine the actuarial equivalent of a straight life annuity a 5% interest rate return on assets must be used.

This is somewhat confusing to me so does anyone have experience determining whether a variable annuity whose payout is based on a stock market index or performance, meets the 415 annual payout requirements, and if so, how?

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13 hours ago, Effen said:

Why not just pay a lump sum and if the person really wants a variable annuity, they can buy one outside the plan.    

Yeah. Actually it's hard to believe that's not exactly what they're trying to sell - a variable annuity IRA. Not that it's a good idea.

I guess if the plan doesn't permit lump sums then that's a different story.

Ed Snyder

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The owners of the business and HCE's want the variable annuity option for the plan. The plan does not permit lump sum distributions. The Regs, 1.415(b)-1 seem to permit variable annuities as a viable option for a DB plan that can still remain in compliance with 415.  Any guidance anyone can provide on interpreting these regs and what is required to offer a variable annuity option in a DB plan that meets 415, would be approeciated.

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I think the only possibility is to purchase some type of variable annuity with a cap of the 415 limit.  I'd agree with Effen and Bird in that this is a terrible idea and you should use your consulting skills to have them consider amending the plan to allow lump sums instead of including this......stuff.

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1.  Offering a variable annuity as a optional payment form is a non-starter because it must be actuarially equivalent to the normal benefit, which involves a static payment stream.  If the payment stream can fluctuate, or has a guaranteed minimum, then you couldn't determine how much benefit you're purchasing for equivalency, or you have to purchase an initial payment that is less than the normal benefit equivalent to account for possible future increases.

vs

A. The decision to purchase a variable annuity product to provide for the payment of the participant's elected optional payment form is a fiduciary decision and must be made with all necessary and applicable due-diligence, and cannot create a benefit/right/feature that is only available on a discriminatory basis.

  1.   Whose benefits are being paid in this manner?
  2.   What is the cost of the annuity vs making monthly payments vs paying a lump sum?
  3.   It must have a guaranteed floor as the monthly payment must be expected to be actuarially equivalent and thus cannot decrease in any future period.

I would disagree with the notion that it must be capped for 415; it's not the Plan's responsibility what happens after the lump sum is paid or annuity is purchased, as long as all due diligence was demonstrated during purchase.  For example, if someone took a lump sum payment in April 2020, enjoyed a 40% return through the end of 2020, and then annuitized the balance in his IRA; is the Plan responsible to then step in and say to the IRA custodian that you can't make a 140% monthly payment.  No.  Also, isn't it mathematically a 415 violation if the participant outlives his expected mortality and continues to get paid his benefit for an additional 5, 10, or 15 years?  On a value basis, yes, but again the Plan doesn't have the ability to exercise that level of control once the payment stream begins.

Considering the interest rate climate for the last 20 years, annuities serve three purposes:  continue retiree payments upon plan termination(or to pay relatively smaller benefits so as to eliminate annual administration costs); use up excess assets to avoid a reversion; and provide a higher deductible contribution to a young owner in a 412 arrangement.  Anything else and you have to look closely to see just how much of a commissionable benefit the sale is to the broker/agent!

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  • 3 weeks later...
On 4/4/2022 at 3:28 PM, Ananda said:

they are raising 415 limit concerns with me

They would with me too, Ananda. I think your general impression and analysis are correct.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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