IRS Wants to Offer RMD Relief for Longevity Annuity Contracts in 403(b)/457, Other Retirement Plans

Guidance on how longevity annuity contracts purchased under 403(b) and eligible 457 retirement plans — as well as certain other retirement plans — can comply with the required minimum distribution (RMD) rules under Code Section 401(a)(9) was proposed Feb. 3 by the IRS.

Code Section 401(a)(9) prescribes rules for a qualified trust under which the distribution of each participant’s entire interest must begin by the required beginning date — generally April 1 of the calendar year following the later of the calendar year in which the participant: (1) attains age 70-½; or (2) retires. If that doesn’t occur, RMD requirements kick in. Section 403(b) plans and eligible deferred compensation plans under section 457(b) are among the plans subject to the RMD rules.

Last year, the IRS, Treasury and the U.S. Department of Labor sought public comments on whether changes to the RMD rules could or should be considered to encourage arrangements under which participants could purchase deferred annuities that begin at an advanced age (sometimes referred to as longevity annuities or longevity insurance). Several commentators noted one impediment to the RMD rules is the requirement that, before annuitization, the annuity’s value be included in the account balance that is used to determine RMDs:

This requirement raises the risk that, if the remainder of the account has been depleted, the participant would have to commence distributions from the annuity earlier than anticipated in order to satisfy the required minimum distribution rules. Some commentators stated that if the deferred annuity permits a participant to accelerate the commencement of benefits, then, in order to take that contingency into account, the premium would be higher for a given level of annuity income regardless of whether the participant actually commences benefits at an earlier date. Some commentators also noted that longevity annuities often do not provide a commutation benefit, cash surrender value, or other similar feature.

Based upon these comments, Treasury and the IRS concluded that “substantial advantages” exist to modifying the RMD rules to make it easier for a participant to purchase a deferred annuity that is scheduled to commence at an advanced age — such as age 80 or 85 — using a portion of his or her account. Accordingly, the proposed regulations (77 Fed. Reg. 5443) would provide that before annuitization, a participant could exclude the value of a longevity annuity contract that meets certain requirements from the account balance used to determine RMDs.

In exchange for this special treatment, qualifying longevity annuity contracts (QLACs) would be subject to dollar and percentage limitations and other requirements, and certain disclosure and reporting rules would apply to the issuers of such contracts.

Specific to 403(b) plans, the proposed rules would apply the tax-qualified plan rules, instead of the IRA rules, to the purchase of a QLAC. For example, the premium limitation would be separately determined for each 403(b) plan in which an employee participates. The tax-qualified plan rules relating to reliance on representations, rather than the IRA rules, would apply to the purchase of a QLAC.

Regarding eligible 457(b) plans, the proposed regulations relating to the purchase of a QLAC under a tax-qualified defined contribution plan would automatically apply. However, the rule relating to QLACs is limited to eligible governmental 457(b) plans, according to the IRS.

Generally, the QLAC requirements would not become effective until a specified period after final rules are published in the Federal Register. Accordingly, the existing rules under Code Section 401(a)(9) continue to apply.

A public hearing on the rules is scheduled for June 1, 2012, and topic outlines must be received by May 11. The IRS is also accepting written or electronic comments until May 3. Electronic comments can be sent via the Federal eRulemaking Portal at http://www.regulations.gov (IRS REG-115809-11). Details on the rules, the public hearing and comment submittal can be found here.

An analysis on the proposed rules will appear in The 403(b)/457 Plan Requirements Handbook, published by Thompson Publishing Group.