Enter to open, tab to navigate, enter to select
IRS Issues Final Regulations Simplifying Use of Annuities in Retirement Plans
Practical Law Legal Update 8-573-0626 (Approx. 4 pages)
IRS Issues Final Regulations Simplifying Use of Annuities in Retirement Plans
by Practical Law Employee Benefits & Executive Compensation
| Published on 03 Jul 2014 • USA (National/Federal) |
The Internal Revenue Service (IRS) issued final regulations relating to the use of longevity annuity contracts in defined contribution plans. These regulations provide guidance necessary to comply with the required minimum distribution (RMD) rules under Section 401(a)(9) of the Internal Revenue Code (IRC) applicable to a plan that holds a longevity annuity contract.
On July 1, 2014, the IRS released final regulations relating to the use of longevity annuity contracts under tax-qualified defined contribution plans, Section 403(b) plans, IRAs and eligible governmental Section 457 plans. The regulations provide guidance necessary to comply with the required minimum distribution (RMD) rules for an IRA or plan that holds longevity annuity contracts.
Purchase of Longevity Annuity Contracts under Tax-qualified Defined Contribution Plans
The final regulations modify the RMD rules under IRC Section 401(a)(9) to facilitate the purchase of longevity annuities that begin at an advanced age (for more information on the RMD rules, see Practice Note, Required Minimum Distributions from Retirement Plans). A longevity annuity is an income stream that is scheduled to commence at an age in the future and that continues as long as the individual lives, for example, an annuity under which payments begin at age 80 or 85. The RMD rules previously required that the distribution of a participant's entire interest begin by April 1 of the calendar year following the later of the calendar year in which the participant attains age 70 1/2 or the calendar year in which the participant retires.
Under the final regulations, the participant is able to exclude the value of a longevity annuity contract (that meets certain requirements) from the account balance used to determine RMDs and is only required to receive RMDs during the period before the annuity begins. Therefore, an annuity contract can be designed with a fixed annuity starting date (ASD) at an advanced age since a participant would not need to commence distribution from the annuity contract to satisfy the RMD rules. These annuity contracts are referred to in the final regulations as qualifying longevity annuity contracts (QLACs).
The proposed regulations were issued on February 2, 2012 (see Legal Update, IRS Proposes Guidance Simplifying Use of Annuities in Retirement Plans) and are similar to the final regulations. Major differences between the final regulations and the proposed regulations include:
- Limitations on premiums. Like the proposed regulations, the final regulations:
- limit the amount a participant is permitted to use from his account balance to purchase a QLAC to the lesser of 25% of the participant's account balance or $125,000 ($100,000 under the proposed regulations); and
- provide that the dollar limit will be adjusted for cost-of-living increases in $10,000 increments ($25,000 under the proposed regulations).
- Longevity annuity premiums exceeding the limits. Individuals that inadvertently exceed the 25% or $125,000 limit on premium payments may correct the excess without disqualifying the annuity purchase.
- Certain death benefit options. A QLAC may offer a return of premium (ROP) feature. This permits purchasing retirees to receive the premiums they paid but have not yet received as annuity payments. This option is appealing to individuals seeking peace of mind since if they die before receiving the annuity as their initial investment is returned to their accounts and passed on to their heirs. The proposed regulations provided that the only benefit to be paid after the employee's death was a life annuity payable to a designated beneficiary that met certain requirements.
- More flexibility in issuing longevity annuities. The proposed regulations required that a longevity annuity contract state that it is intended to be a longevity annuity contract. The final regulations allow such a statement to be included in an insurance certificate, rider or contract endorsement.
- Disclosure and annual reporting requirements. The final regulations retain most of the proposed regulations' disclosure and annual reporting requirements, except for the requirement that the issuer of a QLAC provide a disclosure containing information about the QLAC at the time of purchase. The final regulations do not require this initial disclosure.
The final regulations are effective for QLACs purchased on or after July 2, 2014. In order to avoid surrender charges for contract reissuances and prevent the absence of disclosure forms from delaying the benefit of the final regulations, there is a transition rule that allows an existing contract to be exchanged for a contract that satisfies the requirements to be a QLAC.
Practical Implications
Employers generally have been hesitant to offer annuities in their defined contribution plans due to regulatory barriers, which increased costs and were administratively burdensome. Overall, these final regulations should allow retirement plans to more easily offer their participants annuity options, which will give participants a wider range of choices in how they receive their benefits. Insurance companies also may begin to offer QLAC products now that the regulations are finalized.
Individuals also may welcome the ROP feature since for QLAPs that offer this feature, if an individual dies before receiving an annuity, the original premium can be returned to the individual's heirs.
For more information, see Practice Note, Requirements for Qualified Retirement Plans.