Annuitized 90-24 transfers

[Guest Zahorik]

Some Insurance Co's. won't allow annuitzed 90-24 transfer of individual 403(B) contracts if the employee is under age 59 1/2, and or, still in service. I know you can't take distribution till some key triggers take place, but a) why can't annuity settlement payments be transfered under Rev. Rul. 90-24 to avoid being a distribution, b) If the IRS allows this, how can the Insurance Co. prohibit it?

[jlf]

Is the 403b funds in a payout phase via annuitization? Please clarify.

[Michael Devault]

It is OK to make a transfer under the provisions of Revenue Ruling 90-24 using a payout option, just as long as the option doesn't extend beyond 10 years. The IRS has informally said that it doesn't care about the contractual mechanism used to make transfers, just as long as the the transfer adheres to the provisions of Revenue Rulin 90-24.

But, there's a rub: Revenue Ruling 90-24 is permissive, not mandatory. Transfers are permitted, but vendors are not required to make them. Thus, a number of insurance companies hide behind this in an effort to conserve business. (I guess they feel it's better to keep business on the books than it is to do what their customers' ask.)

Also, a number of companies won't make transfers if there is an existing loan on the policy. This makes more sense, because the value in the annuity is serving as collateral for the loan. And, regulations prohibit reduction of the account balance to offset a loan prior to a distributable event.

Hope this is of some help to you.

[jlf]

Michael,

Why can't the annuitized period be more than 10 years?

[Guest Zahorik]

Thanks Michael, fact about "not mandatory" is a big help.

One more thing though, It's my understanding that a vendor can not discriminate, if they provide for 90-24 transfer for one client, they must provide for all. Is this true?

[Michael Devault]

JLF:

The period can be more than 10 years, but can't extend beyond the required beginning date for required minimum distributions. Companies have a difficult time determining the RMD on policies that are in a "payout status." Additionally, there are concerns about conflict with the direct rollover rules, since the first money out of a policy are deemed to satisfy the RMD rules, thus not transferrable. I suggest less than 10 years for two reasons: First, there's generally no reason to extend the transfer longer than that. Second, use of a less-than-ten year period avoids confusing the transfer from Eligible Rollover Distributions.

Zahoric:

It's my understanding that insurance companies may not discriminate in favor of a class of policyholders. In this context, a class means those policyholders that have annuities issued on the same form. If Annuitant A has their policy on form A123 and Annuitant B has a later policy on form X789, they represent two different classes. The company can permit transfers on one class, but can deny them on the other class.

Most annuities used as 403(B) funding media contain provisions that allow the insurer to maintain the integrity of the 403(B) plan. Some companies "hang their hats" on that language and deny transfers prior to a distributable event. Others, as I mentioned, won't make transfers on policies with loans.

In short, there seems to be no consistency in the industry regarding transfers. Some companies make them, others try to hold onto money for dear life.

[Guest RJT]

Michael, the answer's a bit different than you propose. A 90-24 transfer only applies to payments which are not distributions from the contract. 90-24 replaced 1035 exchanges for 403(B) contracts, making it clear that a contract exchange (per 90-24) or was not a distribution which may otherwise be subject to taxation. It is merely substituting one contract (or a part of one contract) with another.

An annuity "settlement" payment,as describe in Zahoic's question, is a DISTRIBTRUION from a contract under the terms of the annuitization(and not merely an exchange of contracts), which is not therefore eligbile for 90-24 treatment.

If the payment is a distribution, then it is subject to the rollover rules, not the 90-24 trnasfer rules.

Because an annuity payment is typically over a person's lifetime (or if it is for a "period certain" exceeding 10 years), it cannot be rolled over either, because of the rollover rules, and the person becaomes subject to tax on those payouts.

It is virtually impossible to do a 90-24 transfer of an annuitized contract. First, a 403(B)(7) couldn't do it because it is not held by an insurance comany. Secondly, where two insurance companies are involved, both companies would have to separately value the annuity stream of payments and negotiate the value of the income stream being transfrred-none of which is easily done.

It gets a little muddy when a contract is not annuittized, as the individual actually has a choice to either do a 90-24 transfer or a direct rollover. The one restriction is that the individual cannot do a 90-24 transfer of non-annuitized RMD amounts. RMD amounts are distributions, not exchanges, and therefore cannot be afforded 90-24 treatment. They also cannot be rolled over.

Michael, I suggest that insurance often deserve some of the bad press they receive, but not on this one.

[Michael Devault]

RJT, I agree that there is a distinction between transfers pursuant to Rev. Rul. 90-24 and direct rollovers. As you properly pointed out, direct rollovers can be made only when distributions are permitted from the 403(B), such as age 59-1/2 or separation from service (soon to be called "severance of employment"). Transfers are made under the provisions of Rev. Rul. 90-24.

Prior to Rev. Rul. 90-24, the only way to transfer funds from one 403(B) to another was under the provisions of Rev. Rul 73-124. There were a number of steps involved in this type of transaction, including the involvement of the employer. Further, the entire account balance in the annuity had to be moved... no partial transfers were permitted.

Rev. Rul. 90-24 did a number of things, including the revocation of Rev. Rul. 73-124, permitting of partial transfers, and allowing the transfers to be made trustee-to-trustee.

In the classic sense, annuity settlement payments could be considered distributions. However, in the real world, settlement options may be used to effect trustee-to-trustee transfers. It is entirely possible for a policy owner to elect a term certain payout for 5 years, for example, and have those payments sent to another insurance company under the provisions of Rev. Rul. 90-24. Insurance companies do this every day, and, as I mentioned in my previous post, the IRS doesn't care about the contractual method of making the transfer... they just want the provisions of Rev. Rul. 90-24 to be followed.

You brought up a good point. Such transfers should be completed before the Required Beginning Date. If the transfer has not been completed before then, it is quite difficult to value the policy in the payout phase for RMD purposes. However, if all the money has been transferred to a new contract, the RMD can easily be determined.

If an individual has the choice between a transfer and a direct rollover, they should almost always select the direct rollover, primarily because the insurance company is required to permit it. However, as you pointed out, this is not always the case: Unless a distribution is permitted, direct rollovers are not an option. In that case, the only way to move money is by way of Rev. Rul. 90-24 transfer. Some insurance companies will not permit them because they say that the money can't be transferred unless a distributable event occurs. And, if a distributable event occurs, you can make a direct rollover. (Seems like an endless circle, doesn't it.) This is my concern about insurance companies. If they have a client who wants to move money, and their policy form permits a term certain payout, they should permit the transfer to be made. As I pointed out, some companies do so quite willingly. Others, however, try to hang onto the money like it theirs, not their clients. The latter companies are the ones that need to examine their practices.

Thanks, RJT, for helping me clarify my response. As you pointed out, the distinction between direct rollovers and transfers can get cloudy at times.

[Guest Zahorik]

Michael, thanks again. I'm another step closer to an answer. Let me share some details and see where it goes.

Case example; 52 year old teacher still employeed with a 403(b)two tiered annuity contract having a higher "annuity value", and a lower "cash value", no outstanding loans. Cash value is for full or partial surrenders, annuity value is available if annuitizing for a minimum 5 year period certain according to contract. This contract issuer will allow 90-24 transfer of the lower cash value, but won't allow 5 yr annuitized transfer unless over 59 1/2, and or, seperated from service. This puts them in the minority of carriers as the majority will 90-24 transfer either value assuming annutization meets their minimum time frame for annuitizing. What basis, if not specified in the contract, does the issuer have to legally put perameters as to what they will and won't release for transfer upon contract owners request?

[Michael Devault]

Zahoric, the companies that offer two tiered contracts are the ones who are generally the most reluctant to help their policy holders. In my opinion, that makes sense because the products that they offer shows some level of contempt for their customers, anyway. As you pointed out, they get the lower tier upon surrender and can only get the higher value if the contract is annuitized. What is less known is that a number of these companies use a pretty low interest assumption in determining their payout options. One company was sued over the fact that they used zero percent for calculation of payout factors on one of their products. Incredible!

In my experience, these companies won't permit a 5 year payout prior to separation from service or attainment of age 59-1/2 by relying on a policy provision that couples the policy to the Internal Revenue Code for purposes of maintaining the "qualified" status of the policy. IRC section 403(B)(11) states that amounts in a 403(B) attributable to salary reduction can't be distributed unless one of the qualifiying events occur.

This gets back to the discussion with RJT surrounding the differences between distributions and transfers. The two tier companies hang tight on the idea that (a) distributions require a qualifying event and (B) their policy forms don't contain provisions for transfers.

Unfortunately, there's not much a client can do except (a) stay in the policy and hope that the company will treat them fairly when the contract is annuitized using the accumulation value at retirement or (B) take their lumps and transfer the lower cash value.

[Guest Zahorik]

Michael, are there any grounds the contract owner has to file complaint with the state insurance commisioner, or anything to support a fight with the insurance co. on this issue?

[jlf]

It is quite apparent that for all distribution options, other than lifetime annuitization, a 403b retiree would be much better served by investing in mutual funds through a 403(B)(7) Custodial Account rather than in an Annutiy Contract through 403(B)(1).

Additionally the IRS needs to let us know which one of its two guidelines needs to be followed in order to have an "eligible rollover distribution". Guidline 1: On May 19, 1995 the IRS issued a General Information Letter setting forth its position that the access restrictions found in Code Sec. 403(B)(11) are a condition precedent to a distribution---and therefore a rollover---of salary reduction amounts. Or, Guideline 2: In contrast to its Information Letter, the IRS states in its IRM Handbook 7.7.1, Chapter 13, at 13.9.2(1) c. (May 21, 1999):..."there must be a distribution event under the plan or contract to have an eligible rollover distribution."

Unlike the Information Letter, the Handbook Guideline recognizes that the specified distribution events for eligible rollover distributions was repealed under Sec. 403(B)(8) with the UCA '92. This repeal reflects Congressional intent to eliminate the universality of specific distribution events in order to have an eligible rollover distribution. The repeal, as reflected in the Handbook, indicates Congressional intent to have the Plan Document, not the Code, establish the events upon which a participant can have an eligible rollover distribution. In my view the Handbook guideline supercedes the General Information Letter.

The Handbook guideline further recognizes that 403(b)11 is the early distribution provision of section 403(B) while 403(B)8 is the rollover provision.

Best wishes,

Joel L. Frank

[Michael Devault]

Zahoric, there have been countless complaints filed with various state insurance departments which generally lead to no where. The states generally take the position that if no insurance law has been violated, there is no issue in which they should become involved. When they receive a complaint, they forward a copy to the offending insurance company which, in turn, responds to the client and the insurance department. Case closed.

Another approach is for the policy owner to keep screaming until something is done. This "squeeky wheel gets the grease" approach may work, but companies are pretty tough on these issues.

Sorry that I can't give you a more positive outlook.

[Guest Zahorik]

Thank you.