5500 Preparer's Manual for 2012 Plan Years
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The IRS has privately ruled in IRS Letter Ruling 200951039 on a number of issues regarding the effects of Code Secs. 401(a)(9) and (11) and 417 on a proposed transaction in which variable annuity contracts will be issued to, and distributed from, defined contribution plans. Issues addressed include required minimum distribution requirements, election of payments in the form of a life annuity, and annuity payments under a qualified joint and survivor annuity.
A life insurance company proposes to issue two types of nonqualified variable annuity contractsa group variable annuity contract and an individual variable annuity contractto qualified defined contribution plans. The plan will be named as the owner of the group annuity. The group annuity will be used to offer plan participants an annuity form of distribution ("annuity distribution option") among other optional forms of distributions. Participants who elect the annuity distribution option will then allocate amounts among fixed and variable investment options.
Distributions from the group annuity will be paid to the plan as the owner of the annuity. The plan will then distribute amounts to the participants who chose the annuity distribution option. The distributions will begin after the participants allocation of amounts and will be calculated based on the allocations and other factors.
Stream of income payments
The group annuity generally provides a stream of income payments to be made over the lifetime of a participant or the joint lifetimes of a participant and designated beneficiary through two phases. Phase I begins on the valuation date on which the first periodic payment is calculated and ends on the date phase II begins. In phase I, the participant controls the amount, duration, and timing of payments. The group annuity provides for a payment upon the death of the participant during phase I equal to the value of the account.
After phase I ends, periodic payments continue in phase II. The payments are life contingent annuity payments (in contrast to payments in phase I, which are treated as withdrawals against the account), and the participant no longer has the right to control the amount, duration, and timing of payments as in phase I. The group annuity provides for continued payments in the form elected by the participant upon the death of the participant in phase II, as long as the payments satisfy the minimum required distribution requirements of Code Sec. 401(a)(9).
The life insurance company intends to issue individual annuities when a plan that was the owner of a group annuity ceases to offer the group annuity and the plan wants to preserve the option for participants. In this case, the life insurance company will issue the individual annuity to the plan and the plan will then deliver the annuity to the participant who is listed as the owner of the annuity. The individual annuity will operate much the same as the group annuity.
The IRS concluded that, for purposes of satisfying the required minimum distribution requirements of Code Sec. 401(a)(9), the required minimum distributions from the group and individual annuities will be determined under IRS Reg. 1.401(a)(9)-5 during phase I and under IRS Reg. 1.401(a)(9)-6 during phase II. Under the regulations, the manner in which benefits paid under an annuity contract must satisfy Code Sec. 401(a)(9) depends on whether the annuity contract has been annuitized. Prior to the date that the annuity contract is annuitized, the contract is treated as an individual account plan for purposes of Code Sec. 401(a)(9) and must satisfy the rules of IRS Reg. 1.401(a)(9)-5. After the annuity contract is annuitized, the contract must satisfy the rules of IRS Reg. 1.401(a)(9)-6. The IRS observed that it has been represented that the amount and timing of payments in phase I will be within the control of the participant and, thus, do not fit the definition of amounts received as an annuity as described in IRS Reg. 1.72-2(b)(2). However, in phase II, the timing and amount of payments are fixed and satisfy the definition of amounts received as an annuity. Also, it has been represented that the group and individual annuities will be regulated by the states as deferred annuity contracts during phase I and as annuitized or payout annuities during phase II. The IRS said that these representations suggest that the distributions should be considered annuitized at the commencement of phase II.
Election of life annuity
As to when an election by a participant is an election of a life annuity for purposes of Code Sec. 401(a)(11), the IRS ruled that the election of the annuity distribution option constitutes the election of payments in the form of a life annuity. Neither the participants election to receive periodic payments during phase I nor the election to receive periodic payments during phase II alone is an election of a life annuity. The IRS noted that the participants right to control payments in phase I is generally inconsistent with the election of a life annuity. After the end of phase I, the periodic payments continue throughout phase II, when the payments are life contingent annuity payments, which are consistent with the election of a life annuity. As represented, a participant elects the annuity distribution option before the start of phase I and does not necessarily make a subsequent election prior to the start of phase II. In this situation, according to the IRS, the initial election of the annuity distribution option is an election to receive a future benefit in the form of a life annuity, preceded by a distribution of a benefit that is not in the form of a life annuity. Accordingly, for purposes of determining when Code Sec. 401(a)(11) applies to a participant, the election of the annuity distribution option is the election of payments in the form of a life annuity.
Qualified J&S rules
The IRS concluded that the fact that annuity payments in phase II vary with investment performance does not preclude the payments from being considered payments under a qualified joint and survivor annuity described in Code Sec. 417, provided that the payments would otherwise be considered made under a qualified joint and survivor annuity. It was represented that when the group annuity is used by a plan to pay a qualified joint and survivor annuity during phase II, the payments to the surviving spouse will be based on a specified percentage of "annuity units" used to calculate payments during the joint lives of the participant and the spouse instead of a specified percentage of the dollar amount that was payable. It was further represented that this might result in payments to a surviving spouse of a dollar amount that was either less than the one-half of, or greater than, the dollar amount of the annuity payable during the joint lives of the participant and the spouse that is required by Code Sec. 417(b). However, the IRS noted that it was represented that the payments to the surviving spouse will be based on not less than one-half of, nor more than the amount of the annuity units that would be used to calculate the annuity payable during the joint lives of the participant and the spouse. The IRS agreed that this results in an annuity that has the effect of an annuity described in Code Sec. 417(b).
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