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Title: Understanding IRAs

Difficulty: Beginner

Description: As an investment professional, Individual Retirement Accounts

(IRAs) are a natural place to start helping your clients with

retirement planning. The IRA is a powerful tool to help clients retire

in dignity. What is the difference between Traditional and Roth

IRAs? How can the Stretch IRA help with estate planning? This

series gives you a better understanding of Traditional and Roth

IRAs and some of the decisions your clients may face in planning

for retirement.

The Genesis of Individual Retirement Accounts

Employee Retirement Income Security Act of 1974 (ERISA)

The Employee Retirement Income Security Act of 1974 (known as “ERISA”) established legal

standards for employee benefit plans, and introduced tax-deductible Individual Retirement

Accounts (IRAs) as a way for Americans to save for retirement. In the decades since IRAs

were created, IRA contribution limits and personal tax deductions have increased; employers

can establish special IRA plans for employees; and Roth IRAs were created, allowing

nondeductible contributions that can accumulate tax-exempt earnings for years to come.

IRA Definition

An IRA is a tax-favored personal retirement savings plan to which the account owner may

make contributions up to limits permitted per year (indexed for inflation). An account owner

may “rollover” a qualified pension, profit sharing, or Keogh account to an IRA when no longer a

participant in a former plan (or roll an IRA account into a qualified plan in some situations).

There are two basic types of IRAs: (a) traditional and (b) Roth. Let’s get started with some

basics in the law:

There is always a written IRA trust or custodial account document. Individuals cannot be

IRA fiduciaries. Trustees and custodians must be financial institutions such as banks,

federally insured credit unions, broker-dealers, or other organizations that demonstrate

trustworthiness to the IRS. [CFR §1.408-2(e)(2)(i)(A)]

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IRA issuers must provide account owners a “disclosure” statement and a copy of the

plan (and any projections or guarantees), within seven days of purchase.

Compensation includes salary, wages, commissions, self-employment income, alimony,

separate maintenance, or nontaxable combat pay. Compensation doesn’t include

deferred compensation, earnings and profits from property, interest and dividend

income, pension or annuity income, income from certain partnerships, or Conservation

Reserve Program payments.

Contributions may be made as late as April 15th (excluding any extensions) of the year

following the tax year on behalf of which the contribution is made. For example,

contributions for 2016 may be made until April 17 of 2017.

Contributions must be in cash and are limited to the lesser of (a) 100% of compensation

included in gross income or (b) the maximum contribution limit.

An account owner can make a contribution for a non-working spouse if (a) they file a

joint return, and (b) the “non-working” spouse’s compensation is less than the working

spouse’s compensation included in his gross income for the year.

Within seven days of purchase, the account owner may revoke an IRA plan without

paying sales commissions or administrative expenses.

An IRA account owner will normally have an option to complete a beneficiary

designation form. If there is no beneficiary form, the plan itself determines who receives

everything at death.

Anyone can establish an IRA. But to claim a tax deduction for contributions, the account

owner must have compensation and must not have attained age 70½ during the year

for which the contribution is made.

Contributions cannot be invested in life insurance, artwork, rugs, metals, gems, stamps,

antiques, coins, alcoholic beverages, and certain other tangible property. However, a

plan may invest in certain gold and silver US coins, coins issued by states, and some

platinum coins. A plan may purchase certain gold, silver, platinum and palladium bullion

if the bullion remains in the physical possession of an IRA trustee.

Contributions must be nonforfeitable under the plan.

Contributions in excess of those permitted under current contribution limits will incur a

6% excise tax even if made inadvertently.

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The excise tax can be avoided if the excess contribution (and any income attributed to

it) is withdrawn before the due date (April 15th, plus extensions, if any) of filing an

income tax return.

IRA investments can include cash (such as an IRA savings account or CD), mutual

funds, and variable or fixed annuity contracts, among others.

IRA accounts are exempt from an owner’s creditors if necessary for the support of the

owner and his or her dependents

The Bankruptcy Abuse Protection and Consumer Protection Act of 2005 (BAPCPA)

provides a $1 million (adjusted periodically for inflation) exemption for contributory IRAs

regardless of the need for support. Qualified retirement plan assets that are rolled over

into an IRA are completely protected from bankruptcy proceedings even if the amount

exceeds $1 million. SEP and SIMPLE IRAs are also excluded from bankruptcy

proceedings.

The law permits another personal retirement savings account. It is an Individual

Retirement Annuity, and is subject to the same rules as IRAs. The annuity contract must

not permit (a) assignment of the policy to cover a loan, or (b) forfeitability for missing a

premium payment. Someone other than the owner may make annuity payments, but

only the owner or surviving beneficiaries may receive benefits from the annuity contract.

Without paying an income tax, an IRA may be transferred directly to a spouse (or a

former spouse) under a divorce or separate maintenance decree. The IRA is then

maintained solely for the former mate.

An IRA pledged as collateral for a loan is taxable to the extent of the assignment.

The income tax on taxable IRA withdrawals before turning 59½-years of age is

increased by 10% of the portion of the amount includible in gross taxable income. This

is the commonly referred to “penalty tax on premature distributions.”

A nondeductible cash contribution of $2,000 annually is permitted to a Coverdell

Education Savings Account (ESA) – formerly known as an “Education IRA” – for

designated beneficiaries. All distributions are tax-free if they are for qualified higher

educational expenses of the beneficiary paid in the same year the distribution is made.

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In the past, workers counted on employer pensions to see them through retirement. Today,

Americans have become increasingly responsible for their own retirement plans so they can

retire and have more control over their financial future. IRAs represent one of the largest and

fastest growing shares of the US retirement market; and it is expected that IRAs’ share will

continue to grow. Here are a few reasons why:

Contribution Limits - IRA contributions limits rise gradually. For 2016, the maximum

contribution to all of a client’s traditional and Roth IRAs if you’re under 50 is $5,500. The IRA

contribution limit does not apply to rollover contributions or qualified reservist repayments.

Catch-Up Provisions for Those Over 50 Years of Age - There are “catch-up” provisions

where those 50 and over can increase their annual contribution. For 2016, if you are 50 and

over you can contribute $6,500.

Control Over Investments and Account Features - Individuals control their personal IRA

investments, beneficiary designations and payout options; that makes IRAs much more flexible

than most 401(k) and pension programs, which tend to provide limited opportunities for

creative financial and estate planning.

Protection From Creditors – As of April 1, 2016, the first $1,283,025 (adjusted periodically for

inflation) inside traditional and Roth IRA accounts, under most circumstances, is fully exempt

from creditors of an account owner in bankruptcy. The amount over the exemption is subject to

state laws regarding creditor protection. Generally, these plans are protected because of the

penalties and costs incurred by the account owner to access the funds.

It should be noted, there are a handful of States that treat Roth IRAs differently. Roth IRAs are

funded with after-tax dollars, which limits the penalties and costs a debtor may incur by

accessing the funds within a Roth.

This is an industry hot topic. IRA protection from creditors does not apply to all

circumstances. In 2014, the U.S. Supreme Court ruled that funds from an inherited IRA are not

“retirement funds” and, therefore, do not qualify for an exemption from the debtor’s bankruptcy

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estate (Clark v. Rameker, STc., June 12, 2014). The best protection you can provide your

client is to ensure IRA accounts are protected based on the laws of the State in which your

client resides or holds the IRA.

U.S. Treasury Rules - The U.S. Treasury finalizes the rules for distributions from IRAs and

qualified retirement plans. The Treasury makes regulations as they pertain to defined benefit

plans and annuity contracts providing benefits from qualified plans, IRAs and 403(b) contracts.

Traditional IRAs

Traditional IRAs give account owners tax deductions with the benefit of tax-deferred income

earned for the account. Here are some additional rules for these IRAs:

1. Individual tax deductions are limited to the contributions limits (under “the ground rules”

supra), on his or her own behalf to a traditional IRA. However, if an account owner is an “active

participant” in a qualified corporate or Keogh pension, profit sharing, stock bonus or annuity

plan, simplified employee pension, 403(b) tax sheltered annuity, simple IRA or governmental

plan, deductions are reduced or eliminated depending on the taxpayer’s filing status and

Modified Adjusted Gross Income (MAGI).

2. MAGI for purposes of the IRA deduction is adjusted gross income before the IRA deduction

increased by certain excluded income or deductions (such as student loan interest).

3. Deductions for contributions by a married person for a spouse are limited by the lesser of:

The maximum contribution limits of $5,500 (in 2016 [adjusted periodically]) for those

under 50; and

100% of the non-working spouse’s includable compensation, less (i) the amount of any

IRA deduction taken by the working spouse, and (ii) the amount of any contribution to a

Roth IRA by or for the non-working spouse.

4. Once 70½, contributions are no longer permitted to a person's traditional IRA.

5. An IRA deduction is available even though other deductions aren’t itemized. It is an “above

the line” deduction.

6. IRA administrative or trustee fees paid separately are deductible. Sales commissions paid

separately are not.

7. An account owner may elect not to deduct contributions otherwise deductible.

Nondeductible contributions are limited to the excess of the maximum deductible contribution

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over the amount actually claimed as a deduction. (And, nondeductible amounts are reduced by

contributions made that year to a Roth.) The sum not deducted builds a "cost basis" for the

account. Later, when distributions are made from this traditional IRA, the account owner

excludes a portion from taxes.

Example: At age 70½, George has $1 million in traditional IRAs; this includes a nondeductible

contribution of $10,000 (1%). He withdraws $40,000. Accordingly, $400 (1%) of his distribution

is tax-free. Each year that George makes withdrawals from his traditional IRA, he will repeat

this calculation until these exclusions equal $10,000; and then, all withdrawals are taxable.

8. There may be a 10% penalty tax on pre-age 59½ distributions, which will be explained later.

9. Distributions must begin by April 1st following the taxable year an account owner attains age

70½.

Roth IRAs

Roth Rules

Roth IRAs are personal retirement savings plans that don’t give tax deductions for

contributions, but permit accumulations to build up tax-free. (This makes Roth IRAs attractive

to those who expect to have a higher tax rate at retirement.) Here are some additional rules

applicable to Roth IRAs:

Roth IRAs must be designated clearly when established.

Unlike traditional IRAs, contributions to Roth IRAs are permitted after 70½.

Contributions to individual and spousal Roth IRAs (disregarding any active participant

restrictions) are reduced by any contributions (deductible or nondeductible) for the year

made to traditional IRAs.

The Examples within the course rely on more simple, rounded

figures for the purpose of teaching the concept rather than

requiring memorization of numbers from life expectancy tables,

contribution charts, annual estate exemptions, tax rates, etc.

Further, the examples rely on the values assigned to the year for

which the example applies. It is incumbent on you, in your

practice, to use the most recently issued IRS values.

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For 2016, the Roth IRA contribution limit is phased out as indicated in this IRS illustration:

Excess contributions incur a 6% penalty tax. Internal Revenue Code (IRC) Section 4973

imposes a 6% penalty tax on certain excess contributions to a traditional or Roth IRA.

If the account owner is not a married person filing a separate return, he or she can

transfer a traditional IRA to a Roth IRA (technically, a “conversion”). A surviving spouse

beneficiary can also convert to a Roth. The amount rolled over is included in income as

if the traditional IRA was cancelled. Therefore, if only deductible contributions were

made to a former traditional IRA, the entire account value is taxable when rolled to the

Roth.

A Roth conversion is made from either:

A distribution from a traditional IRA to a Roth, within 60 days, or

A direct transfer to that Roth by an IRA trustee.

After five taxable years, distributions from a converted Roth IRA to an account owner

are income tax-free if he or she is 59½ or older; disabled; or the funds are used to

acquire, construct or reconstruct a first residence (or to pay its closing costs) up to

$10,000. The five year period isn’t waived simply because the account owner dies –

even though a beneficiary must usually begin taking withdrawals from the account in the

year following the year of death. However, these distributions are tax-free (up to the

original account owner’s original contribution). Once the five-year period expires, all

distributions are tax-free.

Unlike traditional IRAs, distributions needn’t commence at 70½ (or a spouse’s age 70½,

if he or she rolls over the account at the IRA owner’s death); in other words, Roth IRAs

o Your filing status is married filing jointly or qualifying widow(er) and your modified AGI is at least $184,000. You cannot make a Roth IRA contribution if your modified AGI is $194,000 or more.

o Your filing status is single, head of household, or married filing separately and you did not live with your spouse at any time in 2016 and your modified AGI is at least $117,000. You cannot make a Roth IRA contribution if your modified AGI is $132,000 or more.

o Your filing status is married filing separately, you lived with your spouse at any time during the year, and your modified AGI is more than -0-. You cannot make a Roth IRA contribution if your modified AGI is $10,000 or more. [IRS Pub 590]

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aren’t subject to the age 70½ required minimum distribution (RMD) rules for traditional

IRA account owners.

Rollover IRAs - The Basics

Congress Viewpoint on IRAs

Plain and simple, Congress wants taxpayers to use their IRA for retirement and not as an

emergency fund along the way. Consequently, IRA owners really need to know how to

navigate the rules on:

Withdrawals made before age 59½

RMDs after age 70½

Let’s look first at eligible rollovers, which are taxable distributions from retirement accounts that

can actually be put back into a tax-protected environment. Rollovers are transfers of funds

received from qualified plans, 403(b) annuities, eligible 457 government plans, and IRAs to

another qualified plan or IRA and which follow the requirements set out in the Internal Revenue

Code and Regulations. Rollovers are important because income taxes on the distribution

“rolled-over” are deferred into the future. Here are some of the rules:

When someone receives a distribution from an IRA, 403(b) annuity, eligible 457

government plans or qualified plan, a rollover must be completed within 60 days of

payment.

Since there is a mandatory income tax owed or withheld on all taxable distributions, a

taxpayer pays taxes on the amount of tax retained if he or she doesn’t personally add

this amount to the rollover. For instance, when Harry terminates employment, his

payout from the company’s 401(k) plan is $100,000. After the trustee withholds

$20,000 in taxes, Harry receives $80,000 net. He rolls over only his $80,000

distribution to an IRA. The result: Harry pays taxes on $20,000. And, he may owe a

10% early distribution penalty of $2,000. The solution: To avoid these taxes, Harry

must add $20,000 to his $80,000 distribution and rollover a full $100,000 to his IRA.

The reason: The law considers the $20,000 in withheld funds a “distribution eligible

for a rollover.” If the total amount of Harry’s payout isn’t rolled over it is taxed.

Qualified plans and 403(b) annuities must offer participants the option to have eligible

distributions transferred directly to an IRA or other retirement plan [a qualified defined

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contribution plan, e.g., profit sharing, 401(k) or money purchase pension] that accepts

rollovers. (In Harry’s situation, he could authorize a direct transfer of $100,000 to his

IRA, and there would be no income tax withheld.)

Rollover funds can be divided among several IRAs.

A participant can roll over all or part of any distribution from an IRA except: 1) a required

minimum distribution (RMD), or 2) a distribution of excess contributions and related

earnings.

As long as the RMDs are met, rollovers by individuals who have attained 70½ are

allowed.

A participant who received funds from a qualified retirement plan and placed them in his

wife’s traditional IRA, but not pursuant to a valid Qualified Domestic Relation Order

(QDRO) did not make a valid rollover.

What is a Qualified Domestic Relations Order?

A "qualified domestic relation order" (QDRO) is:

An IRA owner may receive funds from a traditional IRA and roll them into a qualified plan,

regardless of source. For example, someone with a large IRA might establish a new company

that creates a profit sharing plan. Then, she makes a direct rollover of the IRA into her qualified

plan account. As long as a surviving spouse is the sole beneficiary with an unlimited right to

withdraw amounts from her spouse’s IRA (or a portion of it), she may roll it over to her own IRA

at his death. Be aware: The trustee of a trust for her benefit has no automatic rollover right,

even if she is the only beneficiary of the trust.

A domestic relations order that creates or recognizes the existence of an "alternate payee's" right to receive, or assigns to an alternate payee the right to receive, all or a portion of the benefits payable with respect to a participant under a pension plan, and that includes certain information and meets certain other requirements. In divorce, a spouse or former spouse of a plan participant may rollover taxable funds received pursuant to a qualified domestic relations order (QDRO).

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This is an industry hot topic. “60 day rollovers”, i.e., indirect rollovers that allow a taxpayer to

receive the funds outright and re-contribute the same amount distributed within a sixty day

period to a new or the same IRA, are only permitted once per twelve month period. (Note that

this has nothing to do with the calendar year. Such rollovers can only be made once every

twelve months, regardless of how many IRA accounts an individual may have.) However, any

number of direct rollovers can be made that are trustee-to-trustee transfers between plans.

The Penalty Period, Up to Age 59½

Early Distribution from 401(k) and IRA Plans

If a client withdraws money from a traditional individual retirement account (IRA), 401(k),

403(b), or other qualified retirement plan before age 59½, he/she may be subject to an early

distribution penalty of 10%. There are exceptions. This penalty does not apply to Roth IRAs as

long as it has been at least five years since the Roth account was opened. Here's what you

need to know about the early distribution tax.

The additional tax on a distribution prior to turning 59½ is10% of the taxable distribution. The

taxable amount is also included in taxable income. This 10% tax is in addition to regular

income taxes. This is sometimes referred to as the premature or early withdrawal tax penalty,

because it is similar to the penalty banks charge when a savings account is liquidated early.

This can be avoided if the client meets certain criteria, but the withdrawal cannot avoid

inclusion in the taxable income. So you need to make sure clients consider the tax impact

before tapping into retirement accounts for short-term financial emergencies. When Congress

invented traditional and Roth IRAs as long-term retirement savings programs, it was meant to

discourage "early" withdrawals. The result: Most casual early distributions incur a 10% excise

tax, in addition to any regular ordinary income tax. In fairness, however, the law allows IRA

owners some basic exemptions from the tax on premature withdrawals. For example, there is

no 10% premature distribution tax on “early” IRA payments—

To an account owner, after he or she attains 59½;

To a beneficiary, or the owner’s estate, on or after the owner’s death;

After the account owner’s permanent disability; for an account owner’s medical

expenses that exceed the applicable percentage-of-adjusted gross income floor,

regardless of whether the account owner itemizes deductions on his or her tax return;

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For an unemployed account owner’s health insurance premiums;

For "qualified higher education expenses" (tuition, room and board, fees, books,

supplies and equipment - even graduate courses) for the account owner, her spouse

and their children or grandchildren;

For a "qualified" (no home ownership in prior two years) first-time homebuyer’s

expenses of acquiring, constructing or reconstructing a personal residence (including

settlement, financing and closing costs), – up to a maximum of $10,000 during the

account owner’s lifetime;

The portion of a distribution that is not included in taxable income because it constitutes

an account owner’s nondeductible contributions to the IRA;

On account of a federal tax levy;

Distribution to reservists while serving on active duty for at least 180 days; and

One-time (once in a lifetime) rollover distribution to a Health Savings Account.

Real Life Examples

Congress also protects “all substantially equal payments” from an IRA paid over the lifetime of

the account owner (or joint lifetimes of the owner and a beneficiary). What follows are three

real-life situations that show how this exemption might help the taxpayer:

Example One

Let’s say Agnes is 55, and needs $50,000 for a family emergency. Her $300,000 IRA has the

money, but a $50,000 distribution wouldn’t be protected from the 10% penalty tax under the

basic exemptions. Use the following strategy:

Step one: Agnes borrows $50,000 from a commercial lender, friend or relative. Assume

the lender charges 8% interest and her loan obligation is $12,500 annually for five years

- a total payback of $62,500.

Step two: She begins taking a series of “substantially equal payments” from her IRA that

simply amortizes the $300,000 account over her IRS life expectancy. The interest rate

must not exceed a reasonable interest rate (the IRS considers a reasonable rate to be

any rate that does not exceed 120% of the mid-term applicable federal rate (AFR) –

assume 1.5% – on the date payments commence, and the arrangement can’t be

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modified during the next 60 months unless the account owner dies or becomes

disabled.

Observations: Using a 1.5% interest rate (and say, a 29-year IRS unisex single life expectancy

under the Single Life Table –29.6 years rounded downwards), the taxable (but penalty-free)

IRA distribution is $12,834 annually; and this is nearly equal to her loan payment of $12,500

annually. The law requires a period of five years before ceasing or modifying this arrangement,

but (a) then she’ll be 60, and (b) the $50,000 loan will be fully repaid.

Example Two

Norman is 55 and wants to acquire a $500,000 life insurance policy payable to a charity. The

projected tax-deductible annual premium is $21,000 for a 10-year period. He has a $500,000

IRA and a 29.6 year IRS unisex single life expectancy. Use this strategy:

Applying a 1.5% interest rate over 29 years, Norman can withdraw $21,389, annually

from the $500,000 account. This “coincidentally” covers his tax-deductible premium of

$21,000, and is penalty tax-free. After 10 years when his policy is paid-up, he’ll cease

withdrawals. If the IRA has earned say, 8% interest (a 6.5% net gain) consistently, the

account will actually increase from $500,000 to about $770,000.

Example Three

At 55, John’s $300,000 personal residence (the basis is $50,000) is debt-free; and he wants to

upgrade to a $500,000 model. A $400,000 mortgage is available at a 5% interest rate

amortized over 30 years, and the mortgage payment is $25,767 annually (or about $2,147 paid

monthly). He has a $600,000 IRA. Use this strategy:

Step one: Calculate John’s IRS unisex single life expectancy which is 29.6 years.

Applying a 1.5% interest rate over 29 years, a “substantially equal” amortized payment

is $25,667 annually (and this nearly covers his mortgage payment). This distribution is

penalty tax-free.

Step two: John sells his present home tax-free because the gain of $250,000 ($300,000

less $50,000) isn’t taxable.

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Step three: John obtains the $400,000 home loan and will repay a total of $773,024,

including interest of $373,024 - $12,434 annually on average over 30 years. The tax-

deductible interest offsets about 48% of the yearly IRA taxable distributions of $25,667.

Step four: John reinvests (outside his IRA) $300,000 in sales proceeds from his home;

here are possibilities that make some “tax sense:”

Acquire a life insurance policy because of its tax-free inside buildup

Purchase a non-qualified, tax-deferred annuity where there are no RMDs at

70½. And, a surviving spouse beneficiary can also continue the contract (and its

tax deferral) until death or its maturity date

Buy growth oriented securities or real estate that has a basis step-up at death

Use a combination of each option

The result: John has “removed” much of his taxable IRA and sheltered almost half of the

taxable distributions. And, there is no 10% penalty tax. He’ll have $300,000 in tax-free funds

invested outside the IRA, and there won’t be any out-of-pocket mortgage payment. Finally, if

the $600,000 IRA can earn more than 1.5% interest, it will continue building on a tax-sheltered

basis.

Summary

Some words of caution: When recommending a series of payments to avoid the 10% penalty

on premature distributions, you don’t want to assume responsibility for how “reasonable” the

interest rate; ask your client’s tax adviser to make this determination. In summary, use your

imagination! There are many creative strategies to obtain IRA funds pre-59½. The penalty tax

is avoidable; this money can solve a number of financial problems and bring happy smiles to

many IRA client-owners.

Planning Period, 59½ to 70½

Income Tax Considerations

After age 59½, there are no more 10% penalty taxes to pay on premature IRA distributions.

(And, once a five-year “substantially equal payment period” expires and the owner is 59½, a

previous IRA distribution plan can be modified or cancelled without a tax penalty.)

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On the way to 70½, it’s time to plan ahead. Here’s why: Let’s say at 60, Mary has a $1 million

IRA to which she has contributed merely $100,000. The good news: By the time she is 70½,

this should double to about $2 million. The bad news: A maturing, traditional IRA is simply a

pile of taxable income that will be worth much less after income taxes and any transfer taxes at

her death. Mary needs a pre-70½ planning strategy to eventually gain maximum tax and

financial benefits under the law.

The federal estate tax was is part of the permanent tax code since implementation of the

American Taxpayer Relief Act (ATRA) of 2012 (passed in January 2013). ATRA makes the

estate tax permanent and is automatically indexed for inflation. The amount exempt from tax

per person in 2016 is $5.45 million (remember, automatically indexed for inflation) and the top

tax rate on amounts over the exemption is 40%.

Well, Mary is 60 and she has been contributing to an IRA over several decades. Her account is

worth $1 million; and is projected to be worth $2 million in about 10 years. Should she continue

the account and take RMDs beginning at 70½, or is it better to cancel and pay the taxes now?

The answer depends on her objectives and personal philosophy; it also hinges on some

common sense. If you think about it, this IRA has been financed with tax deductions on Mary’s

contributions and has only saved her the amount of her 30% tax bracket (contributions

multiplied by .30). In retrospect, would Mary do it again (or would she purchase tax-deferred

annuities instead)? The real issue though is probably what to do now given her needs,

personal philosophy and circumstances. Here is an analysis of how two advisers might look at

her $1 million IRA in its present form.

The Case for IRA Liquidation

Some believe rates are moving higher and income taxes will continue indefinitely. We already

know the federal estate tax is permanent and automatically indexed for inflation. Since a

traditional IRA doesn’t have a basis step-up at death, they also discount its value as an

inheritance fund. Therefore — Assuming Mary’s Gross Estate is $7 million, including $2 million

in an IRA, it could cost $620,000 in estate taxes and $552,000 in income taxes to pass the

account to the family. Here’s how these taxes are calculated:

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The Tax Calculation

$7,000,000 Gross Estate

- $5,450,000 Federal Estate Tax Deduction

= $1,550,000 Taxable Estate

+ $620,000 Estate Taxes at 40%

+ $552,000 Income Taxes on $1.38 million

IRA at 40%

= 1,172,000 Total Estate and Income Tax

The decedent’s estate will pay the estate taxes. The beneficiary (heir) will pay income tax on

the distributions from the IRA. Luckily, the beneficiary will receive an IRC section 691(c)

deduction for estate taxes paid which are allocable to the IRA. In our example, since all the

estate tax is attributable to the IRA, the beneficiary should pay no income tax on roughly the

first $620,000 of distributions. The remaining 1,380,000 would be taxable.

The Case for IRA Liquidation if the Client’s Goal is Inheritance Planning

A suggestion: It may be best to liquidate the $1 million IRA now and simply pay an income tax

of $400,000 on $1 million. Then, use the remaining $600,000 to purchase a one-pay life

insurance policy for say, $2 million, assuming reasonable mortality and interest projections.

The result: Since the insurance death benefit is income tax-free, a $2 million face amount is

worth more than $2 million in an IRA, before income taxes and the policy’s full value is

available immediately whenever death occurs. Therefore, if inheritance planning is the goal,

liquidating the IRA to buy replacement life insurance is worth considering. As with all

recommendations, the client must be made aware of the costs, fees and downsides of this

approach.

IRA Continuation

If an IRA is liquidated gradually (potentially in a lower tax bracket) – over, say, a 10-year period

– this may result in a gradually lowering tax bracket and reduce income taxes on distributions.

Of course, an insurance policy could be funded gradually over the liquidation period as well.

When (a) cash premiums are gifted to family to fund the policy; and (b) they own the contract,

presumably the death proceeds will be estate tax-free. Alternatively, the death proceeds from a

life insurance policy inside an irrevocable life insurance trust (ILIT) will be estate tax-free.

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The Case for IRA continuation

The second adviser, believes what counts now is tax deferral into the future. Why pay taxes to

liquidate an IRA currently if you don’t have to? (Actually, the same reasoning applies when

paying taxes to convert a traditional IRA to a Roth.) This adviser always focuses on building as

much as possible in tax-deferred investments such as IRAs. When emergencies come up,

theory says spend “outside” funds instead. It may even be best to borrow when extra cash is

needed for personal use. IRAs become the cornerstone to income at retirement and beyond. In

short, IRAs may never be taxed, and protected from creditors. They should be cherished for

generations to come. The name of the game is defer, defer and defer - and protect, shelter and

safeguard. A suggestion: There is a middle ground. An IRA owner can balance the

possibilities; she can take out a portion of her IRA accumulation and acquire life insurance for

inheritance planning purposes. At age 70½, she’ll take what’s necessary for personal use. If

the IRA runs-out, she can withdraw or borrow tax-free funds from the life insurance policy.

Summary

In summary, clients 59½ - 70½ have a 1-to-11-year window to make imaginative, long-range

decisions for themselves and families. They basically have two choices: (1) Liquidate their IRA

and reinvest in life insurance, annuities, or buy-and-hold securities, or (2) build-up the account;

then at 70½ take RMDs (or greater amounts, if necessary) and continue tax deferral as long as

possible. It might be beneficial to hold seminars that appeal to 59½ - 70½, preretirement

prospects that need a distribution plans of action.

The Retirement Period, 70½ Until Death

IRA Distribution Plan

Eventually, some traditional IRA owners don’t cash-out, attain 70½ and begin taking RMDs

under the rules. Let’s look at Harry and Mary Jensen. Here are their facts and circumstances:

Harry and Mary are a married couple, ages 70 and 67. Actually, he turned 70½ in January of

2015; their actual ages on December 31, 2016, will be 71 and 68. His traditional IRA account is

worth $1 million as of their December 31, 2014, year-end statement. The Jensens ask you to

design an effective IRA payout strategy. You accept the assignment.

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Some additional facts: Presently, the Jensens live comfortably on Social Security and a

$50,000 income from non-IRA investments. Their taxable income is also $50,000, and they

have good health insurance, credit and access to funds in an emergency. They really don’t

need an IRA income but are aware of the need to take distributions in the near future.

Eventually, they’ll pass what’s left to family. For now, they want to strengthen their

circumstances.

An IRA Distributions Plan of Action For Mr. & Mrs. Harry Jensen

Harry has $1 million in his traditional IRA. At 70½, he must take at least minimum distributions

from the account. If not, he’ll owe (1) regular income taxes, and (2) a 50% penalty tax on what

he doesn’t take. From Harry’s $1 million IRA, let’s say the RMD is (the statement balance as of

December 31, 2014 divided by life expectancy) $36,496. Unfortunately, he takes only $16,000.

Later, when his income tax return is audited, the missing amount is discovered. He’ll be

assessed a $10,248 (50%) penalty on the shortfall. The reason: Congress insists that account

owners start paying taxes on the tax-deferred buildup accumulated over the years when the

account owner reaches 70½. Since the government means business, it’s essential to have an

IRA distribution plan of action that conforms to your clients’ financial objectives.

Here are four payout possibilities to consider:

Strategy One: RMDs

At 70½, Harry must take at least a minimal amount from the IRA. Here is what you need to

know about the relevant regulations:

Harry may take the first IRA payment in the year (2016) following the year (2015) in

which he turned 70½ – but it must be received by April 1, 2016 – then, he must receive

a second distribution by year’s end on December 31, 2016, a third payment by

December 31, 2017, etc.

Or, he may take the first payment sometime in 2015; receive the second payment

anytime in 2016; the third payment in 2017, etc.

Each payment must be at least a set percentage of the value as of December 31st of

the previous year, the year for which the payment is made. Here’s how this works using

the IRS Life Expectancy Tables:

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The first minimum payment (in 2015 or by April 1, 2016) is calculated by

dividing the IRA value indicated on the December 31, 2014 statement by

Harry’s life expectancy for a 71-year old of 26.5 years ($37,735);

The second minimum payment uses the new IRA balance (as of December

31, 2015) divided by the adjusted life expectancy of 25.6 years; and

The third minimum payment uses the prior year’s December 31st balance

divided by the adjusted life expectancy of 24.7 years, etc.

Strategy One Summary

An RMD strategy is helpful when the client wants:

Less IRA money now;

To reduce income taxes now;

To have an increasing income that may keep pace with a rising cost of

living standard;

To pass a significant account at death to family or charity; or believes

income taxes in the future will be lowered or eliminated.

It may be unwise if the client:

Needs more cash-flow now;

Will be in a higher tax bracket later;

Believes income and estate taxes in the future will be higher;

Has other funds that will be sufficient for family and charity; or

Is unable to manage the IRS minimum payments.

Strategy Two: Level Distributions

Instead of taking Required Minimum Distributions, let’s say Harry needs more IRA income

now – perhaps a steady, predictable amount. Consider this approach: Determine a reasonable

payout period. For instance, you might use Harry’s IRS life expectancy at age 71 of 26.5 years;

or age 70 of 27.4 years.

Next, assume an average rate of return on investments you believe can be achieved easily.

Finally, calculate a level amount, which will bring the $1 million IRA’s value to zero by either

Harry’s life expectancy or his and his wife’s combined life expectancies.

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Advantages

Here are some advantages to this level distributions payout approach:

Presuming Harry is comfortable with (and achieves) the assumed rate of return, level

distributions give him a long, steady, significant payment from the IRA (and a much

higher amount in the early years) than an RMD strategy with smaller payments at the

beginning.

If Harry makes conservative withdrawals initially, and actually achieves a rate of return

higher than the assumed rate, this will extend the payout period. For instance, a 5%

assumed payout rate over 16 years pays $91,000 annually. If the account actually earns

8%, that would increase the payout period to about 20 years. (A lower rate of return

would shorten the payout period, so the client should be shown a variety of scenarios in

order to make an informed decision.)

Observations

Under these scenarios, Harry could end up paying taxes on two distributions made in

2016; or he can elect to pay taxes on one distribution in 2015 and one in 2016.

Although there are required minimum disbursements set by the IRS, one can always

take more. But, if one takes less, the 50% penalty tax is assessed on the shortfall.

If Harry withdraws only the required minimum, which turns out to be about 3.5% in each

of the first few years, and his account earns a higher percentage rate of return (say, 8%

annually), his account grows in value. But, if his account earns less (say, 2.5%), it will

decline in value.

Disadvantages

However, there are some disadvantages to a level distributions strategy where more is taken

from an IRA than the required minimum under the law, and this must be explained to the client:

You may pay more taxes because you’ve taken more income in the early years.

You reduce the advantages of tax-deferred buildup on the remaining balance.

You may run out of money early, if the assumed rate of return isn’t achieved.

There is a reduced inheritance kitty for your family (unless you replace it outside the

IRA).

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If you choose a 16 year period over merely Harry’s life expectancy, there may be

nothing left in the IRA for Mary at his death.

Eventually, there may be a shortfall (subject to a 50% penalty tax), if RMDs exceed the

level payment. The withdrawal plan should be monitored closely to prevent this result.

You must keep some extra liquidity in the IRA for higher distributions in the early years.

Strategy Three: Guaranteed Level Distributions from a Commercial Annuity

In strategy two, we looked at distribution approaches that involved minimum distributions

based on the IRS RMD Life Expectancy Table:

Since there are no guarantees whether an IRA will lose money or earn less than the assumed

rate of return, you must also manage the investments and cash flow in and from the account.

A solution: Insurance companies assume the management function and guarantee payments

from fixed annuity policies. Let’s say a 15-year guaranteed fixed annuity pays $89,000, with

payments beginning one year after purchase. If this policy is purchased March 1, 2016, the

cash will be liquidated and the annual payments will cease on March 1, 2032.

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Advantages

There are no financial or investment worries; the annuity check arrives on time, every

time, and it follows the client anywhere in the world.

As long as a commercial annuity satisfies IRS regulations, there is no possibility of a

50% penalty tax under the RMD rules.

By including a lifetime feature to a fixed period of annuity payments, you guarantee

clients an income that can’t be outlived. This is only available contractually in annuity

policies offered by insurance companies licensed and regulated in the 50 states.

Strategy Four: Variable Distributions from a Commercial Annuity

In strategy three, we reviewed fixed annuity options. If a client is willing to accept more risk and

seek stock market-like rates of return, a variable payout annuity provides distributions that

fluctuate with its underlying investments.

Example: At age 71, assume that a 15-year, $1 million, fixed annuity will pay $89,000

annually. A variable annuity might offer a reduced payment of say, $80,000 the first year and

subsequent amounts that vary depending on how a select portfolio of securities fluctuates in

value. The result: You have a potential upside. Of course, there is unlimited downside as well,

unless limited by provisions within the annuity contract. Always review the policy and

prospectus carefully and insist your clients do the same. Payments always continue for life, a

term certain, or life and a term certain guaranteed in the annuity contract.

Strategy Five: Combination of Strategies

If clients own more than one IRA, an RMD is necessary from each account. However, the full

amount may be taken from any one or more of the IRAs. Consider this illustration, an

imaginative strategy for managing a $1 million IRA:

Example: For your client, age 71½, divide $1 million equally and place into three separate

IRAs, which might be structured as follows:

IRA #1 ($333,000) is invested in aggressive securities projected to earn say, 12%

annually. Observation: $333,000 x 12% equals $40,000, an amount sufficient to at least

pay the first year’s RMD (on all the accounts) of $37,735.

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IRA #2 ($333,000) is invested in somewhat more value-oriented securities. If cash flow

from IRA #1 cannot support the RMDs (based on all three IRAs), the client can use IRA

#2 to make up the shortfall.

IRA #3 ($334,000) is invested in a fixed annuity that earns a guaranteed 5% interest for

five years. Plan to allow this policy to accumulate for 13½ years or so when it may

double in value to about $650,000. Then, take a life and term-certain annuity payout

determined for someone age 84.

Using Two-Directional Savings Strategies

RMDs from an IRA Account

Many IRA owners think of these accounts as cushions at 70½. In some instances, an IRA will

be the primary source of retirement income. In others, the account owner will reluctantly take

RMDs into her taxable income. Let’s assume your client, Mark Thompson, has worked hard to

build his $1 million IRA’s tax-free accumulation over the years. He has attained 70½, and it’s

time to take RMDs (starting at about $37,735 annually). Since Mark already has a comfortable

$50,000 income from bonds and CDs (also worth about $1 million), he views the IRA

payments as a nuisance that increases his taxes “unnecessarily.” He should consider this

planning idea: When Mark’s taxable IRA distributions begin, he cashes-in the non-IRA

investments and acquires a tax-deferred accumulation annuity. (Alternatively, Mark could

convert these funds into a single-premium life insurance policy, a growth-oriented stock

portfolio, investment real estate, or a combination of these approaches.) In other words, Mark

(a) eliminates taxes on income formerly taxable just as (b) new IRA withdrawals are taken into

his taxable income.

The bottom line: RMDs from an IRA account at 70½ shouldn’t be a problem; they should be an

opportunity to shift non-IRA cash into a cottage in the mountains, some needed life insurance

or a more creative, tax-favored savings portfolio. As the IRA is liquidated, the non-IRA monies

are accumulated or gifted to family. In summary, an account owner and the adviser should use

Mark’s account creatively, throughout his lifetime. There will be emergencies pre-59½, a

planning period 59½ - 70½, and an RMD period after 70½.

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Who Should be an IRA Beneficiary?

Questions the IRA Owner Should Consider

Assume a client’s first IRA starts innocently enough with a few hundred dollars. There is a

second IRA and also, a rollover from a 401(k) plan years later. The IRA accounts get larger

and larger. Along the way, family members marry, have children, and divorce. They may have

children from other relationships or unmarried partners. Some have money worries, others are

financially secure, and a few will die before the IRA owner. Are the beneficiary designations

up-to-date? Does your client have copies of each form (or, is paperwork misplaced or lost)?

Ask for this information. Then, prepare probing questions about beneficiaries, heirs and loved

ones. Here are a few eye openers:

Can the beneficiaries manage large sums of money?

Can each of them make financial decisions easily?

Will they understand tax consequences of cashing in, or continuing the account with

RMDs under the law?

Is there a shaky marriage where the money can be lost in divorce?

Is someone in financial trouble where there may be pressure to cash-in the account?

Are they professionals or successful persons who may be targets for litigation?

Could a gifted or impaired loved one be a ward of the state someday and could IRA

money be attached to pay for his care?

Do you want beneficiaries to share the account, or should it be divided into separate

portions? By you? Or, by them?

If the primary beneficiary dies after she receives the IRA, are you concerned about

who succeeds to the money?

Will you name a beneficiary to what’s left at the primary beneficiary’s death? Or, will

your designee?

If a primary beneficiary predeceases you, could the contingent beneficiary be a

minor?

If the beneficiary is a minor, could a guardian of the account be an estranged parent

or in-law?

When a child or grandchild dies, should a spouse receive something or should the

heir’s share pass to his or her children?

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The Bottom Line: It’s really not enough to name a beneficiary and let the “chips fall where they

may.” Have a serious discussion about beneficiaries with IRA clients; this is an opportunity to

bond with them in a meaningful way.

Examples

Here are a few beneficiary designations that can cause trouble.

The beneficiary is “my spouse, Mary.” But, Mary is no longer married to Harry. Since

beneficiary designations aren’t revoked automatically when a marriage is dissolved,

Mary will legally receive the account at Harry’s death.

If Mary is still Harry’s spouse at his death and receives the IRA outright, would it

disturb Harry if she later remarries and names her new spouse as beneficiary at her

death? If so, perhaps the IRA should be left in trust where children and grandchildren

take what’s left eventually.

When IRAs are payable to parents, children, brothers and sisters, and other relatives,

there may be transfer taxes as each dies and bequeaths what’s left of the account. A

well-crafted, multi-generational trust can provide for everyone without ever changing

ownership of the account. The funds will pass intact and estate tax-free if trust

beneficiaries change over time.

If the beneficiary is “lawful surviving children in equal shares,” the portion belonging

to a child who predeceases an IRA owner simply passes to the other children. That

child’s offspring receives nothing. Is this what your client really wants?

The designation, “lawful surviving issue, per stirpes,” leaves a deceased child’s share

to his or her children. Are they minors? If so, there’s always a possibility an estranged

parent or in-law may control the account as guardian. The solution: A trust-payee for

potentially younger beneficiaries.

Whenever children or issue are the named beneficiaries, and they predecease a

benefactor, their spouses receive nothing from the account. Ask if these widows or

widowers should be entitled to at least an income for a period of time. Some creative

trust planning solves the problem. Beneficiary planning is a legacy for loved ones and

should be taken seriously.

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Although outright designations (where IRA accounts pass directly to someone) may seem the

best tax planning method, trusts are often the answer, especially when an owner is concerned

about control over distributions. A properly licensed attorney should handle the legal advice

given to clients.

Who Can Be an IRA Beneficiary?

What the IRA plan document says, i.e., it could actually state that all beneficiaries must

be, “your spouse, if any, and if none — your lawful surviving issue, per stirpes.” If this

plan sponsor won’t accept an alternate beneficiary designation, the account owner

should establish another IRA that permits more flexible beneficiary arrangements.

As provided on a plan beneficiary form completed by the account owner, i.e., the

account owner freely names any individual, estate, charity, trust or other entity

beneficiary of the IRA. Most IRA sponsors provide or require these forms, as well as

“Change of Beneficiary” forms (often available on the sponsor’s website). Treat this

opportunity with care. In some cases, you or your client may be best served to have a

lawyer draft the Appointment of Beneficiary language to reflect family objectives.

Some words of caution: Read the plan document. It may not permit spouses to rollover the

account to their own IRA. Or when the beneficiary is a group of individuals, e.g., children, the

plan might not allow a division into separate shares. The recourse: Select another IRA.

There is No "Designated" Beneficiary

Tax Concept of a Designated Beneficiary

Once IRA owners are clear about whom the beneficiary will be, and what is permitted by the

plan document, make them aware of the tax concept of a designated beneficiary.

By definition, designated beneficiaries are individuals

and certain trusts defined in the law. Estates,

charitable organizations and all other trusts are not

designated beneficiaries.

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Here’s why: If an IRA owner wants the possibility of maximum extended tax deferral over long

periods after her death, he or she must select an appropriate designated beneficiary. If no

beneficiary is designated, the IRA may pass according to state law.

In the following situations, assume there is no designated beneficiary: An account owner dies

before April 1st of the year following the year in which he attains 70½. Let’s assume Harry was

70½ in 2015 (and actual age 71); he will take a first IRA distribution just prior to April 1, 2016.

His account balance on December 31, 2014, is $1 million, and his first payment for 2015 will

be $36,496 ($1 million divided by a 27.4 year life expectancy). Thereafter, the plan is to take

only the minimum payments over the next few years. These amounts will be determined by

dividing the prior December 31st account balance by life expectancy based on Harry’s age.

Unfortunately, Harry dies on February 1, 2016, at age 71, and there is no designated

beneficiary. (Perhaps his IRA beneficiary form is silent or it names “Harry’s estate” recipient of

the account.) The consequence: Since Harry’s death occurs before April 1st (the April 1st

following the year in which he attained 70½), his account must be liquidated by December 31,

2021; in other words, there is no tax deferral past this five-year window after Harry’s death.

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Owner dies on/after April 1st of the year following the year in which they attain 70½

Now, let’s say Harry died at 71 on November 1, 2015 - after April 1, 2015, the date he took his

first RMD. The consequences: Harry’s family gains a tax advantage; since he had begun

taking RMDs from the account, their payments can be spread over his remaining life

expectancy. They’ll take his second distribution in 2016; this payment must be based on his

age of 71, life expectancy of 26.5, and the IRA’s value on December 31, 2015. When the

distribution in 2016 comes up, his family must withdraw the RMD based on Harry’s life

expectancy.

Tax Planning Opportunity

IRA death benefits paid to designated beneficiaries can be spread-out over the beneficiary’s

IRS life expectancy (and not merely over five years or an account owner’s remaining life

expectancy). This is an excellent tax planning opportunity for the beneficiary.

Example: Harry (73) died in 2016 with a $1 million traditional IRA account. His designated

beneficiary was his daughter Melissa, age 39. In 2016, Melissa must commence RMDs using

her own life expectancy.

A Designated Beneficiary Dies After Inheriting the Account

Let’s say Melissa, a designated beneficiary, dies after inheriting her father’s IRA and before the

entire account is liquidated. Any portion remaining must be distributed to the successor

beneficiary(ies) based on Melissa’s life expectancy as determined in the year following her

father’s death.

Example: Melissa inherits her father’s IRA and begins taking RMDs in the calendar year

following his death, when she is age 40 and her IRS life expectancy is 43.6 years. Melissa dies

in 2050 at 75, when the remainder of her life expectancy is 8.6 years (43.6 less 35 years

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elapsed). Melissa’s son, Tom, the successor beneficiary, can then begin taking distributions

using Melissa’s adjusted life expectancy.

A Group of Individuals Sharing the Account

Beneficiaries Establishing Separate Shares

Let’s say Harry, an account owner, names a group of designated beneficiaries such as:

“My lawful surviving children;”

“My lawful surviving children, in joint tenancy with right of survivorship;”

“My lawful surviving children, in tenants-in-common;” or

“My lawful surviving issue, per stirpes.”

When the account owner has not actually established separate shares during life, the group

creates separate shares by December 31st of the year following the year of Harry’s death.

Then each beneficiary can use their individual life expectancies for their own accounts.

However, if the group remains intact, the shortest life expectancy (that of the oldest beneficiary

in the group) is used for the entire IRA. When an account owner has more than one

beneficiary, it’s natural to think in terms of trusts, perhaps one for each child family unit.

Example

Harry has a $1 million IRA and his beneficiary list includes children Melissa and Melinda who

have one child each. He wants to treat each family unit equally and secure protection and

professional management for them. Here’s the recommendation: Harry divides the IRA equally

into two accounts A and B. One is payable to Trust A for Melissa and children; the other is

payable to Trust B for Melinda and children. Distributions to each trust are based on the life

expectancies of its oldest beneficiaries, Melissa and Melinda. At their deaths, RMDs are paid

to the trusts for the balance of their life expectancies as calculated in the year following Harry’s

death.

Note: This example shows how an IRA can be stretched-out over the life expectancy of

someone whose share is held in trust. In the sections that follow, we will look at stretch or

multigenerational IRAs, a strategy for maximum tax deferral possibly over several generations-

to-come and other planning strategies available by state law.

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To summarize, all IRA owners (and their beneficiaries), can be viewed as joint venturers

regarding a significant IRA. This is a great time to be a major contributor: Work with clients to

obtain and update current beneficiary designations. Then, test everything to determine what

happens if a first or second beneficiary inherits the account.

IRA Owner Leaves Account Directly to a Spouse

Primary Designated Beneficiary

In most families, the primary designated beneficiary is the IRA owner’s spouse. The law favors

this and gives the greatest tax advantages when a spouse assumes full control of the account

– a rollover IRA. In this chapter we will explore various approaches for leaving IRAs to

surviving spouses.

The list of possibilities includes:

Inherited IRAs

Rollover IRAs

Annuities and trusts

Each of these possibilities can benefit the surviving marital partner. Spouses who inherit and

maintain traditional IRAs have choices that hinge on the date the first spouse dies.

For instance, Harry asks about what happens when his wife, Mary, receives his $1 million IRA.

You tell him Mary’s first option is to keep the account intact (a so-called “inherited IRA”). If she

does, everything depends on Harry date of death:

He dies before 70½. Let’s say the owner dies on February 1, 2016; He was 65, and

his wife was 60. Since his wife is Harry’s sole beneficiary, Mary can defer taking any

money from the account until 2021, the year he would have attained 70½ had he

lived, keeping the account titled in Harry’s name. She must receive the first payment

by December 31st of that year. An added bonus: As sole spouse beneficiary of an

inherited IRA, Mary can re-determine her life expectancy in each succeeding year,

and reduce her RMD.

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Harry attains age 70½ but dies before April 1st of the following year. Assume he

attained age 70½ on November 1, 2016, and died on December 1, 2016 (before April

1st of the following year). His spouse, as sole beneficiary, may defer her first

distribution until December 31, 2017, the year following her husband’s death. The

reason: Technically, a spouse beneficiary must commence RMDs by the later of (a)

December 31st of the calendar year in which her spouse would have been 70½, or

(b) December 31st of the year following his death. In this instance, December 31,

2017 is her required beginning date. Again, her Single Life Table expectancy (based

on her attained age in 2017 and re-determined in each succeeding year), is the basis

for computing her RMDs.

Harry dies on or after April 1st following the year he attains 70½. Assume Harry died

in 2017 at age 75, after commencing RMDs from his IRA. Any unpaid amounts for

2016 must still be distributed. Then, his spouse’s first distribution would be due by

December 31, in the year following his death. Mary’s life expectancy in that year (re-

determined in each succeeding year) is the basis for her RMDs.

A spouse dies after the IRA owner. Assume the Mary, the surviving wife, takes some

withdrawals from her late husband’s IRA, and then Mary dies. Harry’s remaining

account balance will be distributed according to the plan document. Normally, the

next beneficiary will be whomever the account owner specifies on his beneficiary

form. (However, the plan could permit the surviving spouse to name a successor.) If

no one is mentioned, the plan will probably specify the new beneficiary, e.g., the

owner’s issue, per stirpes (or his estate).

The next beneficiary (successor beneficiary) takes RMDs over the widow’s IRS unisex single

life expectancy, based on the age she had attained or would have attained in the year of her

death. (In other words, a successor divides 1 by this life expectancy to obtain an applicable

percentage; then, she multiplies the account’s value on December 31st of the year of her

death by this percentage.) There is no recalculation, and her life expectancy is reduced by one

in each succeeding year.

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Example

After the account owner’s death, his widow inherits his IRA, but she dies a few years later at

77 when her IRS life expectancy of 12.1 years is frozen because of her death. After any

amounts due to her are paid, the distributions thereafter will be based on this 12.1 expectancy

less one year each year.

Note: When a spouse dies, a subsequent beneficiary calculates the decedent’s life expectancy

determined by her year of death, and takes distributions over that period of time. When a non-

spouse beneficiary dies, a successor continues with the non-spouse’s life expectancy

determined in the year following the original account owner’s death.

Spouse Rolls it Over to Her Own IRA Spouse Assumes Control

Earlier, we described situations where Mary assumes control of Harry’s IRA – an inherited IRA.

There are several reasons why she may do this. For instance:

She wants to follow Harry’s wishes. Let’s say he names children from a former

marriage, as successor beneficiaries after Mary dies. She decides voluntarily (or

perhaps by a written agreement) to keep the account and not to change his designation.

She is under 59½, and any distributions are exempt from the 10% early distributions tax

penalty; if she rolls over the account, what she receives pre-59½ can be subject to this

penalty.

She is older than Harry, and need not commence RMDs until he would have been 70½;

if the account is rolled over (when she is over 70½), she is immediately subject to the

RMD rules. In most cases, however, she will roll over his account to her own IRA. This

is accomplished by simply retitling the account in her name.

Here is the Rationale

Let’s say Harry is older than Mary, and he dies at 65 when Mary is 60. If she rolls over

his account to her own IRA, she can defer distributions until April 1st following the year

she attains 70½ - approximately 10 or 11 years from now. If she simply maintains

Harry’s account as an inherited IRA, she must commence RMDs by the end of the year

he would have attained 70½ - about five years from now.

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After the rollover, when taking RMDs she uses the Uniform Lifetime Table each year

based on (a) her actual age, and (b) the age of someone hypothetically 10 years

younger. If she keeps Harry’s IRA, she uses her actual life expectancy, but it is re-

determined each year.

Example: Harry (65) dies, and Mary (60) decides to maintain Harry’s IRA. Mary is permitted to

defer distributions until the end of the calendar year Harry would have attained 70½, when she

is 65.

Mary’s first payment is based on Harry’s life expectancy and the statement’s balance on

December 31st of the year before Harry died. If instead, she rolls over the account to her own

IRA, she can defer taking payments until April 1st of the year following her age 70½. Her first

payment would be based on the larger balance on the December 31st statement the year

before Mary’s first RMD and her life expectancy. The decision is critical in Mary’s long-term

estate planning.

When Mary rolls over Harry’s account and designates a new primary (and contingent or

successor) beneficiary, e.g., a young child or grandchild, the family gains an additional

tax deferral opportunity. The reason: After Mary’s death, the youngster’s life expectancy

in the following year is the basis for RMD calculations. When this beneficiary dies, a

successor uses any remaining years to calculate ongoing RMDs.

Example: Mary rolls over Harry’s IRA account and names Tommy, her 9-year-old

grandson (or his custodian or trust), primary beneficiary at her death. (Of course, she

can always leave the account in separate shares to several beneficiaries or to a group

of them.) When Mary dies a year later, Tommy’s life expectancy in the year following

her death (71.8 years for the now 11-year old) determines RMDs in succeeding years,

even after his death.

Observations: When Mary dies, Tommy’s life expectancy of 71.8 years will result in a

low RMD and a long distribution period. If Mary had simply kept Harry’s account active,

her remaining life expectancy based on her age in the calendar year of her death -

reduced by one in each year thereafter – would be used to calculate RMDs for Tommy.

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Perhaps Harry has named a subsequent beneficiary for his account, to occur after Mary

dies (but Mary doesn’t agree with his selection and she can’t change the designation). If

she rolls over to her own IRA, the account is totally under her control and she can name

new primary and contingent beneficiaries.

Mary may prefer a completely different IRA, or she has personal reasons for rolling over

the account.

The rollover of several accounts may simplify overall investment and administration by

combining everything into one IRA. As long as it is allowed under the IRA plan

document, there is no time limit on the rollover. A surviving spouse’s rollover after her

mate dies is permitted even if (a) he was already receiving RMDs, or (b) she has

attained the date for taking them. If the deceased former account owner dies after April

1st following the year he attained 70½, she (a) waits until the year following death, (b)

rolls over the account, and (c) takes any RMD in the rollover year. If she is under 70½,

she can always defer distributions from the rollover account until April 1st after her age

70½.

In summary, a surviving IRA spouse beneficiary has options: She may take at least RMDs

based on her recalculated life expectancy (or the plan may allow her to forego distributions

under the five year rule). Or, she may (a) roll over the account, (b) withdraw amounts at her

age 70½ under the Uniform Lifetime Table, and (c) designate new beneficiaries who can use

their life expectancies for RMDs after her death.

Owner Leaves Account “for the benefit” of Surviving Spouse

Surviving Spouse Options

Earlier we discussed a surviving spouse’s options when she receives an IRA directly, by

beneficiary designation. We looked at the inherited IRA concept where Mary merely takes

distributions from Harry’s account. We also discussed when she rolls over his IRA and treats

the new account as her own. However, there are circumstances where an IRA owner may

prefer not to leave an account outright to a spouse. For instance, she needs help with

investments or managing money. Asset and creditor protection is an issue. Or, he doesn’t want

what’s left to pass to her “next” mate eventually. Finally, this may be a second or third

marriage, and he wants the remainder of the account for children from a prior union. When

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someone indicates reluctance to give full control of the account to a surviving spouse, the

following are alternatives to an outright beneficiary designation.

A survivor’s annuity - At Harry’s death, he wants Mary to have maximum cash flow from

the account, without investment or management worries. He also wants a practical

solution that is easy to implement. Consider this idea: Harry’s IRA acquires a

commercial accumulation annuity contract that names Mary income beneficiary. He

selects a settlement option arrangement, which annuitizes the policy at his death. Any

payments remaining at her death are paid automatically to their daughter, Melissa.

A general power of appointment (GPA) marital deduction trust - Harry doesn’t want a

set annuity payout for Mary that pays any more than the gradually increasing RMDs

under the law. Or, he prefers a more flexible arrangement where Mary can choose how

their descendants will receive what’s left in the IRA eventually. Here’s the

recommendation: Harry’s lawyer drafts a trust solely for Mary that gives her a right to

name who receives what’s left from the trust at her death – a general power of

appointment (GPA) trust. The objective is to qualify the trust for a marital deduction for

estate tax purposes and to provide management help for Mary.

Let’s say Harry died at age 65 when Mary was 60; he left a $1 million IRA and a $1

million apartment house to her GPA trust. In the year following his death when she was

66, the IRA earns $100,000 in accounting income and the apartment house had a

$10,000 accounting loss. The question: What did the trustee owe Mary? The answer: It

depends. There are a couple options.

Possibilities

First, to obtain a marital deduction, she clearly is entitled to the trust’s net accounting

income of $90,000 ($100,000 from the IRA, less the apartment’s $10,000 loss).

Therefore, her trustee must presumably withdraw up to $90,000 from the IRA and pay it

to her – even though this exceeds any RMD in the law.

Actually, at age 66, Mary’s IRS unisex life expectancy is 20.2 years – accordingly, the

trustee’s minimum withdrawal for her from a $1 million IRA would be only $49,505 ($1

million ÷ 20.2.) And, the minimum withdrawal for her (and successor beneficiaries after

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her death), would be based on the elapsed years method by subtracting one year in

each succeeding year until her 20.2 life expectancy is “used up.”

Fortunately, Mary’s GPA trust probably won’t have to withdraw a full $90,000 from the

IRA. As long as she can compel her trustee to withdraw all of its accounting income and

make a distribution to her of that amount the trust should still qualify for the marital

deduction. And, if Mary’s trust gives her this right, her trustee can withdraw as little as

her minimum distribution ($49,505), and this would probably be the payment.

Some creative financial and legal planning can reduce Mary’s trust distribution even more. If

Mary’s trust document requires that she receive all IRA income actually paid to the trust (so

these amounts will never be accumulated in the trust for remaindermen), a so-called conduit

trust, she will be deemed the IRA’s sole beneficiary and treat the account as an inherited IRA.

The result: IRA distributions can be deferred until Harry would have attained 70½. Thereafter,

Mary’s IRS life expectancy can be re-determined annually until her death when it is frozen (and

reduced by one year, each year, thereafter). Although her trustee can always withdraw up to

the IRA’s full accounting income and pay this to Mary, this trust language can reduce her

required taxable distributions to zero for five or six years, and markedly thereafter. Mary’s GPA

trust might be drafted with even greater imagination.

Second, let’s say this trust gives Mary an unlimited and continuing right to withdraw all

assets of the trust, including the IRA. Consequently, it effectively gives her a general

power of appointment in favor of herself. Although this withdrawal right may be

inconsistent with the purpose of the trust (which is, say, to provide investment

management for Mary), the trustee should now be able to exercise an IRA rollover on

Mary’s behalf.

The result: After the rollover, no RMDs are necessary until Mary is 70½. At her death,

Mary’s beneficiary can use his or her own life expectancy to spread-out distributions

gradually over many years into the future.

The bottom line: Harry’s attorney must be thoroughly aware of the regulations when

drafting a GPA trust that is named beneficiary of an IRA. And, if the objective is to slow-

down taxable distributions for Mary and her successors, this trust can always enhance

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Mary’s authority over her trustee – even to the extent of giving her the ability to make a

rollover of the account.

QTIP Definition

Qualified terminable interest property (QTIP) is property in a decedent's estate that, even

though subject to certain restrictions, can still qualify for the estate tax marital deduction. The

term also includes property given to a spouse during life that qualifies for the gift tax marital

deduction, even though it is subject to similar restrictions.

Brief Review of the Marital Deduction

When people leave property to others at death -- or give property away during life that exceeds

or does not qualify for the annual gift tax exclusion -- that property is generally subject to

federal estate tax (death transfer) or a federal gift tax (lifetime transfer) if the total transfer

exceeds the applicable exclusion amount sheltered from federal estate tax by the applicable

credit amount. However, when property is left (or given) to a surviving spouse, the "unlimited

marital deduction," allows a spouse to transfer any amount of property between him or herself,

during life or at death, without triggering the federal estate tax or the federal gift tax.

Terminable Interests

Property left (or given) to the spouse cannot be a "terminable interest" if it is to qualify for the

marital deduction. So, what is a "terminable interest"? Basically, it is an interest in property that

can expire due to the passage of time, or that can terminate due to the occurrence of some

future event, or the failure of some event to occur.

Example One: Husband leaves wife a 10-year income interest in a trust. After ten

years, the trust corpus will be held for the husband's invalid brother. The wife has no

power, by will or otherwise, to change the use of the trust corpus. She has a

terminable interest in the trust, and her interest will not qualify for the marital

deduction in her husband's estate.

Example Two: Wife leaves Shady Acres Ranch to her husband, but only for as long

as he remains unmarried following her death. If he remarries, Shady Acres will pass

to the wife's niece. Her husband has a terminable interest in Shady Acres, and it will

not qualify for the marital deduction in his wife's estate.

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In Example Two, did we wait and see whether the husband remarries before we draw our

conclusion? No. The mere fact that he could lose Shady Acres Ranch by virtue of remarriage

is enough to cause forfeiture of the marital deduction.

Qualified Terminable Interests

While terminable interests generally do not secure the marital deduction, the law does allow

certain types of terminable interests to qualify for the deduction. First, such interests have to

meet certain legal criteria that make them a "qualified" terminable interest. Second, the

executor of the deceased spouse's estate (or the donor-spouse in the case of a lifetime gift)

must elect to take the marital deduction for a terminable interest that has been so "qualified.“

Qualification Requirements for QTIPs

Two kinds of terminable interests can be "qualified":

Lifetime income interests

Income interests in charitable remainder trusts

In both cases, the surviving spouse's interest in property can terminate at her death, but the

law will still allow the marital deduction if the requirements described are met. In community

property states, a spouse's interest in the participant-spouse's qualified retirement plan, IRA, or

SEP, arising from community property laws, may qualify for QTIP treatment if the participant-

spouse dies before the nonparticipating spouse.

Lifetime Income Interests

Lifetime Income Interests are also called the "qualifying income interest for life." Often, the

surviving spouse has an income interest in property held in trust, but the trust is not a

necessity. In all cases, the surviving spouse must meet the following criteria:

The right to all income from the property for as long as she (or he) lives

Income must be payable annually or at more frequent intervals

No one, not even the surviving spouse, may have a power to appoint the property to

anyone other than the surviving spouse

The deceased spouse's executor (or the donor-spouse) must irrevocably elect to take

the marital deduction for the property on the federal estate (or gift) tax return

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Income Interests in Charitable Remainder Trusts

Suppose the spouse is the income beneficiary of a charitable remainder annuity trust or

unitrust. The spouse's income interest will eventually terminate. At that time, the charity will

succeed to the full interest in the trust property; the spouse has no power to dispose of the

trust property by will. However, if the spouse and the charity are the only trust beneficiaries,

the trust can qualify for the marital deduction. In this case the spouse does not have to have a

lifetime income interest. The income interest could expire after a period of years, say 20, when

the charity is scheduled to take over.

Tax Consequences of QTIPs

When regular property qualifies for the marital deduction at the first spouse's death, it avoids

estate tax at that time. But any amount that remains at the second death is taxed in the

surviving spouse's estate. That's usually because the spouse either received it outright or had

a general power of appointment over it. So, the IRS essentially says, no tax at the first death,

but we're going to even things up at the second death. The net effect of all these legal fictions

is that the tax is delayed until the second death, even though the first spouse to die actually

controls how the property is ultimately distributed.

Why Use QTIPs?

There are several reasons why QTIPs make sense, and why they are commonly used. A QTIP

trust adds flexibility to the estate plan of the first spouse to die. Since the final decision

regarding whether to qualify the QTIP property for the marital deduction is delayed until after

the estate owner's death, the current circumstances of the surviving spouse and other

beneficiaries can be taken into account.

The surviving spouse can be assured of receiving all of the income from the QTIP

property for his or her entire lifetime.

The estate owner can restrict the ultimate disposition of the QTIP property without

sacrificing the marital deduction.

Sometimes it is inappropriate to leave property outright to a surviving spouse - perhaps

because the spouse is aged, unwell or unsophisticated in financial affairs or property

management. The QTIP trust allows property to be managed for the spouse's benefit without

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becoming a burden. The QTIP trust is especially useful for those in second marriages. The first

spouse to die can be assured the property will eventually pass to his or her children or other

heirs, rather than to the surviving spouse's children from a prior marriage, while still providing

lifetime financial security to the surviving spouse. The QTIP also addresses "remarriage fear"

that estate owners may have. If property is left outright to a surviving spouse who later

remarries, the property could wind up in the hands of the new spouse. The QTIP trust provides

for a surviving spouse, but retains control over the ultimate disposition of the property if, for

example:

Harry is concerned about Mary remarrying and losing his IRA to Mary’s new spouse, or

Harry wants to ensure the children from his first marriage will receive what’s left at

Mary’s death

Consider this approach: Harry’s lawyer prepares a marital deduction trust that gives Mary all of

the trust’s accounting income annually for life. However, at her death, the remainder of any

trust assets pass to beneficiaries previously named by Harry. Mary may or may not have

additional rights in trust principal while alive. This is a QTIP marital deduction trust. Harry

names this trust beneficiary of his IRA, and the trust dutifully follows the rules that qualify it as

a designated beneficiary.

Some observations: As with GPA trusts (supra), a QTIP trust may give Mary all amounts the

trustee takes from Harry’s IRA – a conduit trust where she is deemed the IRA’s sole

beneficiary. Presumably, a QTIP trust could also allow for the rollover of the account. In

summary, the lines are drawn clearly for married account owners. When he or she names a

spouse sole direct beneficiary, the survivor can always:

Roll over the account

Control its assets

Name new primary and contingent beneficiaries

Alternately, when IRA owners want more protection, professional management or “power” over

the account, they’ll probably opt for:

A sound but somewhat rigid survivor’s annuity or

A more flexible spousal trust arrangement

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Either usually forces out greater taxable income than a simple rollover IRA. In contempt for the

slightest possibility of “unreasonable” tax-deferred buildup, the US Treasury’s message is

clear: If account holders want maximum potential for tax deferral, and minimum of complexity,

leave the IRA directly to the surviving spouse.

IRA Owner is in a Second or Third Marriage

Options Available

In second or third families late in life, an IRA owner may want children from a former marriage

to inherit the account. When there aren’t adequate non-IRA funds for a surviving spouse, here

are three planning concepts:

Life insurance for a spouse; heirs receive the IRA.

Life insurance for the heirs; a spouse receives the IRA. If he names successor

beneficiaries (and she doesn’t change the beneficiary or roll over the account), the heirs

inherit what’s left at her death. If she rolls over his IRA to her IRA, she may just leave

the remainder to them anyway.

A reversionary annuity for a surviving spouse; heirs receive the IRA.

Example: Assume Harry Jensen wants to leave an IRA to his children from a previous

marriage. After discussing their financial goals, Mary agrees that a $5,000 monthly lifetime

income would be sufficient to meet her needs. The solution: Harry obtains a special life

insurance contract payable to Mary. The policy has neither cash value nor face amount, and

pays Mary a lifetime income of exactly $5,000 (payments cease at her death). This is a

reversionary annuity. In the first and third options presented, the Jensen's may need a post-

nuptial document to memorialize this agreement, and should seek the advice of legal counsel.

When an IRA Owner Does Not Leave an IRA a to Spouse

Probate Laws

Assume Harry is not happily married to Mary and inquires about naming another designated

beneficiary. Some words of caution: Harry needs legal advice; the following information is

merely an overview for readers. A married participant’s beneficiary choices in qualified

retirement plans (employer-sponsored profit sharing, pensions and 401(k)s) are limited by

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certain spousal rights under federal law. For instance, he or she is automatically entitled to a

survivor annuity benefit when the participant dies. When it comes to IRAs, spouses have no

protection under federal law. Therefore, unless Harry’s state provides spousal rights in IRA

benefits, he may be able to prevent Mary from taking the account. The probate laws in Harry’s

state may entitle Mary to receive Harry’s IRA. For instance, let’s say Harry owns a $1 million

account (payable to his brother), and his other holdings consist of a $200,000 home and

$200,000 in cash for total assets of $1,400,000. In their state, Mary has a legal right to one-half

of Harry’s overall property. The result: When Harry dies, Mary can claim a total of $700,000

(50% of $1,400,000). Certainly, Mary will look to the IRA to make up any shortfall. If Harry

wants to exclude Mary as an IRA beneficiary and you assist both with their financial planning, it

may be unethical to maintain a professional relationship with either of them. At the very least,

insist that Harry seek legal advice before making any changes in his estate plan. In this

section, we have looked at problems and solutions for married account owners. They include:

Outright beneficiary designations where there is a potential for spousal rollovers

Annuities for a surviving spouse, and

GPA and QTIP trusts that qualify for the estate tax marital deduction

IRAs in second or third marriages and even where one spouse wants to disinherit her

mate

It may take a team of professional annuity/insurance agents, investment strategists,

accountants and lawyers working closely to help married IRA owners achieve personal

objectives. If there is marital friction it may be necessary to have more than one set of

advisers.

Owner Leaves Account for the benefit of a Surviving Spouse

Prepare Your Client

With the popularity of moving money into IRAs, it's important to educate IRA prospects in one-

on-one client discussions or in IRA seminars. Acquaint IRA owners in their 50s and 60s with

what lies ahead. This will help build a strong client base for the next 30 or 40 years. Imagine

yourself in front of an audience of IRA owners. Here are some questions, comments, and

examples that may get your prospects and attendees disturbed about what they may have

overlooked.

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Before age 70½, begin to prepare to take at least minimum distributions (RMDs) from

your IRAs. (Explain the 50% penalty tax on shortfalls, the need for regular distributions

and the percentage payments that must be distributed.)

By taking RMDs, you'll create more potential to earn tax-deferred growth, and this wins

big in the long run.

It's attractive to keep net worth where it is protected from creditors and lawsuits. And, an

IRA does exactly that.

With the help of a financial adviser, assure that your IRA money has optimum potential

for tax deferral, cash flow and asset protection. Make plans to keep it there for as long

as possible. If you need income, liquidate other assets and resources before taking a

premature distribution from an IRA. Only withdraw extra sums from your IRA as a last

resort.

Since it's not likely you'll liquidate your IRA while alive, a good share of it will probably

be there for a successor(s). Think of your IRA as a partnership or joint venture with you

and your beneficiaries. It's good to preserve everything for them as well.

Suggest assembling all IRAs into one account for the client that eventually creates

subaccounts for beneficiaries.

Obviously, an IRA beneficiary designation form is a big deal. It determines who inherits the

IRA, and it has everything to do with when payments are taxed after the IRA owner's death.

Here are a series of questions for prospects and seminar attendees that relate to "Who is Your

Beneficiary?" These focus squarely on IRA beneficiary forms and the designation itself.

Discussion Pointers Regarding IRA Planning

Importance of a Well-Conceived Beneficiary Designation Plan

The objective: Acquaint IRA owners with the importance of a well-conceived beneficiary

designation plan. Ask them:

Where is your beneficiary form stored (it may be lost; check and find out).

Who is the beneficiary of your IRA? Many people don't know or recall.

On reviewing the form, is the named beneficiary deceased, a divorced spouse, a minor,

in financial difficulty or disabled? If so, a trust beneficiary is an alternative.

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Is a charity, trust or estate one of the beneficiaries? Charities, trusts and estates aren't

individuals with life expectancies. Separate the IRA into one account per beneficiary.

Alternately, leave them specific fractional shares. When a trust is the named

beneficiary, there are complicated exceptions to the five-year payout requirement

If your beneficiary predeceases you, who receives the IRA? You are referring to a

contingent beneficiary who may not be mentioned. If not, the default beneficiary will be

your client‘s estate and not a chosen contingent beneficiary.

Does your IRA provider permit distributions over the beneficiary's life expectancy?

Believe it or not, some providers only make lump sum payments. They aren't equipped

to follow the beneficiary around and make distributions in small amounts. Offer to study

their situation. If ongoing distributions aren't permitted or feasible, suggest the client or

prospect move the account.

Once your beneficiary receives the IRA, who gets any payments remaining at his or her

death? This refers to a successor beneficiary who must be named. If no one is named,

the default beneficiary will likely be the first beneficiary's estate.

Can non-spouse beneficiaries transfer their IRA share to another fiduciary in a trustee-

to-trustee or custodian-to-custodian (provider) transfer? The form should permit this

transfer, unless the account owner doesn't want it. A trustee-to-trustee transfer has no

immediate tax effect.

Does your provider permit a group of beneficiaries to split the account into shares for

each of them? It should! If it doesn't, a group of people must take (larger) distributions

over the oldest person's (shorter) life expectancy. The result: More taxable income

received sooner than necessary. The split must be accomplished by years' end of the

year following the account owner's death. If surviving children are squabbling, this can

be difficult. Thus, it may be better to split the account now into specific shares for each

beneficiary; alternately, make the split automatic at the IRA owner's death.

Do you want to name successor beneficiaries or should this be left up to the first

beneficiary? Read the form. It may not have the right language to accommodate your

client's wishes. If it doesn't, he or she deserves better.

Does the beneficiary form permit a per stirpes designation? “My issue per stirpes”

passes the share of a deceased child down to his or her children. Contrast this with “my

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children, equally,” which passes a deceased child's share across to the surviving

children. The form needs to spell out everything carefully. If it can't, it should.

Does the form cover what occurs if:

o The IRA owner becomes incapacitated? A power of attorney should state what

happens;

o There is a divorce? The other spouse could be removed automatically as a

beneficiary (unless the divorce decree states otherwise); or

o It is impossible to determine whether the account owner or beneficiary died first,

as in the tragedy when John F. Kennedy, Jr., and his wife died in a plane crash?

You'll rarely see these matters addressed on a provider's beneficiary designation

form and, for good reason. These issues are usually covered in a well-crafted

trust document. Ask your client's attorney to work with the IRA provider to include

preferred language as an appendix to their form. Otherwise, name a trust

beneficiary; the trust document can then contain the proper language.

What is your provider's minimum account balance? Let's say the amount is $150,000. If

a $300,000 IRA is payable to three children equally, they will have only $100,000 each

(well below the required minimum account balance). If your client's children cannot

transfer their accounts, they may have to cash-out and pay taxes prematurely.

Will your provider pay annual RMDs or IRA annuity income to a trustee? If not, a trust

beneficiary isn't an option. Your client needs to understand this.

Will your provider accept a customized (personalized) beneficiary designation form?

Providers usually don't want complex beneficiary arrangements. These cost more to

administer and a court may view everything as assuming fiduciary responsibilities.

Know the limits of the form. If your client wants more, consider a trust beneficiary, or

move the account.

For those who have qualified funds elsewhere: Who is the beneficiary of your 401(k)?

Note: Only spouses can rollover these distributions to an IRA. Non-spouse beneficiaries

cannot cash-out say, a 401(k) fund, place it in an IRA, and take RMDs over their

individual life expectancies. Therefore, if only lump sums are payable to non-spouse

beneficiaries, a retiring plan participant should probably rollover his account to an IRA.

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Multigenerational IRA

Income Tax Planning Strategy

Earlier we looked at the concept of how to stretch an IRA’s taxable withdrawal over

generations; a fascinating income tax planning strategy that almost every family unit should

consider. There are also a number of rewards for financial planners who can explain how

these plans really work. For instance:

You’ll bond with clients and their loved ones and possibly become their trusted financial

adviser;

There will be annuity, life insurance and investment needs along the way, and you’ll

write this business; and

There will be referrals to others in similar circumstances. Clients will probably tell you

how difficult it’s been to build a substantial IRA - a family treasure that can only get

better. Agree with them and use this opportunity to explain the perils beneficiaries

experience as they take money from an account. You need to ask some tough

questions and carefully seek even more difficult answers.

In summary, it's essential to have the "who is the beneficiary" discussion with your IRA clients

and prospects. The beneficiary form determines who will get the account, and when the money

will be taxed. Many IRA owners have misplaced or misconstrued their forms. And, many

providers won't give quality options, especially to the "second" IRA holder - your client's

beneficiary. If these are important (and it is suggested that they always are), investigate

alternatives, including IRA annuities. Here's why: Insurers know how to send small amounts to

individuals over long periods of time. The best planning achievable in IRA planning includes a

quality annuity product that includes a creative beneficiary designation form, and an insurer

that can administer everything long-term.

Example

YOU: “Harry, you asked about the IRA and what happens at your death. One possibility, and

there are many, is to treat this as a family treasure — a tax-protected memorial the Jensen

descendants can manage and enjoy for generations to come. Let me explain it this way. Let’s

say you die, and we’ll assume Tommy, your grandson, is designated beneficiary of the

account. Next year when he is five, the law requires that he take at least a long series of RMDs

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and if he doesn’t, there is a severe tax penalty of 50% of the shortfall. For instance, if the

account is worth $1 million on December 31st of this year, he must take at least $12,870

sometime next year, based on the life expectancy of a 5-year-old. Of course, he can always

take more.

Even if Tommy dies, the account can be liquidated slowly over his remaining life expectancy

based on his age when he began taking payments. Here’s the point: Say the account earns

6%, there will be a net gain of $47,130 or 4.7130% (6.0000 less 1.2870% taken by the first

RMD) the first year. The account will build considerably, and this comes down to some

significant tax-free growth in the years ahead. In fact, if Tommy takes only the minimum

payments, it’s not difficult to imagine a total payout of tens of millions of dollars. The secret lies

in the continued build-up of tax-deferred earnings in excess of the amount distributed to

Tommy or his heirs.”

HARRY: “I’m puzzled. This sounds good, but won’t Mary need some income from the

account?”

YOU: “Of course. Here’s what you do. Name Mary primary beneficiary (perhaps, Tommy is the

contingent beneficiary); she’ll roll over your account under the law, and make it her own. Then,

Tommy can still take what remains at her death over his lifetime. Due to her withdrawals and

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Tommy’s older age at her death, there may be less tax deferral overall, but this will give Mary

use of the account while she is alive.”

HARRY: “It seems like she could also name a friend or new husband beneficiary instead of

Tommy. What about this”?

YOU: “That is correct; how do you feel about this possibility?”

HARRY: “Well, we’ve had a good marriage based on mutual trust. I suppose I owe her the

final decision.”

YOU: “I’m glad you said that. Of course, you could name a QTIP trust beneficiary for her

benefit and Mary can be the trustee – if Tommy is the trust beneficiary at her death, she’ll have

no power to change that – and this protects Tommy. The problems with most QTIP trusts are

at least twofold. First, Mary must take more from the account than if it actually becomes her

rollover IRA. Second, Tommy eventually won’t be permitted to use his long life expectancy to

determine ongoing RMDs. Instead, Tommy has to use Mary’s expectancy as if Mary were still

alive. This goes against the tax deferral objective of a multigenerational IRA.”

HARRY: “I could leave Mary some other property, but I’m not sure there is enough.”

YOU: “I certainly understand your concern for her financial requirements. One possibility is an

additional life insurance policy that provides a completely tax-free lump sum for her benefit.

Another concept is a reversionary annuity that merely pays an income – perhaps four or five

thousand dollars a month – for the rest of her life.”

HARRY: “If I did something like that, could she claim the IRA as her own, anyway”?

YOU: “Possibly; we’d need to review this with your lawyer. But since this is an IRA, there

should be no automatic claim to it, at least under federal law.”

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HARRY: “Well, let’s say we did the insurance or reversionary annuity for Mary, does Tommy

get the IRA money without paying any inheritance taxes”?

YOU: “Another question for your lawyer. In 2016, the federal estate tax exemption of

$5,450,000 protects all amounts under the exemption amount from your property and IRA that

passes to your descendants; both of which are definitely part of your taxable estate. Keep in

mind, however, everything over the exemption is subject to the estate tax of 40% – and

possibly a generation skipping tax when it goes to grandchildren instead of children.”

HARRY: “This is getting complicated. Let me see if I understand. You say that to save the

most in income taxes, I should pass this IRA to a youngster who may pay an estate tax and

generation skipping tax just to keep the account intact.”

YOU: “That’s basically correct. But, any estate taxes should be paid with liquid funds outside

the IRA. If this cash isn’t available, someone must “reach into” the account to get the estate tax

money. When this happens, they’ll pay income taxes as well – a real disaster where 75-80% of

these funds could be lost to taxes overnight.”

HARRY: “It looks like I’ve created a monster. There’s another matter that concerns me. What

about the rest of my family? I have three children and two other grandchildren. What about

them?”

YOU: “I used Tommy as sole beneficiary to keep the explanation relatively simple. The easy

answer may be to divide the account in three shares, one for each grandchild. Or, you could

leave the IRA to them as a group; then, they can break it into three shares by December 31st

following the year of your death, and each can use their own life expectancies for future

withdrawals from their accounts.”

HARRY: “I’m thinking about my children too. What about them?”

YOU: “Good question! If you leave the IRA to them, it’s their life expectancies that measure the

distributions. If permitted by your plan document, you can specify their children (your

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grandchildren) receive what’s left at the death of each of your children. But the younger

grandchildren are forced to continue using their parents’ life expectancy as if they were still

alive. Here’s something that gives flexibility. Name the children beneficiary and perhaps they’ll

disclaim their shares in favor of the grandchildren, who will now use their own life

expectancies.”

HARRY: “Why would my children do that? They are not really that unselfish.”

YOU: “I understand, and that’s always a risk in any multigenerational plan where there are

several layers of beneficiaries. Here’s another idea: Leave the children cash in a life insurance

trust. Then have the trust document state that some of their trust benefits are removed unless

they disclaim their IRA shares. This strategy can be a significant incentive to follow the plan

you established. One more thing: You could leave the IRA to a trust that considers everyone in

the family. This is something on which I’d definitely like your lawyer to comment.”

HARRY: “Each of my children has special circumstances. For instance, Melissa is divorced. I

wouldn’t want her former husband or in-laws to get their hands on her share.”

YOU: “I understand, and we must recognize the possibility of Melissa’s former husband being

a custodial guardian of Tommy if your grandson is a minor when he receives the account.”

HARRY: “Also, Bobby isn’t likely to have children. It doesn’t seem fair to force his portion over

to his nieces and nephews.”

YOU: “Another reason to get legal advice. Perhaps a trust can leave some of his share to

nieces and nephews and the rest to someone he names.”

HARRY: “And, Matthew died tragically a few years ago; I do care about Helen, his wife, as well

as his children.”

YOU: “A reversionary annuity might be suitable for her, as well.”

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HARRY: “Won’t all these required distributions be hard to arrange? Who’ll manage all of this?”

YOU: “I think we can set-up a strategy for ongoing administration of your IRA. One approach is

to take withdrawals from annuities to satisfy RMDs. We’ll ask the lawyer and accountant what’s

necessary to avoid any tax penalties in the law.”

HARRY: “How complicated! Perhaps I should forget the whole thing and let this IRA fall apart

after I’m gone.”

YOU: “Obviously, that’s one option. But, believe me, when we work this out, the financial

benefits justify the effort. It would be unfortunate to let all your hard-earned money go down the

drain. Besides, what if there is no income tax someday? Why pay taxes now if we don’t have

to and we don’t know what the future holds?”

HARRY: “What else?”

YOU: “It looks like we need some combination of IRA administration, annuity, insurance and

trust planning. We also must look carefully at your IRA beneficiary designations, which control

everything we’ve discussed. I recommend a conference with your attorney, Norma Morrison,

and, eventually, a family meeting to explain the entire plan to your children. May I have your

permission to set up an appointment with Norma? Would you have any objection to my briefing

her in advance about our IRA discussion?”

HARRY: “No objections. It’s time I do something about all this. Thank you for making this more

understandable to me.”

Client Candidates for Stretch IRAs

What is a Stretch IRA?

A stretch IRA is not a special type of IRA created by Congress. There are no special IRA

agreements that establish stretch IRAs but a financial organization may want to add language

to its current IRA agreements to enable stretching. Here, the term “stretch” refers to a method

for extending the duration of traditional and Roth IRA beneficiary distributions to certain

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successor beneficiaries, beyond the death of an original designated beneficiary—a method

especially valuable to a non-spouse beneficiary.

After an IRA owner’s death, a spouse beneficiary can treat an IRA as his/her own if he/she is

the only beneficiary. If there are multiple beneficiaries, a spouse beneficiary can always take a

distribution of his/her share in an IRA and roll it over to a personal IRA. Once the assets are in

his/her own IRA, he/she can name his/her own beneficiaries.

After an IRA owner’s death, a non-spouse IRA beneficiary, under the final required minimum

distribution (RMD) rules, generally takes RMDs based on his/her single life expectancy. An

original beneficiary’s death generally requires distribution of any remaining IRA assets in a

single sum to his/her estate. With stretching, the duration of death distributions can continue to

a series of successor beneficiaries beyond the death of an IRA’s original beneficiary, but not

forever.

To Whom Do Stretch IRAs Appeal?

Stretch IRAs should be appealing to IRA owners who have these points of view:

They claim to “pay more taxes than their fair share”;

They have well defined goals and close knit family who understand the benefit of long-

range, cooperative financial planning;

They have a tolerance for wealth preservation strategies. They also comprehend that

when someone “reaches-into” an IRA to get money to pay taxes, the entire plan is

disrupted and probably destroyed.

They understand the significance of taking merely RMDs from the account.

They have good family credit and adequate non-IRA funds for living expenses, luxuries

and family emergencies.

Although still an option, it should be noted that while in office,

President Obama proposed ending stretch IRAs, in favor of

making distributions to beneficiaries (other than a spouse)

payable within five years of the IRA owner’s death.

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Stretch IRA Example

Let’s take John Burns who has a $8 million estate consisting of:

$2,000,000 Traditional IRA

$4,000,000 In non-IRA assets

$2,000,000 Home

$8,000,000 Total

Total less about $1 million in estate taxes and expenses.

Since John’s objective is to leave a full $8 million in assets to David and Todd equally, you

propose a liquidity plan to pay $1 million in estate costs and taxes.

1st planning strategy: At John’s death, liquidate $1 million in non-IRA assets to get the

tax money. John’s advisers oppose this because these are valuable holdings (and some

are illiquid). And, this leaves only $7 million for David and Todd to divide.

2nd planning strategy: At John’s death, liquidate his IRA to get the tax-cash. Here is the

math:

$2,000,000 IRA (gross)

- $1,000,000 Approximate expenses and estate taxes related to the IRA on a gross estate of $8,000,000

= $1,200,000 IRA after estate taxes

- $ 480,000

Federal and state income taxes or 40% on $1.2 million after a Sec. 691(c) deduction of

$800,000 in federal estate taxes leaves a net IRA balance of $720,000 after $1,280,000 in total

taxes is subtracted. The bottom line: It costs $480,000 in income taxes to cash-in the IRA. This

money is lost forever. When you explain the advantages of on-going tax deferral, John is

against liquidating the IRA. Besides, when his account is the source of both income and estate

taxes ($1,280,000), only $720,000 is left from the IRA. John really wants David and Todd to

divide equally a full $8 million estate, including the IRA.

3rd planning strategy: Acquire a $1 million life insurance policy in an irrevocable trust.

John gifts the annual premium of, say, $40,000 to the trust, and the proceeds are estate

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tax-free. David and Todd need not liquidate either the IRA or non-IRA assets; they’ll

inherit everything intact (after premiums are subtracted from John’s assets or income).

Estate Tax

How insurance proceeds pay the estate tax. Let’s say John leaves his IRA to David and Todd

equally, by beneficiary designation. John’s will bequeaths his $4 million in non-IRA assets to

them, as well. His will also includes a clause that obligates his estate and sons to pay the $1

million in estate taxes. When John dies, his insurance trust will probably use the cash to “buy”

$1 million of non-IRA assets from his estate. With the cash, John’s estate representative pays

$1 million in estate taxes. The result, after these transactions:

$2,000,000 traditional IRA (David and Todd)

$4,000,000 non-IRA assets to the trust (for David and Todd)

$2,000,000 home (David and Todd)

$8,000,000 Total

An alternative plan: You observe that David has two young children and Todd has none. You

suggest that it might be better to divide John’s estate as follows:

$2,000,000 IRA to David

$2,000,000 in non-IRA assets to David

$4,000,000 in non-IRA assets to Todd

$8,000,000 Total

Observations:

If the Burns family agrees with this recommendation, John’s will could obligate Todd

alone to pay the estate’s tax obligation. The idea is that the $1 million in insurance cash

will acquire non-IRA assets and John’s estate will pay the tax bill. David gets the $2

million IRA (outside the will), and Todd obtains the $2 million home and a $2 million

trust fund.

If John names Marilyn and Trevor contingent and successor IRA beneficiaries, David

can always disclaim in their favor without paying any transfer taxes on these “gifts.”

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It is arguable that John’s $2 million IRA is worth less for David and his family, after all

income taxes are paid. However, you might say the IRA is really worth more because its

earnings accumulate on a tax-deferred basis. The family should weigh all these factors

in their planning deliberations.

Certainly, John’s finances will change over his lifetime. Therefore, any planning that

separates these assets for David and Todd should be kept up-to-date. In drafting John’s

will/trusts and IRA beneficiary designation, his attorney should also allow for values,

taxes and family circumstances to change over the years.

Strategies for Paying Life Insurance Premiums

Take withdrawals from the IRA - Assume that John leaves his $2 million IRA to David

and $2 million in non-IRA assets to Todd. There is also a $1 million insurance policy,

and John (presently 70½) begins taking RMDs from his account – about $40,000 in the

first year – to pay the premiums. Let’s say John has been living on about $40,000 from

the non-IRA assets. Since John’s estate is composed of 50% in IRA funds and 50% in

non-IRA assets, an “equitable” philosophy to funding a $40,000 premium is probably

(a) Take the premium cash from the IRA, and

(b) Continue spending $40,000 from non-IRA assets for living expenses. (If John

takes $80,000 from the IRA for both premiums and living expenses, he is actually

depleting David’s inheritance while Todd’s share is growing in value.)

Non-Tax Factors are the True Basis for Long-Term IRA Planning

Client with a Significant IRA or 401(k) Accounts

Assume a client has significant IRA or 401(k) accounts and asks about income and estate

planning opportunities. Although it’s tempting to immediately discuss creative beneficiary

designations, multigenerational strategies, insurance and annuities that back-up solutions,

don’t hurry. Get good information first about family dynamics, concerns and objectives. As you

dive into a fact-finding session, ask tough questions like:

If you pre-decease your mate, do you feel okay about his/her remarriage?

Does your spouse understand tax and financial planning?

Are your young children and grandchildren free from special needs, drug addictions or

other problems?

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Do your adult heirs get along well with each other?

In general, is your relationship with their spouses and in-laws positive?

Can your heirs handle money well?

Is everyone’s exposure to lawsuits and civil liability well handled?

When it comes to IRAs, our system gives most tax breaks to beneficiaries who are individuals.

Therefore, it may seem natural to suggest IRA distribution plans where the account passes

person-to-person down the line. But if your client gives halting responses to non-tax and

personal questions or the answers are mostly "No," trusts can provide flexibility, management

and protection required under the circumstances. The bottom line: Don’t over-commit to

impersonal, tax and technical textbook solutions that your clients usually reject in the long run.

When non-tax objectives are understood first, you will recommend more "perfect" solutions,

and clients will adopt them. You’ll also sell more insurance, annuities and investments to those

who follow your advice. Here is a situation where a client uses asset balancing and trusts to

save estate taxes. (Assume a lawyer uses creative drafting skills and tailors the trust to suit the

client’s non-tax planning objectives.)

Planning Problems: IRAs Payable to a Credit Shelter Trust

Credit Shelter Trust Pros and Cons

Unless a spouse as a trust beneficiary is deemed the sole beneficiary of its IRA, her

trustee must commence RMDs by December 31st in the year following the original

account owner’s death.

The IRA payout to the trust will presumably be based on the spouse’s actual life

expectancy using the elapsed years method. Consequently, it is likely that the account

will be fully distributed by her death, leaving little of it for their children.

Unless the spouse as a trust beneficiary can demand all IRA and trust assets be

distributed to her, her trustee will not be permitted to roll over the IRA to Rhonda’s own

account.

At a spouse’s death:

o Her trustee continues taking distributions over her remaining life expectancy as

established in the year following her spouse’s death.

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If she had inherited the account directly, a successor beneficiary would

use her (longer) life expectancy based on her age (or the age she would

have attained) in the year of death.

If she had rolled over an inherited account to her own IRA, her designated

beneficiary(ies) could take distributions over their own life expectancy; and

At their death(s), any remaining payments would continue until this

expectancy is "used up."

Observation:

Once more, in helping a family make tax planning decisions, the law reduces RMDs (and gives

income tax deferral advantages) when a surviving spouse inherits an IRA directly, or rolls it

over to her own account and names a youngster as primary beneficiary. Unfortunately, when a

spouse receives income from a credit shelter trust that is the designated beneficiary, the IRA’s

income tax deferral potential is usually quite limited. That’s why we look at types of trusts that

allow a married investor to avoid estate taxes when passing assets on to heirs. The trust is

structured so upon the death of the investor, the assets specified in the trust agreement (up to

a specified maximum dollar value) are transferred to the beneficiaries named in the trust

(generally the couple's children). However, a key benefit to this type of trust is that the spouse

maintains rights to the trust assets and the income they generate during the remainder of his

or her lifetime.

A credit shelter trust moves into the highest federal income tax bracket at a much lower

level than do human beings. Consequently, naming a credit shelter trust beneficiary will

usually tax IRA distributions at a higher rate than if they were paid to individual family

members.

IRA Credit Shelter Trust

The advantage of using retirement benefits to fund a credit shelter trust is the savings of estate

taxes on the exemption amount, plus on any subsequent appreciation. But, it is often best to

use other available assets to fund the credit shelter because of the disadvantage discussed: A

credit shelter trust will typically provide for the income it earns to be paid to the surviving

spouse. If power is given to invade corpus to meet the spouse's needs, that power must reside

in a trustee other than the spouse. Otherwise, the power might cause the trust to be included

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in the surviving spouse's estate. But, there also must be a provision to invade corpus when

required to meet the minimum distribution requirements.

An IRA credit shelter trust should not have an estate support clause that permits the

eventual acquisition of assets from the surviving spouse’s estate (in order to provide

liquidity for payment of estate obligations). The reason: The IRS may take the position

that the IRA, in effect, is payable to her estate - a non-designated beneficiary.

The bottom line: IRAs are difficult assets to work with in a financial and estate plan. If possible,

account owners should not leave them to credit shelter or family trusts. Unfortunately, this may

be the only choice available.

IRA Planning Alternatives to Credit Shelter Trusts

Options to Consider vs. Credit Shelter Trusts

There aren’t many concrete substitutes for IRA credit shelter trusts in the estate plan. Let’s

look at two:

Leave IRAs to the surviving spouse (disregard the credit shelter trust) as an IRA

beneficiary. This may work if the owner cares more about a spouse's financial

situation than later estate taxes, or if they believe:

They will live long enough that exemptions will cover estate taxes at the

death of the second spouse.

The income tax advantages of a Stretch IRA distribution outweighs the

estate tax advantages of using credit shelter trusts;

If it is best for the family, a surviving spouse can disclaim in favor of a

credit shelter trust named as contingent beneficiary.

Leave IRAs directly to children, or grandchildren. This works if the IRA owner:

Has sufficient other assets, or traditional life insurance (or a reversionary

annuity) for a spouse’s financial security;

Believes children and grandchildren are capable of making good financial

decisions; and

Really likes the idea of a creative, multigenerational, IRA distribution plan.

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Planning Solutions and Estate Preservation for the Wealthy

Wealthy Client Example

Consider this situation: Warner Gates is in his mid-60s. He hands you a financial statement

that includes more zeroes than you’ve seen in a while. There is a $5 million IRA and millions in

non-IRA assets. Warner definitely falls within the “wealthy” category, and he is frustrated

because his advisers “don’t seem to have any quality advice” for him. Warner tells you that his

family includes the “usual suspects.” There have been several divorces and second marriages

and he doesn’t always get the respect he deserves. Warner’s first wife died, and he has

remarried. He loves her, and there is no prenuptial agreement. He is moderately interested in

philanthropy, but he takes real joy in his 10 grandchildren, ages 8-18. Warner hasn’t invested

much in life insurance or annuities. He seems wealthy enough to do almost anything that

"makes sense." Warner wants help in arranging his financial affairs. What would you tell

Warner? Should he buy life insurance? If so, what kind and how much? Should it be payable to

an irrevocable trust? What should he do with the IRA? How should he provide for his wife and

his "ungrateful" children?

Federal estate taxes focus on the wealthy – like Warner Gates; consequently, it’s too

soon to cancel life insurance, and he should probably consider additional coverage. You

could recommend Warner purchase coverage for estate liquidity up to about 40% of the

value of his holdings. The policy should be owned by an irrevocable life insurance trust

(ILIT) with an estate support clause. The emphasis should be on death benefits and not

cash values. Warner can always cancel the policy later.

Regarding his grandchildren, the $5 million IRA can be divided into 10 accounts and

name 10 conduit trusts beneficiaries of $500,000 each (or 10 annuities or some

combination of trusts and annuities). Each grandchild’s life expectancy would be used

for calculating his or her RMDs. The trustees might be parents of the beneficiaries. This

strategy could secure an education or retirement income for Warner’s heirs.

It’s possible to disinherit children who are estranged or leave a limited inheritance that

becomes void if someone attacks the arrangement. However, most wealthy clients

leave meaningful shares to their children regardless. It is usually easier to provide for

all, than perpetuate bitterness.

Warner might consider a reversionary annuity for his second spouse. They should

probably have a post-nuptial agreement if her overall inheritance rights are restricted.

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In summary, it’s always a challenge when significant IRAs are held by wealthy estate owners.

Professional planners need to:

Assess client needs for trusts as part of the plan;

Include all advisers early in the process;

Have frank client discussions about tax legislation;

Discourage cancellation of life insurance, and promote additional coverage; and

Thoroughly address the difficulties associated with IRAs in the plan – basically, clients

have to decide whether IRA tax deferral is more important than the protection trusts can

offer their families. And know that the "best" solution usually involves a combination of

planning strategies.

When a Client’s Estate Includes a $1 Million IRA

Examples Considering Significant IRA Assets in an Investment Portfolio

Let's look at two situations where the IRAs are significant assets in someone’s investment

portfolio.

First:

The estate tax exemption is exactly $5.45 million

The IRA’s value is $5.45 million when the owner dies

The account must be liquidated to pay estate taxes, debts and other cash

obligations

The taxable estate (including the $5.45 million IRA) is precisely $5.45 million

There are no estate taxes

Assuming an income tax rate of 40%, federal income taxes on liquidation are

$2,180,000 or 40% of the IRA’s value ($3,270,000 remains).

Or

Second:

The gross estate (including the $5.45 million IRA) is $8 million

The full estate tax attributable to having this $5.45 million IRA included in the

client’s gross taxable estate is $1,020,000.

Assuming a 40% bracket, the income tax is 40% of $4,430,000 ($5.45 million

less $1,020,000 = $4,430,000) or $1,772,000.

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Total taxes are $2,792,000 ($1,020,000 plus $1,772,000) or about 50% of the

IRA's value ($2,658,000 remains).

The bottom line: In each scenario the tax bill (which can be even higher if there is a generation

skipping tax) depends on a number of factors and each client’s particular circumstances. Since

these taxes are always devastating, you must definitely determine if your client is charitably

inclined.

Charitable Tax Planning Strategies for Large IRAs

Client with Philanthropic Intentions

If a client has philanthropic inclinations, the planning alternatives range from simple to

complex. Here are several possibilities for clients with large IRAs:

Take minimum level or variable annual distributions, and make current cash gifts

directly to the charity, which are deductible up to 50% of adjusted gross taxable income

(AGI).

If older than 70 ½, direct RMDs to a qualified charity. Such distributions, if less than

$100,000, are tax-free. RMDs over $100,000 will have to be included in income but can

also be directed to charities – see above point.

Take annual distributions and acquire life insurance payable to the charity. The

premium cash is deductible up to 50% of AGI.

Take annual distributions, pay income taxes, and use the net withdrawal to acquire life

insurance for family. Name the charity beneficiary of what remains from the IRA at

death.

When there is an existing bequest to charity in an IRA owner’s will, substitute the charity

as beneficiary of a corresponding portion from an individual IRA. Then, leave the

bequest to family. Everyone receives more funds when tax-paid assets pass to non-

charitable beneficiaries, and taxable funds are left to charities.

Create a separate IRA payable to charity. Under RMD rules, the designated beneficiary

must be an individual or a trust. Since a charity is not an individual, it cannot be a

designated beneficiary. Consequently, if the charity is only one of a group of

beneficiaries, the others may be required to take distributions more rapidly than desired.

The solution is to create a separate IRA payable to charity. Since separate accounts

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need not be established until December 31st of the year following the IRA owner’s

death, a group of beneficiaries can always break apart one IRA left fractionally, or in

percentages, to a charity and the owner’s heirs.

Leave the IRA directly to a spouse; name the charity as the successor beneficiary of

any balance remaining at her death. There is some risk the surviving spouse will roll

over the account and change the charitable beneficiary. Although the balance can be

included in her gross estate for federal estate tax purposes, it qualifies for the estate tax

charitable deduction.

Alternately, leave the IRA directly to a QTIP trust for a spouse and name the charity

beneficiary of the remainder at her death. This is an effective strategy when an IRA

owner is concerned that the surviving spouse may change the beneficiary to another

charity or non-charitable designee. However, a QTIP trustee (for a spouse) must usually

take IRA distributions more rapidly than if they were paid to him/her individually.

Charitable Remainder Unitrust (CRUT)

The most popular and flexible type of life income plan is a charitable remainder unitrust

(CRUT). Cash, securities, real property, and other assets are transferred into the trust. The

trustee manages the trust assets and pays the client, or others chosen, a variable income for

life or a term of years.

Leave the IRA directly to a testamentary charitable remainder unitrust trust (CRUT) that

names a surviving spouse sole interim non-charitable beneficiary at the account owner’s

death. This approach works well when the owner understands that a set spouse’s cash

flow qualifies for a marital deduction, and the charity’s remainder interest is a charitable

deduction for the owner’s estate. There should be no taxable income reported when

this trust receives the IRA. At the spouse’s death, any balance of the CRUT included in

the taxable estate qualifies for a charitable estate tax deduction. Once more: In a

charitable CRUT, there can be no distributions of principal in the event a spouse needs

additional funds for emergencies, support, etc. If this concerns an owner, a QTIP trust

where the remainderman is a qualified charity may be more appropriate.

If there is no surviving spouse, leave the IRA directly to a testamentary CRUT that

names a child or other relative interim beneficiary at the account owner’s death. The

value of the non-charitable beneficiary’s share will be included in the owner’s gross

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taxable estate. But, the charity’s remainder value qualifies for a charitable estate tax

deduction. Payment of an IRA to the trust should not cause immediate income taxation

to anyone.

Alternately, leave the IRA directly to a non-CRUT charitable trust where a child or

grandchild is interim beneficiary (and the designated beneficiary for RMD purposes).

There is no charitable estate or income tax deduction at the owner’s death. However

any balance remaining at the descendant’s death that passes to the charity qualifies for

a charitable estate tax deduction in the descendant’s estate.

Use a combination of non-charitable and charitable beneficiary options. For example, an

account owner might break a large IRA into several accounts before his death. Each

child and grandchild reaches a share and can take "stretch-out" distributions over their

lifetimes. Another account is paid directly to a spouse who rolls it over to a new IRA.

Finally, the last account is left to a testamentary CRUT where payments can be

distributed to family members before the remainder is eventually paid to a charity.

In summary, IRAs are tax volatile assets. They can be remarkably valuable if coupled with

RMDs and maximum tax deferral over several generations. Alternately, it’s possible to think of

an IRA as a 65-70% tax time bomb, if there may be an early cash-out to pay taxes, debts or a

beneficiary’s living expenses. In the latter circumstance, a charitable IRA plan may be a

compelling option. Life insurance can also be part of the solution when it replaces assets that

go to charities of choice.

An Important Point to Contemplate

Impact of Baby Boomers

Baby boomers (those born between 1946 and 1964) make up the largest part of the American

population. By 2024, all baby boomers will be between 60 and 78 years of age. Approximately

10,000 boomers reach the age of 65 every day. By 2060 there is expected to be 92 million

citizens 65-years and older in the U.S. These potential retirees will face the question of

whether to roll $8 trillion or so in 401(k) funds, pensions, TSAs and 457 government plans into

their personal traditional IRAs.

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Some who leave their employers will simply cash-out to pay bills or spend their money to

bridge a gap between jobs. But many will need bundles of advice. Some should leave their

cash cache' where it is, if granted that option. The reasons: Lower management fees, access

to certain low-cost investments and possible fiduciary protection not found in IRAs.

Others should exercise dominion and make everything their own in an IRA rollover. What

makes this so fascinating is there aren't any easy or blanket answers. Most everyone will need

an opinion or two, and that's where you come in.

The subject of IRA rollovers begins with the transfer of funds from a pension, profit sharing,

SEP, 403(b) annuity or an eligible Section 457 government plan (qualified plans, according to

the rules issued by the IRC),

Generally, an employee can make a rollover if he or she receives the balance from qualified

programs and transfers the distribution to an IRA within 60 days of receipt. Of course, direct

trustee-to-trustee transfers are allowed, but technically these are not rollovers. Surviving

spouses who receive cash-outs from qualified plans, etc., can roll over these payments to their

own IRA; however, other beneficiaries and heirs don't have a similar privilege. The decisions of

whether to rollover these distributions usually involve a number of interesting issues; tax and

non-tax related. Let's look at 10 practical matters that can come-up for Harry, a hypothetical

client. You'll find some of these challenging and even surprising.

Will the plan force-out the funds (and induce the rollover decision)? Plain and simple,

most qualified plan trustees don't see themselves as managing money for participants

and beneficiaries no longer associated with the employer-sponsor. If Harry is still on the

payroll, now is the time to get a handle on the plan's practice. Perhaps there can be an

amendment to make everything more former-employee friendly. If not, then at least he

knows what to expect if he is let go.

Does the plan hold appreciated employer stock? It's not uncommon for 401(k) plans

(and certainly employer stock ownership plans [ESOPs]) to hold employer stock that

has grown in value. If so, the choices for that portion of the distribution are:

Leave the stock in the plan, if permitted

Take the stock as a lump sum and probably keep it

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Rollover the stock to an IRA and make a "sell" decision later. This can really be a

thorny planning problem. Let's look at the possibilities:

If permitted, leave the stock in the plan where taxes can be deferred. Here,

Harry may not have the ability to diversify into other investments.

Everything depends on the trust agreement.

Assume personal control, pay ordinary income taxes on the stock's

purchase price (its basis) and defer tax on the gain if any. All excess

appreciation will be long-term capital gain if and when the stock is sold. Be

aware: There is no basis step-up on that gain if Harry dies before selling

the stock.

Rollover the stock to an IRA. This defers taxation, but causes all

appreciation (over basis) to be taxed eventually as ordinary income.

Example: From ABC Company's 401(k) plan, Harry takes out 100 shares of ABC stock at

termination of employment. The trustee purchased the shares for $100 and their distribution

value is $200. If Harry keeps the shares, and sells them eventually for say, $500, he pays

ordinary income taxes on $100 now and capital gains on $400 later. If he rolls over the shares,

he pays no tax now and everything is ordinary income later. Harry's choices seem clear and

straightforward.

If he retains the ABC shares, he might look forward to years of tax deferred appreciation

but capital gains tax someday.

Alternately, a rollover eventually converts everything to ordinary income.

What would you do? Here are a few factors that could tip the scales one way or another:

If Harry is younger than 59½, and rolls over the ABC stock, he could be subject to a

10% premature distribution tax;

If ABC stock pays hefty dividends, retention may not be so obvious because there may

not be much appreciation anyway;

If Harry is in a low tax bracket (and anticipates a high bracket later) this favors retention.

Or vice versa; or

Perhaps Harry wants to diversify, in which case he would probably choose a rollover.

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In substance, consider retention If:

A low tax bracket now and a high bracket later,

Dividends aren't anticipated, and

A low capital gains rate is expected in the future.

A rollover may be best if:

A high ordinary tax bracket now and a low bracket is expected later,

A Roth conversion can be worked out,

There is a high dividend rate anticipated in the future, or

There is a high basis compared to current value.

Employee Considerations

Will the employee work into his or her retirement years? Let's say Harry is in his 60s

and reaches normal retirement age. He plans on working for ABC Company on a full or

part time basis. His 401(k) plan allows him to keep his account in the plan or take it

where he can rollover the funds. If Harry keeps his account intact, he can delay taking

distributions until shortly after actual retirement. If he rolls over to an IRA, RMDs are

mandatory at age 70½. Consequently, if Harry doesn't need the money, he might leave

it in the 401(k).

Is the employee considering a divorce? Let's say Harry is in an unhappy marriage and

could start divorce proceedings in the near future. Know that funds that stay in some

profit sharing plans and all pension programs (where they are subject to Joint and

Survivor annuity requirements) require the notarized signature of a spouse before

release. Still, if the 401(k) or pension funds can get into an IRA, they may be subject to

a QDRO if the matter is in court. Once a divorce is complete, if a portion of a 401(k) or

pension fund is granted the former spouse, there is no pre-age 59½ penalty tax issue. If

the award is from an IRA, the 10% tax is applicable if Harry is pre-age 59½. A word of

caution: If there are any marital issues or problems (and there is a significant 401(k),

pension, TSA or IRA), get Harry to a qualified attorney. You want counsel to advise

regarding any rollover and beneficiary issues from this point forward.

Is the employee considering a marriage? If so, and Harry doesn't want his spouse to

have survivorship rights in a qualified plan, he can eliminate them by rolling over the

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money before his wedding. A word of caution: Once rolled over, state law may still give

a spouse inheritance rights without a prenuptial agreement.

Is a stretch IRA payout in the future? Assume Harry is single with children or married

where the offspring are contingent beneficiaries of a 401(k) or pension account. Further,

he is interested in preserving his fund for the next generation. Review the 401(k) trust

agreement; it will probably require a lump sum payout at death. Since only spouse

beneficiaries can rollover the qualified plan money, Harry will want to consider getting

the funds out of the plan and into an IRA. Then, any children beneficiaries can take

distributions over their lifetimes. Observation: Whenever there is a desire to stretch the

IRA, you probably have the most potent reason to suggest a rollover. Simply put, if the

qualified plan pays only lump sums at death, rigorously investigate how to get the

account into Harry's name. Then, he can rollover to an IRA and create tax savings in a

designated beneficiary plan for children and grandchildren.

Is the 10% premature distribution penalty tax an issue? If a terminating employee is

under age 59½ and may need money, there are some tricky rules that can save the

10% penalty tax. For instance;

The penalty tax doesn't apply to distributions from IRAs (only) to pay:

Health insurance premiums during unemployment

College costs of taxpayer, spouse, child or grandchild, or for

The first time purchase of a home, up to $10,000

The penalty tax doesn't apply to distributions from qualified plans (only)

If the employee has separated service at age 55 or later

Subject to a QDRO, or

Is a certain dividend on ESOP stock

If in a difficult planning situation, be aware of the differences. They could help tip the

scales.

Is creditor protection an issue? After the Bankruptcy Abuse Prevention and Consumer

Protection Act:

There is protection in bankruptcy for funds in a 401(k) or other qualified plans,

including SEPs and SIMPLE IRAs.

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There is inflation-adjusted protection for IRAs up to $1 million, and shelter for

excess in the rare instance that more than $1 million is reasonably necessary for

support.

When rolling over to an IRA, assets in 401(k) plans, profit sharing and pension

plans, 457 and 403(b) annuities probably maintain fully exempt status.

Does the employee want to control the money? We have seen a number of insider fraud

and stock manipulation court cases in the news. In some instances, workers have seen

their entire 401(k) or pension account lost or greatly reduced in value. With the attention

given these matters, the groundswell to control "my money" and rollover to a personal

IRA just gets greater. Whether the issue is (a) to control, or (b) a worry about what can't

be controlled, you'll find retirees wanting to rollover their retirement funds. Here, the

rollover is probably a foregone decision. Get good at where to put the money and how

to designate primary, contingent and successor beneficiaries. That's where you can

really help.

Can the participant handle control over their retirement funds? When all roads seem to

lead to a rollover, terminating employees and retirees still need to know their tendencies

once retirement funds are outside a qualified plan (and into the IRA). It may be that

one's lifestyle and habits will cause premature liquidation of the IRA. Some people can't

resist the urge to "dip into an IRA" and waste what should be preserved for many years

in retirement. If Harry fits this profile, he may be best served by leaving his 401(k) or

pension fund where it is.

In summary, you'll surely encounter many terminated employees and retirees in the years

ahead. You may even be the adviser to a plan trustee or a company's employee benefits

manager. Develop questionnaires and checklists, and give good advice to those who have

significant account balances. This will certainly lead to good selling relationships and great

referrals, too.

Reasons Why Young Taxpayers Should Consider a Roth IRA

Roth Advantages

There are several reasons an investor may select a Roth over a traditional IRA.

Growth on a Roth is tax-free;

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Roth distributions are income and penalty tax-free, provided the account has existed for

five years, and the participant is age 59 ½. or meets one of the other exceptions.

There is no RMD requirement at age 70½. The fund can continue growing tax-free; You

could say compared to a Roth, traditional IRAs have a slight disadvantage when clients

could be contributing to them now (only to receive distributions later in a higher bracket).

However, older taxpayers probably have most of their IRA money in traditional

accounts.

» It could be psychologically difficult to give up the tax deduction for IRA

contributions;

» The account owner may have rolled-over a qualified plan distribution to a

traditional IRA, and doesn't want to pay a huge tax now; and

» To convert to a Roth, it's always necessary to come up with significant tax money

at once. And paying taxes when it’s not necessary just doesn't make much sense

to most people. Converting to a Roth still has a lot of appeal, especially for IRA

owners who (a) have significant account balances, and (b) are motivated by

wealth transfer planning.

In addition to the advantages above:

The "no Roth RMDs after age 70½" rules are suspended for surviving spouse

beneficiaries, too;

If a trust is the beneficiary of a Roth, there isn't any worry about its higher tax brackets;

It may be possible to shelter a traditional IRA from some tax when converted. For

instance, if an IRA owner can use more charitable or net operating deduction carry

forwards, investment tax credits, etc., these might coincide with the conversion;

For IRA owners with taxable estates, it isn't possible to deduct state estate or

inheritance taxes against a traditional IRA taxable distribution. However, by converting

to a Roth, in effect the IRA owner gains a full estate tax deduction (federal and state) for

any income taxes paid now; and

Once converted, post-age 70½ contributions to a Roth are allowed, provided the

participant still has earned income; contributions to a traditional IRA are not possible

after reaching age 70½.

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Further, when income taxes -- at the point of conversion -- are paid outside the account, there

can be financial and mathematical advantages for a Roth. Here's an example: John and Joan

each have a $100,000 traditional IRA. Both have a constant 30% income tax bracket and a

$30,000 savings fund, which can be used for the conversion taxes. John converts to a Roth

and pays the $30,000 tax with his outside savings money. Over time, his Roth grows to

$200,000, which he withdraws tax-free. Joan keeps her traditional IRA, and over the same

period it grows to $200,000; she withdraws her money and nets $140,000 after a 30% tax.

However, if Joan's $30,000 savings fund earns taxable interest, she'll actually have less than

$60,000 ($200,000 less $140,000) accumulated outside her IRA.

Other Roth Considerations

It's not that simple.

In the John and Joan example, each is presumed to have a $30,000 kitty to pay

conversion taxes. If either's fund has untaxed gain, that must also be considered. John's

$30,000 could already be tax-paid in a savings account, and Joan's $30,000 may have

mostly untaxed profit. She doesn't want to:

Pay taxes just to pay more tax, or

Sell an appreciating asset prematurely. These factors favor John's conversion

and Joan staying put.

If John believes that income tax rates will rise even higher, this favors his conversion. If

Joan believes income tax rates will be reduced - or replaced by a consumption tax –

she probably won't convert. Why pay taxes that might not be owed later?

Let's say John believes his IRA investments have considerable upside; Joan is worried

about downside. These views favor John's conversion and Joan staying put.

Note: A Roth conversion technically is a "qualified rollover contribution" and only surviving

spouse beneficiaries can complete this transaction. If Laura predeceases Bob, his contingent

beneficiary can always "collapse" the traditional IRA and use insurance cash to pay income

taxes; but he or she cannot convert to a Roth and maintain the IRA structure.

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Observation: Ever wonder how many IRA owners of traditional accounts don't know that their

surviving spouse can convert to a Roth? Life insurance can make this possible. It is a realistic

planning opportunity for all married taxpayers that have significant traditional IRAs.

Example One

Ronald and Katherine Harper have a $300,000 IRA (in Ron's name) and like the idea of a Roth

conversion for his account. But, like many they don't want to sell some appreciated

investments and create a $100,000 tax fund to complete the transaction. (As a sidebar, Ron

and Katherine have significant equity in their home.) A solution: Ron and Katherine take out a

$100,000 home equity "interest-only" loan to pay income taxes on the conversion. Interest (on

up to $100,000 in home indebtedness) is deductible, regardless of the purpose of the

indebtedness. However, such qualified indebtedness interest must be added back into income

for alternative minimum tax (AMT) purposes if the loan proceeds aren't used to buy, build or

substantially improve their residence. The Harpers will take small Roth distributions to pay the

loan interest; they'll repay the loan when the residence is sold. The result: They won't pay

capital gains taxes to finance taxes at point-of-conversion. They'll also deduct the loan interest

cost.

Example Two

George (age 60) and Cathy Wilson like the idea of a Roth conversion for George's $300,000

IRA, but this pushes their tax bracket from 25% to 33% or more. A solution: George and Cathy

convert the IRA in stages, say at the rate of $30,000 each year for 10 years. By spreading-out

the conversion evenly, they will "average" into the tax-free Roth and level their marginal tax

bracket. In summary, consider IRA conversion in stages for clients and prospects with

significant IRAs. Most taxpayers like the idea of creating a Roth entity for themselves and

generations-to-come where tax-deferred can now become tax-free. The problem, of course,

may be coming up with tax money to do the transaction. Ask good questions, get correct

answers, become creative and show clients some conversion strategies they may not have

considered.

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Roth Recharactizations

A recharacterization allows an individual to “reverse” or “undo” a Roth conversion. This is

handy when the individual later discovers the tax liability on the conversion was greater than

expected and does not want to pay the tax. This could happen if he or she receives a windfall

from an inheritance (perhaps from an annuity) or wins the lottery, and the unexpected income

pushes the taxpayer into a higher tax bracket. Another reason an individual might wish to

reverse the conversion is that the value of the converted amount decreases significantly,

resulting in a taxable amount that is greater than the current account value. By

recharacterizing the conversion, the taxpayer can avoid paying the tax in the current year and

later reconvert the lower account value, possibly saving significant taxes.

In order for an individual to recharacterize, the amount transferred from the Roth must be

transferred back to a traditional IRA in a trustee-to-trustee transfer. Any earnings must also be

transferred and are treated as though earned in the traditional IRA. The recharacterization

must be made by the due date of the tax return, including extensions. This means that a

conversion occurring on January 4, 2016 must be recharacterized by April 17 of 2017 (and can

even be extended to October 16, 2017, provided the taxpayer files a valid extension request).

IRA Protection from Creditors

We will now look at some information on when, and if, IRAs are protected from the creditors of

account owners and beneficiaries. You will learn how IRAs and qualified plan accounts (QPs)

are sheltered in general creditor situations and bankruptcy. We will also address whether

income streams from IRAs and QPs are protected at point-of-receipt. Finally, we'll consider

what happens when income is from an annuity policy.

Protection for Qualified Plans and IRA Accounts

The Safeguarded Standard

QP accounts: Short of bankruptcy, someone's QP account is fully safeguarded under

federal law - the Employee Retirement Income Security Act of 1974 (ERISA). However,

once these funds are paid-out, federal courts have held frequently that this shelter is

lost. The message is clear: If clients seek ongoing creditor protection, qualified plan

money should be left where it is.

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IRAs: Short of bankruptcy, IRA funds are safeguarded according to state laws. All states

give some protection for funds within the account. A few give partial shelter, e.g., the

amount necessary to give a reasonable annual income. What's important is all of this

could depend on the laws of the individual states. For instance, the IRA custodian is in

State A, but the funds are in State B. The creditor lives in State C - the debtor in State

D. Which state's law applies and what if that state says you apply the law of one of the

other states? Regarding withdrawals, state laws vary. Don't assume that shelter for the

IRA itself translates into protection once payments are distributed. RMDs may not retain

that protection.

Preferred creditors: There will always be preferred creditors whose claims may be

enforceable regardless of exemptions in the law. Although spouses, dependents, the

IRS, QP/IRA plan administrators and fiduciaries generally are preferred claimants, even

they can come up short. It could come down to a matter of negotiation or whether legal

counsel can find leniency under a federal statute or the laws of a debtor-friendly state.

IRA accumulation and payout annuities: IRA owners who want the greatest safety

should determine if annuities are sheltered separately under their state's law. If there is

sanctuary, cash values in accumulation annuities and income streams from payout

annuities may provide an additional measure of overall protection for the account.

Example One

Vince has an IRA that is partially sheltered from his general creditors in state X. But, his IRA

holds an accumulation annuity that has full protection (separately) in that state. The result:

Vince's IRA is strengthened to the extent it includes this policy.

Example Two

Harold has an IRA that is partially or fully sheltered from his general creditors in State Y. Yet,

there is either (a) no sure protection for withdrawals, or (b) there is law that specifically (or

inferentially) cancels protection at point-of-receipt. Fortunately, there is a separate case or

statute that says annuity cash values and annuity incomes are protected from a policyowner's

creditors. The result: Harold's IRA is strengthened because it holds an accumulation annuity

contract. He will look forward to even greater protection when he annuitizes this policy. Let's

run through this again by way of questions. Your answers will provide a track to run on.

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Under the applicable state's law, do personally held accumulation annuities shelter cash

values from the policyowner's general creditors? If so, to what extent?

Under these laws, is a payout annuity's income protected? If so, to what extent?

Does the law protect payments to a policyowner? Annuitant? Payee? Beneficiary?

Everyone?

If there is protection for personal annuity values and incomes, is there any reason IRA

annuities shouldn't be protected too?

If you conclude that an IRA's annuity income is safeguarded, can a right of commutation

(where someone cashes in the present value of any remaining payments) change the

rules? (For instance, if state law gives partial protection to IRA assets and full protection

for annuity incomes, a right of commutation might make a fully protected income look

more like the partially protected asset it came from.) If so, then it might be wise to

separate one's IRAs.

Let's say Henry has $500,000 in an IRA that is partially protected in his state. An IRA's

annuity income stream is fully sheltered, but you feel there is less protection if the

policyowner can accelerate (commute) some of the payments.

Henry (a) needs good creditor protection, and (b) wants at least a partial right to cash-in

if he annuitizes. Advice: Separate the IRA into two annuity contracts. Both are

annuitized; one can be commuted; the other cannot. The former offers more flexibility,

while the latter, more protection. The result: Henry has a plan that suits his tolerances to

a "T." This isn't easy stuff. It's just that we need to get good at helping clients safeguard

their retirement funds. As IRAs grow in stature, it's essential to get matters right.

Protection for Qualified Plans and IRAs While in Bankruptcy

Bankruptcy Abuse Prevention and Consumer Protection Act

The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) changes how we

look at QPs and IRAs when someone takes the final step and files for bankruptcy. This law

should influence our thinking about some extra advantages that IRA payout annuities may

offer.

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First, some good news for debtors who must declare bankruptcy:

Nearly all retirement funds held in QPs are exempt from creditors' claims in bankruptcy.

The protection doesn't depend on whether a debtor is choosing between state and

federal bankruptcy exemptions. The bottom line: QP and former QP participants and

their beneficiaries are likely able to safely assert that their interests in these funds will

be exempt when they declare bankruptcy. As with all legal matters, this should be

confirmed with the client’s bankruptcy attorney prior to filing.

Similarly, funds in traditional and Roth IRAs are exempt, up to a $1 million cap, which is

adjusted to reflect changes in the Consumer Price Index (As of April 1, 2016, the cap is

$1,283,025).

Most commentators indicate that rollovers from qualified plans to IRAs are protected.

Unfortunately, for an IRA owner considering bankruptcy, some negative implications remain:

QPs and IRAs are available for domestic support obligations - alimony, maintenance

and support. Let's say there is a debt that occurs before, on, or after a discharge in

bankruptcy; and this obligation is to a spouse, former spouse, account owner’s debtor,

the child's parent, legal guardian, responsible relative or a governmental body that has

given assistance. The result: These debts aren't dischargeable, and a QP account or

IRA (that is otherwise exempt) will be available to domestic creditors for alimony, child

support, etc.

There is a fair amount of discussion in BAPCPA about claims for taxes, especially those

resulting from fraudulent income tax return filings. Check with counsel about whether

any unpaid federal or state taxes can be obtained from QP or IRA funds otherwise

exempt.

The bankruptcy law excepts from discharge any amount owed by the debtor to qualified

plans or even an IRA. These debts should also be recoverable from funds otherwise

exempt.

The law gives considerable protection for QP accounts and IRAs in bankruptcy. But,

let's say the debtor is discharged still holding these exempt accounts. He or she will now

most likely look to ERISA (QPs) and state law (IRAs) for protection from general

creditors in the future. If the money is withdrawn and no longer in the hands of plan

administrators, will it become fair game for creditors?

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Not every "bankrupt" debtor will want to declare bankruptcy.

First, a bankruptcy now stays on one's credit record for 10 years; this will make it

more difficult later to get credit or possibly a job.

Second, a debtor in trouble may not even qualify for Chapter 7 bankruptcy.

Third, creditors who could force someone into bankruptcy aren't likely to take that

step. Consequently, if bankruptcy is not on the table, everything depends on

what happens with general creditors in non-bankruptcy proceedings.

In seminars or client discussions, it's best to make only general statements about asset

protection; do not provide legal advice and use common sense. You might merely offer the

following comments and observations:

IRAs are now protected in bankruptcy up to at least $1 million. (QPs may have greater

protection); and IRA rollovers may be sheltered fully. Therefore it's a good thing (in the

worst of financial circumstances) that people have plenty of QP and IRA accumulations

for retirement.

A client may not foresee the possibility of a general creditor's claims or bankruptcy. But,

what about the financial problems of beneficiaries, e.g., in divorce where a disgruntled

spouse certainly can become an aggressive creditor and worst nightmare? Here a

large, inherited IRA could come in really handy.

It's more likely there will be a general (non-bankruptcy) creditor claim. Look to:

Federal law that fully protects QPs, and

State laws that generally protect IRAs (domestic claims, tax liens and plan

fiduciary claims are still allowed in most cases). A word of caution: Tell everyone

that state laws can be tricky and may not completely safeguard IRAs.

Whether or not there is a bankruptcy, be concerned about funds withdrawn from QPs

and IRAs. Know that income streams from accumulation IRA annuities can give debtors

the greatest protection. This occurs because state laws may give:

Accumulation contracts extra shelter for cash values,

Annuitized contracts a protected income to account owner, beneficiary, or

Both.

If anyone wants an overall asset protection plan or is facing a claim threatened or

pending, it is suggested to get to a qualified attorney immediately.

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Creditor Protection for Annuities and Pensions

Protection for Annuity and Pension Withdrawals

Some words of caution: The following information is an extended analysis of whether annuity

or pension income from retirement plans and IRAs can give special creditor protection at point-

of-receipt. As mentioned, federal courts often take the view that ERISA protects funds only

within QPs. This is interesting because ERISA does have an avowed policy to assure pension

beneficiaries their benefits. Also, other federal laws protect pension benefits once received,

e.g., the Social Security Act, 42 U.S.C. Section 407(a). Finally, the U.S. Supreme Court hasn't

been asked to decide whether creditors are entitled to someone's pension if he gets to the

money first, to this extent, the issue remains open.

Regarding IRAs, most state laws seem to protect the account, itself. Unless there is a debtor-

friendly court case, we might assume that IRA withdrawals (once taken) aren't safeguarded.

Consequently, can anything be done if IRA distributions aren't protected at point-of-receipt?

First, a retiree might direct pension income to offshore trust accounts in a debtor-friendly

country where the trustee pays her credit card bills and other living expenses. This process

might forestall creditors if they cannot timely access the funds. Also, the funds may be

sheltered automatically on transfer. A word of caution: Offshore asset protection is a highly

specialized field of the law.

Second, annuitized distributions may be protected under state laws that shield a stream of

annuity income. Here is a brief look at a few applicable statutes:

It's possible for a state to protect:

An accumulation annuity policy's cash values

A policy's death benefit

An annuitized income stream for the policyowner, annuitant, payee, or everyone,

and/or

An annuitized income stream for a beneficiary after someone dies.

Some states protect everything. Or, there can be limited protection. A few states

offer no shelter.

When there is protection, it may be limited to "reasonably support one's dependents."

Or a beneficiary's income may be shielded, but only if a policyowner – while alive –

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arranges a supplementary contract. Of course, all protection fails to the extent

premiums are paid in defraud of creditors.

The laws may authorize a court to extend or expand any shelter on income once

received.

Again, a careful reading of the laws is necessary since sometimes:

The annuity contract itself is protected

The benefits (including the income) are that which is sheltered

Both the policy and the benefits are shielded

Sometimes, annuity payments placed in other investments are still safeguarded, as

long as everything can be traced back to the policy itself.

Regarding a beneficiary's annuity income via supplementary contracts (settlement

options planning), it's always best that a policyowner arrange the terms while alive.

This is a contractual right in the policy, but not often availed of in real life. In short, the

beneficiary can always select an income; but then it may be too late to protect

payments from creditors who want them.

In general, states are amending statutes to provide more (and not less) creditor

protection for annuities and insurance values. This bodes well for IRA and

nonqualified annuities, especially when they are annuitized.

A good question is whether a protected annuity income becomes available to

creditors if the policyowner can accelerate payments and re-obtain cash values. It

just seems reasonable that a right to commute makes everything look more like a

lump sum than an income benefit when determining if either or both are safeguarded

from attachment.

Third, once you know whether annuities and their incomes are protected, everything may still

depend on which state's law applies. For non-qualified annuity contracts, it's possible that is:

Where the policyowner-debtor lives

Where the contract was sold

Where the insurer's home office is located, or

Where the creditor is located. For qualified (IRAs for example) contracts, you could add

the law in the state where a provider custodian or trustee is located.

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Fourth, if you find only limited protection for annuity incomes likely, look to "pension incomes"

as defined in that state's law. This could add shelter. Let's say George's annuitized IRA policy

pays $2,000 monthly, and $750 in annuity income is protected under state law. But, state law

separately safeguards 70% of any retiree's pension income up to say, $1,000 monthly. The

conclusion: Although 70% of $2,000 is $1,400, at least $1,000 of George's IRA annuity payout

is safeguarded. That's still more than $750.

Fifth: When pension income seems only partially protected look further. A state may fully

safeguard pension incomes of certain employees, e.g., teachers and state employees, and an

annuity might provide this income. In the earlier example, assume George is a schoolteacher

whose full pensions [401(b) annuities, school programs and IRA payments] are protected.

Voila! His $2,000 IRA annuity payment is completely sheltered.

Sixth: Remember, advice regarding the protection of IRAs and IRA incomes is the province of

a qualified lawyer. But that doesn't limit your quest for information. Go to a public library and

ask the location of your state's "Revised Statutes." In the Index, go to "Annuities," "Debtor and

Creditor," and "Bankruptcy - exemptions." Then, photocopy key pages for your files. You'll refer

to these in planning sessions with client advisers.

In summary, emphasize that it is just sound planning to protect from creditors what the law

allows. A good example is knowing that QPs and IRAs have special safeguarding in the

system; a better example can be an IRA annuity (especially when it is in payout status). Here,

an account owner may have the ultimate in sound asset protection planning: annuity status

that strengthens everything during both accumulation preretirement and payout in retirement.

Trusts in General

Trust Origins

Trusts are incredible structures. Trusts originated from the English common-law legal system.

Look at it this way: If we didn't have trusts that benefit people, many of those less fortunate or

incapable of managing money might lose everything to creditors, the unscrupulous, and the

system. Let's get more specific and discuss trusts as IRA beneficiaries.

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What Trusts Offer: Pros and Cons of Trusts

Favorable circumstances might include:

A desire to control things;

An individual is infirm, incapacitated, a spendthrift, financially unsophisticated,

incompetent or a minor;

There is the possibility of a beneficiary's divorce;

A need to give trustee discretion regarding distributions;

Estate tax planning indicates a "family trust" for an IRA;

To assure "stretching" the IRA (because family or friends would probably

liquidate the account prematurely just to gain personal control of the money);

There is a second marriage; the spouse needs income with remainder to children

from another marriage.

To assure income to children with, perhaps, remainder to grandchildren.

Unfavorable circumstances might include:

IRA owner wants to keep things simple;

No need to control;

Family or friends are adults, competent in managing money and in good marriages;

No need to incur drafting fees, trustees fees, trust tax returns, accounting fees or

separate sets of records;

An attitude that trusts can be rigid, ambiguous, and even poorly drafted;

Uncertain as to who should be trustees over possible long periods of time;

A trust's high income tax bracket (not important with Roth IRAs); and

Less need for creditor or divorce protection under the bankruptcy law (BAPCPA).

How a Trust Becomes Designated Beneficiary

Steps in Setting Up a Trust as Beneficiary

Let's say the decision is made to pay an IRA to a trust. It's not enough to simply list the trust as

recipient on a beneficiary form. Instead, the trust must be qualified as designated beneficiary;

in effect, it becomes a "see-through" trust. Otherwise, the IRS will treat the trust as one's

estate, and not an individual. The result: The IRA must be distributed (with any applicable

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income taxes) within five years of the account owner's death. Here are the requirements for a

see-through trust.

It must be valid under state law (or it would be valid if it had been funded with other

property);

It is irrevocable at an IRA owner’s death, e.g., a revocable living trust that becomes

permanent at the creator’s death or a testamentary trust under her will;

The trust’s beneficiaries must be identifiable; i.e., they are mentioned specifically in the

trust document; and the trust paperwork must be given to the IRA administrator by

October 31st of the year following the IRA owner’s death.

Observation: Meeting these requirements isn't difficult; what's challenging is a decision of

whether the trust should be discretionary or a conduit. Still, here are a few real-life examples of

what can actually happen on the way to perfecting a see-through trust.

Example One

Harry names his revocable living trust beneficiary of an IRA. The trust is valid and has

identifiable beneficiaries. Harry died on November 1, 2016, at 70 before commencing minimum

distributions. Unfortunately, the trust paperwork is not delivered by October 31, 2017, to the

IRA’s plan administrator. The result: The IRA is not payable to a designated beneficiary, and

must be liquidated under the five-year rule, by December 31, 2021. Note: If Harry died at age

74, after commencing RMDs, this IRA could be liquidated over his remaining life expectancy

(using the elapsed year method).

Example Two

Harry’s revocable trust is named beneficiary of his IRA. However, a provision in this trust

directs that the trustee pay Harry’s debts and last expenses. The problem: Since Harry’s estate

is responsible for these obligations, it’s likely his trust will not be a designated beneficiary.

Instead, his estate will be the deemed payee. Once a trust is treated as a designated

beneficiary, the trust individual beneficiary with the shortest life expectancy (i.e., the oldest

trust beneficiary) is now the designated beneficiary for measuring RMDs.

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Example Three

Harry Jensen names the Jensen Trust beneficiary of his IRA, and the trust qualifies as a

designated beneficiary. Trust income can be (a) accumulated or (b) distributed to Harry’s

children, John age 24, Mark age 30 and Susan age 35. Susan, the oldest trust beneficiary, is

36 in the year following Harry’s death. Consequently, her 47.5-year Single Life Table

expectancy (Appendix) is used for calculating RMDs payable to the trust. Once a trust is

treated as a designated beneficiary, it can name trusts as sub-beneficiaries. Then,

beneficiaries of each trust are the designated beneficiaries.

Example Four

The ABC trust is a designated beneficiary. It has sub-trusts A for Andrew, B for Barney, and C

for Carmen. Assuming each trust qualifies as a designated beneficiary, RMDs to the sub-trusts

could be based on the individual ages of Andrew, Barney and Carmen, respectively. Once a

trust qualifies as a designated beneficiary and receives its RMD, it is permissible for the trust to

retain the distribution (i.e., the trust doesn’t have to distribute these funds to its own

beneficiary).

Example Five

The ABC Trust is a designated beneficiary and receives an RMD of $50,000. It can distribute

(or keep) all or any portion of this sum without violating the minimum distribution rules. The

trustee is governed by the trust document in making this decision. If the trust keeps trust

income it pays the tax; if it distributes income to a beneficiary of the trust, he or she pays the

tax. Finally, a designated beneficiary trustee must report to (a) the trust beneficiary and (b) the

IRS, the amount of all RMDs made from each IRA. The IRS seems serious about assessing

the 50% excise tax on any distributions shortfalls.

There you have it: The requirements for a trust to be a designated beneficiary. If so, a trust

beneficiary is treated as if it is an individual; now, it may use the trust's oldest beneficiary's

expectancy under the Single Life Table to measure RMDs from the IRA.

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Discretionary or Conduit Trusts

Which is Best for the Client

So far, so good! An IRA owner has considered everything, and has decided (at least for now)

to name a trustee beneficiary of a significant IRA. Further, counsel will draft and qualify the

trust as "see-through." In a "see-through trust" the IRS "looks through" the trust and uses the

oldest trust beneficiary's life expectancy for distributions. Consequently, it will now become a

designated beneficiary; once more, RMDs can be stretched over someone's life expectancy

under the IRS, unisex Single Life Table. It's now time to decide whether this trust should be (a)

a "discretionary" (accumulation) trust or (b) a "conduit " trust. This decision will have everything

to do with exactly whose life expectancy measures RMDs withdrawn from the IRA.

Discretionary Trusts

Actually, most ordinary trusts are discretionary in that trustees have latitude to either

accumulate or pay out current income and principal (IRA RMDs too) to trust beneficiaries (and

there are probably a class of trust beneficiaries - children and grandchildren usually.) The

reason: Trust creators are typically less likely to know whether a family will need money now or

later. Presumably, the trustee knows best. When it comes to IRAs, however, the IRS presumes

the oldest beneficiary, including trust remaindermen, will receive any RMDs that are

withdrawn. That's logical. We can't be certain who gets the money. So, why not assume this

person will be potentially an older individual. The result: More taxes now, instead of later when

there is a discretionary trust. The bottom line: Discretionary trusts take RMDs from an IRA

based on the expectancy of the oldest individual trust beneficiary, who also has the shortest

life span. (And, the beneficiaries of a discretionary trust will include current beneficiaries and

remaindermen too.)

Example: George age 75 dies and leaves his $1 million IRA to a trust that benefits his

granddaughters, Rose and Marie, ages 9 and 15. The trustee has discretion to accumulate

income within the trust. After Rose and Marie die, the trust's remainderman is George's

brother, Paul - presently age 60. The trustee takes George's last RMD. The next year, RMDs

will be based on Paul's 24.4-year life expectancy.

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Conduit Trusts

A trust is a "conduit" when RMDs get paid immediately, as if the trust's existence was only a

formality. Here, a trust beneficiary pays tax at personal rates and the trust deducts the amount

distributed. The remainderman's expectancy isn't an issue.

Example One: Franklin, age 75, dies and leaves his $1 million IRA to a trust for his niece,

Deborah age 35. The next year when she is age 36, an RMD is paid to the trust based on her

47.5-year expectancy. Immediately, the RMD is passed through to Deborah and taxed at her

personal bracket. Next year, the trust's RMD is based on her 46.5-year remaining expectancy

at age 37, etc.

Example Two: Morris, age 75, leaves a $1 million IRA to a trust for his nieces, Victoria, age 35

and Laura, age 20. The trust document requires that this trust be divided into two sub-trusts -

one for Victoria and one for Laura. The objective: Have separate identifiable, conduit trusts for

each niece. The Result: This isn't good enough. The trust will be treated as an accumulation

trust with all RMDs based on Victoria's age 35.

Example Three: Harold, age 75, leaves his $1 million IRA to a trust for his nieces, Janice, age

35, and Beverly, age 20. Here, the beneficiary form directs the account be divided into two

separate accounts within the trust; one for Janice and one for Beverly. The objective: Have

separate conduit trusts for each niece. The result: This works. The trust will be treated as a

conduit trust. Janice's sub-trust will receive RMDs based on her life expectancy. Similarly,

Beverly's trust will receive RMDs based on her life expectancy.

Conduit Trust as IRA Beneficiary

When to use a conduit trust - as IRA beneficiary:

A desire to use individual (longer) lifespans with stretch-like thinking;

A large IRA that can be divided into still-large separate trusts;

No concern about dealing with all the separate trusts; and

Less interest in maximum control.

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When a trust isn't so important:

Competent beneficiaries and good non-trust IRA administration;

All trust income paid out, anyway;

Maximum interest in stretch-like planning;

There are smaller IRAs;

Desire to avoid complication, expense, paperwork and trust tax bracket;

Less interest in control and more faith in the individuals; and

With the bankruptcy law, individual IRA beneficiaries presumably have slightly over $1

million in creditor protection under BAPCPA; therefore creditor protection in trusts is

probably less important.

In summary, trusts are wonderful. But, Congress and the IRS seem to believe that individuals

are implicitly better beneficiaries of IRAs; hence, all the rules when trusts come into play. The

bottom line: If income tax deferral for IRA beneficiaries is the main goal, it's probably simplest

and best to use annuities.

The Broad Concept of Annuitizing

Maximizing Cash Flow

Maximizing a retiree’s lifelong cash flow normally presents a challenge to clients, their advisers

and institutions that manage capital sums. A commercial payout annuity – the only product that

provides an income that can’t be outlived – outshines other liquidation strategies. Simply put:

Payout annuity contracts convert principal and income into guaranteed payments for life; the

check arrives on-time, every-time and follows you anywhere in the world. How can you beat

that? Unfortunately, we aren’t getting this message across. Let’s discuss further.

In one year, life insurers paid all policy owners and beneficiaries $225 billion in maturing

insurance and annuity values ($174 billion in cash values from policies terminated voluntarily

and $51 billion in death benefits). Yet, only $2.2 billion (about 1%) was annuitized with a life

contingency. This is a shame. Life carriers compete aggressively to get premium dollars on the

books. Yet, they allow most of this cash to leave, without any real active effort to retain it. It’s

probably just easier to say, “It’s their money; when someone wants it, it’s not our role to

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question how or why.” This is not likely the case, since the reasons for leaving policy values

with insurers are so compelling. Consider:

For years, literature seems to have focused on accumulation and how to build a

retirement kitty; generally missing from the literature are solid facts on how to spend that

which has accumulated. Eventually, clients will require this information. Baby boomers

moving into retirement will make the need for this information loud and clear.

A 28% tax bracket, and (b) a 5% risk of outliving fund assets. The result: Variable

annuity income has outpaced mutual fund cash flows by as much as 100%. If there is a

fully taxable payout (where there is no tax rate differential between ordinary income and

capital gains in an IRA), payout annuities become even more desirable.

In uncertain times, lump sums don’t seem to last. A steady cash flow from an annuity

that may be protected from lawsuits, mismanagement, divorce and creditors is,

perhaps, a better choice. We are living longer and need incomes that don’t cease during

our lifetimes. For example:

Year Born Life Expectancy

1900 49.4 years

1960 70.8 years

2000 77.2 years

2014 82.9 years

Life expectancies have continued to increase for over a century. What happens if we live

longer than our life expectancies, and outlive our money?

Social Security is in trouble as are defined benefit plans. In a society where workers live from

paycheck-to-paycheck, our clients should pre-establish for themselves and their beneficiaries

steady streams of income. Insurers need to promote that only they can likely fulfill such a

promise.

Consumers are optimistic about living into their 90s and 100s. A primary reason for purchasing

accumulation annuities is the opportunity to have an income your customers can’t outlive.

Creditor protection legislation in the 50 states encourages us to annuitize cash values and

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death benefits and leave this money with the carriers. We need to understand the significance

of these laws and explain them to clients. Plain and simple: Get the message to clients about

how settlement options and annuitization can help everyone in the family. Here are a few

thoughts about annuity incomes in retirement and how insurance advisers and insurers can

work together to the client's advantage (and yours, too).

Financial planners and agents should:

Emphasize payout features and guaranteed purchase rates when selling accumulation

annuities; this may help solidify the acquisition and maintenance of the contract;

Be more aware of how payout annuities are useful in retirement income planning

(laddering policies, two-directional and split-annuity investment planning, annuitizing to

fund-fixed everyday bank obligations and insurance premiums, etc.);

In conversations with clients and prospects, use phrases like - "just knowing you'll have

lifelong income is worth its weight in gold." Corny, perhaps, but true!

Educate policyholders on the tax and financial advantages of payout annuities (tax-

favored exclusion ratios, creditor-protected settlement options, 691(c) estate tax

deductions to beneficiaries, quality management of funds over long periods of time,

etc.);

Encourage local lawmakers to strengthen creditor protection for annuity values. The

laws are improving, but much needs to be done. Be less concerned that low

commissions on payout annuities means an end to compensation on the premium cash.

Don't fear: Insurers will find a way to give trailers and more commissions as baby

boomers demand more for their retirement income dollar.

Insurers should:

Give more competitive annuity purchase rates to those who purchase nonqualified or

IRA accumulation policies on the way to retirement, and communicate with

policyholders as to why these rates are special;

Not accept wholesale tax-free exchanges of nonqualified accumulation annuity

contracts as a "way of life." Instead, give existing policyholders and servicing agents

more incentives to leave these policy values in-house to annuitize eventually;

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Compare the value of keeping maturing cash values and death benefits on the books

with the cost of losing this business and obtaining new business to replace it. Then,

promote payout annuities and return any savings to those who annuitize their maturing

death benefits and cash values;

Pay agent compensation (interval bonuses and annual “trailers”) if policyholders and

beneficiaries annuitize surrender values and death benefits in-house. After all, if a

planner is primarily compensated based on money under “private management,” you

have some idea where it will go;

Market IRA accumulation annuities that offer a range of creative options at retirement,

including (a) multiple generational distributions, (b) annuitization, and (c) cash-outs after

the policy is annuitized - Actuaries need to sharpen their pencils;

Provide really creative payout annuities that have cost-of-living and equity-indexed

increases, and give across-the-board periodic bonuses to those who take long-term

contractual payments. (It will cost something, but generally long-term policyholders will

accept this.);

Move the annuity purchase rate section of an accumulation annuity contract to the front

of the policy and sales literature; the annuitization feature is a primary reason to

purchase – not an afterthought.

A Brief History of IRA Distributions Regulations

Historical Perspective

Here's the story on the IRA regulations that tell us how to "spend" our IRAs; in particular,

identifying the rules that pertain to commercial annuities and their role in annuitizing IRAs.

Before ERISA there weren't any IRAs. Then, the pension tax law was applicable to qualified

plans sponsored by employers for their employees. For corporate plans, there was no age

70½ distributions requirement, and no age where the plan had to pay out retirement benefits;

that was up to what the trust document said.

ERISA changed everything. That law created the IRA and introduced a "required beginning

date" of the April 1st following the later of someone's age 70½-calendar-year or the calendar

year of retirement. ERISA also conceived the phrase "required distributions at and after a

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required beginning date." (Later, IRS regulations referred to these as "required minimum

distributions.") The result was ERISA:

Mandated when taxable funds had to be taxed,

Defined minimum amounts taken, and

Assured most retired and terminated employees that their retirement income began at

age 70½.

ERISA created the idea of a "designated beneficiary," or any individual named by the

employee or IRA owner. It introduced the notion of a life expectancy payout for employees and

spouses that could be re-determined annually when calculating RMDs.

You would think the changes in ERISA wouldn't be all that difficult to comprehend. Yet, it took

13 more years for the U.S. Treasury to publish proposed distributions regulations; their

interpretation of ERISA regarding required payouts from tax-qualified plans, TSAs, IRAs and

government sponsored Sec. 457 plans. Taxpayers could rely on these propositions until further

notice. Unfortunately, there was considerable confusion about:

Effective dates

Recalculations of life expectancies

Whether certain taxpayer elections could be changed, terminology, etc.

It took another 14 years for the Treasury to propose a set of "simpler" distribution regulations.

These were published in the Federal Register. A public hearing on the “temporary regulation”

was held. The IRS noted comments and concerns and responded with Internal Revenue

Bulletin 2004-26, which is what made the “temporary” regulation final. It covers annuity

payments directly from DB plans, and from commercial annuity contracts that provide benefits

under qualified plans, IRAs, TSAs, etc.

The U.S. Treasury Law on Distributions

IRS View on Distributions

Briefly, the Treasury's general position:

The IRS seems to favor distributions from an IRA annuity policy. However, the payments must

provide retirement income, and not benefits at death. Nor should there be a significant

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increase in income later while the IRA owner is alive. The reasons seem obvious. If very small

annuity payments are taken now - with a balloon later - this violates ERISA and RMDs at age

70½ that increase gradually over one's lifetime.

The IRS wants tax revenue sooner and not later. So, Treasury doesn't favor:

Payout periods that exceed one's lifetime,

Lump sums or balloon payments later on, or

Any changes or surprises once payments begin.

Treasury is also concerned with extras that aren't associated with one's income; the

"actuarial value" of these benefits may have to be added to the annuity's cash

accumulation value to determine RMDs after age 70½.

Payout annuities must follow rules applicable to tax qualified defined benefit plans,

under IRS regulations.

How to structure an IRA annuity policy at point-of purchase:

If an account owner wants to purchase a payout contract with only a portion of an

account, the remainder must be distributed according to the RMD rules and the Uniform

Lifetime Table, etc. If less than 100% of an IRA will be used for a single premium,

separate the account properly and use all of one account for the premium; it's easier to

do this administratively.

Periodic annuity payments must be made monthly, quarterly, semi-annually or annually.

(A payment "every other year" doesn't meet this test.) And, once payments have

commenced over a term certain, it can't be changed even if a new period is shorter than

the former period.

For owners 70½ or younger, the first annuity payment must be received by April 1st of

the year following age 70½; however, the second payment isn't due for another 365

days (into the next tax year).

Modifications are allowed. Once non-annuity RMDs begin, it's still possible to acquire a

payout contract at a later date. However, the policy's first payment interval must begin

on or before the purchase date.

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Example: On July 1st, the policy's effective date, 75-year old IRA owner Harry uses his

account to acquire a single premium annuity that makes payments annually. The policy's first

payment interval must commence by at least July 1st, and the first annual annuity payment

must be received by no later than June 30th of the following year.

A level IRA Annuity Income for the Account Owner

Life-only payments from commercial annuities are permitted. The rationale: Annuity income

that ceases at an IRA owner's death completely liquidates the account and is a "fair-bargain"

for both taxpayer and the IRS. If someone dies too soon, the payout is smaller and the IRS

possibly loses tax revenue; if he or she lives too long, more is paid and the account owner

pays greater taxes overall. IRA owners can also purchase annuities that have terms certain.

Or, policies with life contingencies and term certain too. Any term, however, must be limited by

one's life expectancy under the Uniform Lifetime Table, determined at point-of purchase.

Example One - A Life Annuity: With $100,000, Mary's IRA acquires an annuity that

pays her a $10,000 lifelong level annual income. This is an acceptable policy.

Example Two - A Term-Certain Annuity: With $100,000, Mary's IRA acquires a fixed

term level annuity that pays her $7,000 annually for precisely 20 years. She is age 71.

Since her life expectancy under the Uniform Lifetime Table is 26.5 years, the term is for

a lesser period. This is an acceptable policy.

Example Three - A Life Annuity With Term Certain: With $100,000, Mary's IRA

acquires a level life annuity that pays her $6,000 annually with a 20 year guarantee.

She is age 71. Since her life expectancy under the Uniform Lifetime Table is 26.5 years,

the term is for a lesser period. This is an acceptable policy.

Let’s look at a level IRA annuity income for the account owner and a beneficiary who is a

spouse. Usually, an IRA owner has something in the account after he dies. He or she can look

at any IRA as a "partnership" or with the beneficiary. We need to pay more attention to

beneficiary designations in all financial planning. Commercial annuity payouts are no

exception. Whether the policy pays a Joint and Survivor income or pays for a lengthy period

certain, it's possible for IRA annuities to continue payments for two or more lifetimes, and a

generation to come. Here are some examples where beneficiary designations are prominent in

a decision to annuitize. Examples 4, 5, 6 and 7 involve Harry's surviving spouse, Mary.

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Example Four - A 100% Joint and Survivor Life Annuity With a Spouse: With $100,000,

Harry's IRA acquires a level life annuity that pays $6,000 annually - a 100% survivor's

benefit - for as long as he and his spouse, Mary are alive. He is age 71 (and she can be

any age). This is an acceptable policy.

Example Five - A 100% Joint and Survivor annuity with a spouse, that has a term

certain: With $100,000, Harry's IRA acquires a level annuity that pays $7,000 annually

for a fixed period of 20 years. If Harry dies before the 20 years expire, Mary takes the

balance of his payments. Harry is age 71 and Mary is age 61. Mary is sole beneficiary.

Harry's life expectancy under the Uniform Lifetime Table is 26.5 years, and the term

certain is for a lesser period. This is an acceptable policy.

Example Six: Assume Harry is age 71 and his spouse, Mary, is much younger at age

46. With $100,000, Harry's IRA acquires a level annuity that pays $6,000 annually for a

fixed 30 year period. If Harry dies before the 30 years expire, Mary is sole beneficiary

and takes the balance of payments. Harry's life expectancy under the Uniform Lifetime

Table is 26.5 years. Even though the term certain exceeds this life expectancy, it is an

acceptable policy. The reason: The sole beneficiary is his surviving spouse, and their

joint life expectancy under the Joint and Last Survivor Table is 30.1 years.

Example Seven - A 100% Joint and Survivor life annuity with a spouse, that also has a

term certain: With $100,000, Harry's IRA acquires a level life annuity that pays $5,500

annually for as long as he and Mary, his spouse, are alive. Harry is age 71 and Mary is

age 46. There is a 30-year guarantee. Their combined life expectancy under the Joint

and Last Survivor Table is 30.1 years. You'd think this would be an acceptable policy

(according to Example 6). However, it is not. The reason: Since this annuity has life

contingencies, its fixed period is limited to Harry's 26.5 year life expectancy under the

Uniform Lifetime Table.

Example Eight - A Joint and Survivor Life Annuity with someone who is not a spouse:

With $100,000, Harry's IRA acquires a level annuity that pays $6,000 annually for as

long as he and his daughter, Nancy, are alive. He is age 71 and she is 41. This is not an

acceptable policy. The reason: When the survivor is not a spouse, his or her annuity

payment is limited to lower percentages of the owner's benefit. Their age difference is

30 years. Consequently, her $6,000 payment must be reduced.

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Example Nine - a Joint and Survivor Annuity, with someone who is not a spouse, that

has a term certain: With $100,000, Harry's IRA acquires a level annuity that pays

$7,000 annually for a fixed period of 25 years. If Harry dies before 25 years expire, his

daughter, Nancy, receives the balance of any payments. Harry is age 71 and Nancy is

41. Nancy is Harry's designated beneficiary. Harry's life expectancy under the Uniform

Lifetime Table is 26.5 years, and the term certain is for a lesser period. This is an

acceptable policy.

Example Ten - a Joint and Survivor Life Annuity, with someone who is not a spouse,

that has a term certain: With $100,000, Harry's IRA acquires a level annuity that pays

$6,500 annually for as long as he and his daughter, Nancy, are alive. Harry is age 71

and Nancy is 41. There is a 25-year guarantee. The annuity's fixed period is less than

26.5 years, Harry's life expectancy. This is an acceptable policy.

A level IRA annuity income for someone after the account owner dies - There are a group of

pre-age 70½ IRA owners who should purchase accumulation annuities. They want contractual

guarantees, death or nursing home benefits, stock market like upsides and policies that may

offer downside protection, extra layers of creditor safeguarding, etc. Even after 70½, these

account owners might maintain the IRA policy as an accumulation annuity and merely take

RMDs or more cash, if desired. It's here that IRA owners should consider a supplementary

contract (a settlement option) to distribute what's left of the policy when the account owner

dies. The IRS recognizes this possibility and has a number of rules for IRAs that are annuitized

for beneficiaries at the owner's point of-death. Consider these examples 11 through 16:

Example Eleven - a life annuity for a beneficiary who is a spouse: Harry's IRA acquires

an accumulation annuity policy from which he withdraws at least RMDs while alive. He

establishes a settlement option plan for his wife, Mary, which pays her a level lifetime

income commencing at his death. This is an acceptable arrangement.

Example Twelve - a life annuity for a beneficiary who is not a spouse: Harry's IRA

acquires an accumulation annuity policy from which he withdraws at least RMDs while

alive. He establishes a settlement option plan for his daughter, Nancy, which pays her a

level lifetime income commencing at his death. This is an acceptable arrangement.

Example Thirteen - a life annuity selected for a beneficiary, by a trustee or other

fiduciary: The facts are the same as in Examples 11 or 12 except Harry's goal is to

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obtain the best annuity purchase rates possible at his death. Consequently, he gives his

IRA provider (trustee or custodian) discretion to

Convert his accumulation policy to a life-only annuity or

Exchange it immediately for another contract that pays more. Either policy should

be acceptable.

Example Fourteen - a life annuity benefit with a term certain (or a term certain annuity)

for a spouse beneficiary: Harry's IRA acquires an accumulation annuity policy from

which he withdraws at least RMDs while alive. He arranges a settlement option payout

for his wife, Mary that includes a term certain. At his death, Mary is age 70. Harry’s

daughter is named beneficiary of the remaining payments, if any, at Mary's death. As

long as Mary's IRS unisex single life expectancy in the year following Harry's death is

the basis for the term certain, e.g., 16.3 years at age 71, this is an acceptable

arrangement.

Example Fifteen - a life annuity benefit with a term certain (or a term certain annuity)

for a non-spouse beneficiary: Harry's IRA acquires an annuity policy from which he

withdraws at least RMDs while alive. Harry arranges a settlement option plan for his

daughter Nancy, but dies immediately. Nancy receives a level lifetime annuity income

beginning in the year of her birthday-age 41. Since her IRS unisex single life

expectancy then is 42.7 years, this policy can pay for up to a 42-year term certain.

Query, if the annuity is payable over the joint lifetimes of Nancy (41) and her daughter

Betty (21), must Betty's benefit be reduced to no more than 73% of Nancy's payment? If

there is a term certain, it should be limited to 42 years, Nancy's IRS unisex single life

expectancy.

Example Sixteen - a policy simply names a spouse successor owner or beneficiary - in

cash: Harry's account acquires an annuity policy from which he withdraws at least

RMDs while alive. At his death, when his spouse Mary receives the policy as its sole

beneficiary, she rolls it over to her own IRA and retitles it in her name. She begins a

series of RMDs as well and arranges a settlement option at her death for her daughter,

Melissa. When Mary dies, for example, Melissa's payout can have a term certain based

on her life expectancy in the year following Mary's death. This rollover strategy gives

Melissa potentially a much longer term certain than if a term certain payout policy is

purchased for Mary at Harry's death and continued for Melissa after Mary dies.

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Let’s briefly overview IRA annuity payments that can increase over time or be accelerated into

cash surrender.

In the last few sections, we have described IRAs paid out as level annuity payments for

account owners and their beneficiary's lifetimes, or for appropriate terms certain. Now, let’s

discuss "increase in annuity payments." Again, the Treasury is concerned about annuity

payments:

Directly from a qualified plan or IRA, or

From a commercial annuity that starts out slowly and increases significantly - that

balloon or are back-loaded.

Suppose Sam has a traditional IRA. ABC Insurance offers him a $100,000 variable, indexed or

fixed IRA life annuity that begins paying out a guaranteed minimum amount of $2,000

annually. There is a 20-year term certain, and the payment can be much greater beginning in

the 15th year. ABC's literature suggests that in the 16th year, the annual payment might be as

much as $30,000 - indeed, a significant increase. You might even call this a balloon (or back-

loaded) contract. The result: This increasing payment contract violates the spirit of the RMD

rules, which mandate a gradual release of traditional, taxable funds to the account owner. The

reason: "Small payments now and much larger payments later" gives funds on-hand

inappropriate tax deferral in the meantime.” The Bottom Line: The Treasury wants taxes

sooner rather than later. Consequently, ABC's policy fails the RMD test and would cause at

least a 50% shortfall penalty tax. The Treasury has studied the entire area of distributions from

qualified plans and IRAs.

On a positive note: The Treasury understood that commercial annuity policies would play

prominently in the distributions of trillions of dollars from qualified plans and annuities. Public

hearings and good faith efforts tried to get a grasp on how design and market these contracts.

On a Negative Note: The annuity "increasing payments" regulations can be confusing and is

described in the Code of Federal regulations. It does not appear that those who wrote the

regulations were instructed in annuity policies or the use of plain English. (Imagine an example

that describes how a participating annuity should work: The Treasury refers to a “retired

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participant (Z2), in a defined contribution plan (Plan X) who acquires an annuity contract (Y2)

from Insurance Company (W).” How much simpler if only "John Jones receives an annuity

policy sold by ABC." Then, instead of referring later to annuity contract Y2 from insurance

company W, all references could simply be to "this policy." The IRS gives examples of

increasing annuities that can be (a) variable, (b) participating, or (c) have guaranteed

enhancements. Each contract has the potential for or gives payments in future years. And, the

examples tell us when and why any payment improvements are permitted. [IRS Bulletin: T.D.

9130, as amended; 26 CFR §1.401(A)(9)-6]

"Increasing Payment" Annuities

An annuity payment directly from a qualified plan, or under a commercial contract, can

increase using, for example:

An annual percentage increase that doesn't exceed the percentage increase in an

eligible cost-of-living index (e.g., the Bureau of Labor Statistics' CPI);

A percentage increase that occurs at specified intervals (e.g., annually);

To the extent of an enlargement in:

Payments due to a survivor payee's death;

Cancellation of a potential survivor due to a QDRO in a divorce;

Increased benefits due to a plan amendment; or

Conversion of a survivor’s income benefit to a lump sum at the payee’s death.

The laws governing accumulation, annuitization, distribution, etc., are often amended (updates

are available online for each of the Federal Register rules). For the most current, all-inclusive

list of allowable increasing payments, see 26 CFR §1.401(A)(9)-6 (Q-14) (A-14) (a) through (f),

available online.

When it comes to commercial policies only, the regulations give more instances where an

increasing payment is allowed. In each: "The total future expected payments (according to the

Single Life Table or the Joint and Survivor Table, if applicable), without regard to any increases

in annuity payments and taking into account any remaining term certain, must exceed the total

value being annuitized.” [26 CFR §1.401(A)(9)-6, e.g., see (c) and (f)]

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General Example: John is age 70, and his life expectancy under the Single Life Table is 17

years. With $100,000, his IRA acquires a life annuity that pays him $3,750 annually. There is a

17 year fixed period, with potential increases via dividends, extra interest, etc. In other words,

John or his beneficiary will receive assuredly $102,000 ($6,000 x 17) over the period certain -

he will likely receive more. The important thing is that he'll receive at least $102,000 over 17

years; and, that's more than the $100,000 single premium. The result: John's annuity meets

the test because his expected return (without regard to any anticipated increases and

considering any remaining term certain) will exceed the total value being annuitized.

An Analysis:

Let's say John acquires a $100,000 IRA payout annuity that guarantees level payments

(and no increases) over a 27-year fixed period, his expectancy under the Uniform

Lifetime Table. The carrier amortizes and credits 3% annually. The result: His annual

payment is $5,456 – a total guaranteed payout of $147,312 ($5,456 x 27). That's it!

If however, this is an increasing annuity, e.g., his annual payments can rise variably or

with dividends, we must use the Single Life Table and divide $100,000 by John's 17-

year life expectancy. The result: His initial annual payment (and annual payment floor),

without regard to any increases, must be essentially $6,000. Then his payments can

build as the years go by. All the IRS wants is that he anticipates $6,000 per year, which

gives him a total of about $100,000 after 7 years.

Distributions Planning with a Twist

IRA Personal Accounts

Let's return to some basics from the preceding sections. We've learned that IRAs are almost

magical in the world of financial planning. Personal accounts:

Consist mainly of assets in traditional accounts, rolled-over from employer sponsored

qualified plans;

Are increasing in size at a pace far greater than other assets within the retirement

planning process;

That are traditional accounts will likely stand the tests of time. The reason: If tax

legislation curbs IRA contributions and deductions, traditional accounts remain a

repository for an upcoming rollover landslide;

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Aren’t a very good asset (from an income tax planning perspective) when paid to a trust

for family;

Are blessed by Congress and Treasury as a personal tax shelter as long as the money

stays in the account;

Are an asset protection strategy in themselves, now that we have the bankruptcy act;

Need a good beneficiary designation structure to maintain the account properly,

perhaps over 80-100 years into the future; and

Presently don't have very good distributions structures in place.

Now, let's assemble this knowledge and emphasize annuities while we are at it. We will begin

with:

A review of what IRANs and IRA annuities are, and

IRANs as the cornerstone to an IRA financial plan.

Then, we will look at:

IRA distributions thinking with some bells and whistles, and

A few insurer IRA beneficiary forms.

IRANs in General

IRAN Definition

An IRAN is an annuity contract issued by insurance companies to individual taxpayers. This

policy is nontransferable and nonforfeitable. In other words, it cannot be assigned or pledged

as security for a personal loan outside the policy. Otherwise, it has all the "rights and

privileges" accorded other funds held in IRAs. IRANs cannot have a "substantial" element of

life insurance. Required minimum distributions (RMDs) are mandated and policy loans are

prohibited. Annual premiums cannot exceed the maximum annual contribution limit for the tax

year in question. IRANS are just what you think. They are annuity contracts issued as IRAs

that have features contained within a typical policy.

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Importance of Relationships with Clients

It is important that you ask IRA owners about their beneficiary designations. Point out that

most IRA providers don't have very good beneficiary forms. And, give information about how

the money must be paid out beginning at the IRA owner's age 70½ or death. Tell them you can

improve the distributions process, and suggest that IRAs are really a long-term joint venture of

sorts between owner and a beneficiary. The goal is to have a bonding relationship where you

are their annuity adviser and insurance agent. Let's say you have a good relationship with

someone who is informed and aware of financial and estate planning goals and issues. He or

she has some or all of the following qualities and characteristics:

A view that they'll probably not spend all of their IRA - there may even be more for a

beneficiary than what is withdrawn – and a desire for lifetime income planning;

A belief their IRA is a government approved asset protection and tax sheltered program

(which is exactly what it is);

Interest in an insurer's capability to manage, accumulate and distribute money over long

periods of time;

An appreciation for the importance of income that can't be outlived;

A values oriented long-range view of wealth preservation;

An understanding of stretch-like IRA forward thinking;

Other assets to leave family for emergencies and capital needs; and/or

A desire to set up their beneficiary's financial security for life.

In short, your prospect is a candidate for an IRA accumulation annuity that can distribute its

money creatively. When the IRA owner attains age 70½, this policy will pay to him or her and

their beneficiaries over possibly an 80-100 year period. Here comes the surprise: The system

isn't ready for you and your client. It's sideways and backwards. Carriers want to manage

money, but they are quick to payout lump sums instead of annuity incomes. Beneficiaries also

tend to want the cash now even though lump sums don't seem to last. Finally, planners just

aren't comfortable with annuitizing and amortizing thinking even when this may be the best

way to go. IRAs, per se, are different and special. Here, it's almost never right to take lump

sums, pay taxes now, and make everything available to the system. And, IRANs are naturals

when built to distribute and accumulate. Annuity carriers can set the standard and get really

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good at designing IRA policies, especially those that payout the money. If you do this, clients

will see more like 90% of IRA assets in annuities than 10%.

Annuity and Distribution Options

Imagine that ABC Insurance (ABC) already has a good IRA annuity product with all the right

accumulation features. If a variable contract, it has guaranteed "insubstantial" death benefits,

minimum rates of return options, and indexed possibilities. If a fixed contract, it has indexed

options. All policies might have long-term care boosters at payout, and enhanced income later,

in exchange for less access to cash values now. Your client is interested in this product. Here's

the really good part: ABC is aware of all the money moving into IRAs. To meet the needs of

customers, its policies have special options at the owner's retirement say, age 70½ (or death)

for all that is there. For instance, an IRA owner can elect:

1. RMD – Annuity Options

RMDs, with RMDs for a beneficiary

Comments: Here, an IRA owner wants RMDs for himself and maximum tax deferral for

beneficiaries, too. Consequently, he chooses RMDs for everyone (an optimum stretch-

like payout plan), something you could refer to as an "RMD annuity." He may or may not

give beneficiaries cash payout extras, spousal rollover rights, or commutation privileges.

He is aware of successor beneficiary possibilities available in the distributions process.

RMDs, with an annuity income for a beneficiary

Comments: Here, an IRA owner selects RMDs now and a supplementary contract for

the next in line. Her goal is to build the policy's cash values to provide an annuity

income for a beneficiary. At the owner's death, the cash values will be annuitized and

paid over her beneficiary's lifetime. There is a term certain available, for example, up to

82 years for a beneficiary age one; and commutation and successor beneficiary

designations as well. It's just that her thinking shifts to formal annuitizing of the contract

for a beneficiary.

An annuity income, with annuity payments, too, for a beneficiary who is a spouse

Comments: This IRA owner is married and wants annuity payments for as long as either

spouse lives. (Assume there are no children; if there are, they are provided for

elsewhere.) If there is a term certain, it is measured by the Uniform Lifetime Table or

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Joint Life and Survivor Table (if longer). If there is both a lifetime feature and a term

certain, the term is measured solely by the owner's life expectancy under the Uniform

Table. This policy is formally annuitized moving forward and it will stay that way possibly

over multiple lifetimes.

An annuity income, with annuity payments, too, for a beneficiary who is not a spouse

Comments: This IRA owner is probably single. (Or, her spouse is provided for

elsewhere.) Let's say the annuity payment is Joint and Survivor over the combined life

expectancies of owner and daughter. Consequently, look to the Table for Reducing

Joint and Survivor Annuity amounts for non-spouse beneficiaries to determine the

percentage reduction in income at the IRA owner's death. If there is a term certain or life

incomes with terms certain, look to the Uniform Lifetime Table for the owner's life

expectancy. As in already indicated, this policy is formally annuitized potentially over

multiple lifetimes.

A life-only annuity income for the IRA owner

Comments: This IRA owner is probably single and has no children. (Or, his beneficiaries

are provided for elsewhere.) His goal is to maximize income in retirement; annuity

payments will cease at his death. Or, perhaps, there is a partial cash refund if say, he

lives only a short time.

A combination of annuity and RMD options

Comments: Most IRA owners have several beneficiaries in mind. They are also aware

of changing circumstances where a beneficiary can predecease them, become divorced

or have children in the years ahead. ABC's distribution options provide for these

possibilities and will also allow for separate shares or "buckets" within the contract. To

summarize, ABC really has dedicated itself to the IRA marketplace particularly to baby

boomer retirees, their agents, brokers (and client advisers). It probably pays trailer

commissions, and up-front compensation periodically or when an IRA accumulation

policy is annuitized. ABC has committed administratively, financially and technically to

managing everything involved. Finally, ABC will get its share of IRA contributions and

rollovers, and then some.

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2. Special features in IRA annuities and the distributions process

In addition to RMD annuity distribution options, ABC offers a number of special features,

which give IRA owners and beneficiaries great flexibility in the years ahead. As

determined by the IRA owner, these include:

Annuity accumulations and payouts that are variable (on variable contracts only),

guaranteed or indexed;

RMD annuities, life-only annuities, life annuities with extensive terms certain, and

life annuities with a cash refund;

Joint and Survivor payouts for IRA owner and spouse, a beneficiary and spouse,

a beneficiary and child, etc.;

Annuity payouts with cost-of-living increases;

The division of the annuity contract into buckets or sub-policies for each named

beneficiary;

Within these sub-policies, annuity incomes for some beneficiaries and RMDs for others;

A boost in annuity payments when a beneficiary reaches a certain age or ages;

Maintenance of a youngster beneficiary's share under the Uniform Transfer to Minor's

Act (UTMA);

Beneficiary rights to take cash each year (in addition to RMDs), possibly up to a

maximum amount;

Increases in an IRA owner's annuity income if a potential survivor-annuitant dies or

divorces the primary IRA owner-payee;

RMD payouts to trusts;

Spousal rollovers and spousal limitations;

Rights to commute or accelerate payments (at anytime or at specific times), or to

receive cash in lieu of RMDs or annuity income;

Transfers (not a rollover) of a non-spouse beneficiary's interest to a new provider;

Per stirpes beneficiary designations where values pass through to children of a

deceased person;

Automatic removal of an account owner's spouse-survivor beneficiary if they divorce;

Automatic succession to a new beneficiary when the spouse beneficiary of a deceased

IRA owner remarries;

Named successor beneficiaries whenever an annuity payout is in a term certain;

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The designation of successor beneficiaries by either the account owner or first

beneficiary (as determined by the owner);

Joint and survivor payments that reduce by "an applicable percentage," when required;

RMD payments to a successor beneficiary over a first beneficiary's remaining life

expectancy;

A customized beneficiary distribution from within limits, for a fee, or after meeting certain

conditions.

Some words of caution: Admittedly, ABC's distributions process is forward thinking. ABC is

well aware of its need to handle everything administratively. Counsel has cautioned that giving

too much flexibility may cause responsibilities as a fiduciary. Accordingly, ABC may already

have acquired or created banking or trust powers to coordinate the IRA distributions process.

Moreover, ABC may require that a policy owner's attorney review and "sign-off" on specific

distribution processes.

IRA Beneficiary Forms

IRA Beneficiary Options to Consider

IRA beneficiary forms vary from carrier-to-carrier. It is important that you review each carrier's

forms and understand them completely. As you review the forms, consider whether an IRA

owner can:

Arrange an RMD payout instead of annuitization;

Limit a beneficiary to RMDs;

Give a beneficiary a right to sums exceeding RMDs;

Select a successor beneficiary (or at least give the first beneficiary the right to choose a

successor);

Give a right to commute;

Choose an indexed payout;

Choose percentage or CPI increases;

Direct payments to a trust beneficiary;

Select a lengthy term certain such as 40 or 50 years, or longer; or

Restrict a spousal payout (where the IRA owner doesn't want a rollover).

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Conclusion

To summarize, it doesn't seem that annuity carriers (and perhaps Congress) are comfortable

with the "stretch IRA" concept. To improve things, they needn't assume the role of trustee

where they have discretion over distributions. All they need are more quality alternatives that

truly reflect an IRA annuity owner's desires for financial control over the long-term. As time

passes, the independent retirement account, Roth and Traditional, life and annuity products,

will surely see more in the way of accumulation and distribution options. Individuals and

families who take control over their financial destinies will reap the reward of not relying on

Social Security retirement benefits as their only source of income.

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Appendix I – Code of Federal Regulation Title 26, Part 1

[Source URL: US Government Printing Office Electronic Code of Federal Regulations]

§1.401(a)(9)-1 Minimum Distribution Requirement in General

Q–1. What plans are subject to the minimum distribution requirement under section 401(a)(9),

this section, and §§1.401(a)(9)–2 through 1.401(a)(9)–9?

A–1. Under section 401(a)(9), all stock bonus, pension, and profit-sharing plans qualified under

section 401(a) and annuity contracts described in section 403(a) are subject to required

minimum distribution rules. See this section and §§1.401(a)(9)–2 through 1.401(a)(9)–9 for the

distribution rules applicable to these plans. Under section 403(b)(10), annuity contracts or

custodial accounts described in section 403(b) are subject to required minimum distribution

rules. See §1.403(b)–6e for the distribution rules applicable to these annuity contracts or

custodial accounts. Under section 408(a)(6) and 408(b)(3), individual retirement plans

(including, for some purposes, Roth IRAs under section 408A) are subject to required

minimum distribution rules. See §1.408–8 for the distribution rules applicable to individual

retirement plans and see §1.408A–6 for the distribution rules applicable to Roth IRAs under

section 408A. Under section 457(d)(2), certain deferred compensation plans for employees of

tax exempt organizations or state and local government employees are subject to required

minimum distribution rules.

Q–2. Which employee account balances and benefits held under qualified trusts and plans are

subject to the distribution rules of section 401(a)(9), this section, and §1.401(a)(9)–2 through

1.401(a)(9)–9?

Individual Retirement Accounts (IRAs) are governed by federal law. The final actions taken by a federal agency become the laws published in the Code of Federal Regulations. It is not congressionally or fiscally possible to change published laws on an annual basis; the law presented here remains current; however, the figures have changed (most of which are adjusted annually for inflation). STUDENTS ARE RESPONSIBLE FOR

IMPLEMENTING APPROPRIATE, CURRENT-YEAR FIGURES.

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A–2. (a) In general. The distribution rules of section 401(a)(9) apply to all account balances

and benefits in existence on or after January 1, 1985. This section and §§1.401(a)(9)–2

through 1.401(a)(9)–9 apply for purposes of determining required minimum distributions for

calendar years beginning on or after January 1, 2003.

(b) Beneficiaries.

(1) The distribution rules of this section and §§1.401(a)(9)–2 through 1.401(a)(9)–9 apply to

account balances and benefits held for the benefit of a beneficiary for calendar years

beginning on or after January 1, 2003, even if the employee died prior to January 1, 2003.

Thus, in the case of an employee who died prior to January 1, 2003, the designated

beneficiary must be redetermined in accordance with the provisions of §1.401(a)(9)–4 and the

applicable distribution period (determined under §1.401(a)(9)–5 or 1.401(a)(9)–6, whichever is

applicable) must be reconstructed for purposes of determining the amount required to be

distributed for calendar years beginning on or after January 1, 2003.

(2) A designated beneficiary that is receiving payments under the 5-year rule of section

401(a)(9)(B)(ii), either by affirmative election or default provisions, may, if the plan so provides,

switch to using the life expectancy rule of section 401(a)(9)(B)(iii) provided any amounts that

would have been required to be distributed under the life expectancy rule of section

401(a)(9)(B)(iii) for all distribution calendar years before 2004 are distributed by the earlier of

December 31, 2003 or the end of the 5-year period determined under A–2 of §1.401(a)(9)–3.

(c) Trust documentation. If a trust fails to meet the rule of A–5 of §1.401(a)(9)–4 (permitting the

beneficiaries of the trust, and not the trust itself, to be treated as the employee's designated

beneficiaries) solely because the trust documentation was not provided to the plan

administrator by October 31 of the calendar year following the calendar year in which the

employee died, and such documentation is provided to the plan administrator by October 31,

2003, the beneficiaries of the trust will be treated as designated beneficiaries of the employee

under the plan for purposes of determining the distribution period under section 401(a)(9).

(d) Special rule for governmental plans. Notwithstanding anything to the contrary in this A–2, a

governmental plan (within the meaning of section 414(d)), or an eligible governmental plan

described in §1.457–2(f), is treated as having complied with section 401(a)(9) for all years to

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which section 401(a)(9) applies to the plan if the plan complies with a reasonable and good

faith interpretation of section 401(a)(9).

Q–3. What specific provisions must a plan contain in order to satisfy section 401(a)(9)?

A–3. (a) Required provisions. In order to satisfy section 401(a)(9), the plan must include the

provisions described in this paragraph reflecting section 401(a)(9). First, the plan must

generally set forth the statutory rules of section 401(a)(9), including the incidental death benefit

requirement in section 401(a)(9)(G). Second, the plan must provide that distributions will be

made in accordance with this section and §§1.401(a)(9)–2 through 1.401(a)(9)–9. The plan

document must also provide that the provisions reflecting section 401(a)(9) override any

distribution options in the plan inconsistent with section 401(a)(9). The plan also must include

any other provisions reflecting section 401(a)(9) that are prescribed by the Commissioner in

revenue rulings, notices, and other guidance published in the Internal Revenue Bulletin. See

§601.601(d)(2)(ii)(b) of this chapter.

(b) Optional provisions. The plan may also include written provisions regarding any optional

provisions governing plan distributions that do not conflict with section 401(a)(9) and the

regulations thereunder.

(c) Absence of optional provisions. Plan distributions commencing after an employee's death

will be required to be made under the default provision set forth in §1.401(a)(9)–3 for

distributions unless the plan document contains optional provisions that override such default

provisions. Thus, if distributions have not commenced to the employee at the time of the

employee's death, distributions after the death of an employee are to be made automatically in

accordance with the default provisions in A–4(a) of §1.401(a)(9)–3 unless the plan either

specifies in accordance with A–4(b) of §1.401(a)(9)–3 the method under which distributions will

be made or provides for elections by the employee (or beneficiary) in accordance with A–4(c)

of §1.401(a)(9)–3 and such elections are made by the employee or beneficiary.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 33293, June 15,

2004; T.D. 9340, 72 FR 41159, July 26, 2007; T.D. 9459, 74 FR 45994, Sept. 8, 2009]

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§1.401(a)(9)-2 Distributions Commencing During an Employee's Lifetime

Q–1. In the case of distributions commencing during an employee's lifetime, how must the

employee's entire interest be distributed in order to satisfy section 401(a)(9)(A)?

A–1. (a) In order to satisfy section 401(a)(9)(A), the entire interest of each employee must be

distributed to such employee not later than the required beginning date, or must be distributed,

beginning not later than the required beginning date, over the life of the employee or joint lives

of the employee and a designated beneficiary or over a period not extending beyond the life

expectancy of the employee or the joint life and last survivor expectancy of the employee and

the designated beneficiary. (b) Section 401(a)(9)(G) provides that lifetime distributions must

satisfy the incidental death benefit requirements. (c) The amount required to be distributed for

each calendar year in order to satisfy section 401(a)(9)(A) and (G) generally depends on

whether a distribution is in the form of distributions under a defined contribution plan or annuity

payments under a defined benefit plan or under an annuity contract. For the method of

determining the required minimum distribution in accordance with section 401(a)(9)(A) and (G)

from an individual account under a defined contribution plan, see §1.401(a)(9)–5. For the

method of determining the required minimum distribution in accordance with section

401(a)(9)(A) and (G) in the case of annuity payments from a defined benefit plan or an annuity

contract, see §1.401(a)(9)–6.

Q–2. For purposes of section 401(a)(9)(C), what does the term required beginning date mean?

A–2. (a) Except as provided in paragraph (b) of this A–2 with respect to a 5-percent owner, as

defined in paragraph (c) of this A–2, the term required beginning date means April 1 of the

calendar year following the later of the calendar year in which the employee attains age 70 1/2

or the calendar year in which the employee retires from employment with the employer

maintaining the plan.

(b) In the case of an employee who is a 5-percent owner, the term required beginning date

means April 1 of the calendar year following the calendar year in which the employee attains

age 70 1/2.

(c) For purposes of section 401(a)(9), a 5-percent owner is an employee who is a 5-percent

owner (as defined in section 416) with respect to the plan year ending in the calendar year in

Page 108 of 239

which the employee attains age 70 1/2.

(d) Paragraph (b) of this A–2 does not apply in the case of a governmental plan (within the

meaning of section 414(d)) or a church plan. For purposes of this paragraph, the term church

plan means a plan maintained by a church for church employees, and the term church means

any church (as defined in section 3121(w)(3)(A)) or qualified church-controlled organization (as

defined in section 3121(w)(3)(B)).

(e) A plan is permitted to provide that the required beginning date for purposes of section

401(a)(9) for all employees is April 1 of the calendar year following the calendar year in which

an employee attains age 70 1/2 regardless of whether the employee is a 5-percent owner.

Q–3. When does an employee attain age 70 1/2?

A–3. An employee attains age 70 1/2 as of the date six calendar months after the 70th

anniversary of the employee's birth. For example, if an employee's date of birth was June 30,

1933, the 70th anniversary of such employee's birth is June 30, 2003. Such employee attains

age 70 1/2 on December 30, 2003. Consequently, if the employee is a 5-percent owner or

retired, such employee's required beginning date is April 1, 2004. However, if the employee's

date of birth was July 1, 1933, the 70th anniversary of such employee's birth would be July 1,

2003. Such employee would then attain age 70 1/2 on January 1, 2004 and such employee's

required beginning date would be April 1, 2005.

Q–4. Must distributions made before the employee's required beginning date satisfy section

401(a)(9)?

A–4. Lifetime distributions made before the employee's required beginning date for calendar

years before the employee's first distribution calendar year, as defined in A–1(b) of

§1.401(a)(9)–5, need not be made in accordance with section 401(a)(9). However, if

distributions commence before the employee's required beginning date under a particular

distribution option, such as in the form of an annuity, the distribution option fails to satisfy

section 401(a)(9) at the time distributions commence if, under terms of the particular

distribution option, distributions to be made for the employee's first distribution calendar year or

any subsequent distribution calendar year will fail to satisfy section 401(a)(9).

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Q–5. If distributions have begun to an employee during the employee's lifetime (in accordance

with section 401(a)(9)(A)(ii)), how must distributions be made after an employee's death?

A–5. Section 401(a)(9)(B)(i) provides that if the distribution of the employee's interest has

begun in accordance with section 401(a)(9)(A)(ii) and the employee dies before his entire

interest has been distributed to him, the remaining portion of such interest must be distributed

at least as rapidly as under the distribution method being used under section 401(a)(9)(A)(ii) as

of the date of his death. The amount required to be distributed for each distribution calendar

year following the calendar year of death generally depends on whether a distribution is in the

form of distributions from an individual account under a defined contribution plan or annuity

payments under a defined benefit plan. For the method of determining the required minimum

distribution in accordance with section 401(a)(9)(B)(i) from an individual account, see

§1.401(a)(9)–5. In the case of annuity payments from a defined benefit plan or an annuity

contract, see §1.401(a)(9)–6.

Q–6. For purposes of section 401(a)(9)(B), when are distributions considered to have begun to

the employee in accordance with section 401(a)(9)(A)(ii)?

A–6. (a) General rule. Except as otherwise provided in A–10 of §1.401(a)(9)–6, distributions

are not treated as having begun to the employee in accordance with section 401(a)(9)(A)(ii)

until the employee's required beginning date, without regard to whether payments have been

made before that date. Thus, section 401(a)(9)(B)(i) only applies if an employee dies on or

after the employee's required beginning date. For example, if employee A retires in 2003, the

calendar year A attains age 65 1/2, and begins receiving installment distributions from a profit-

sharing plan over a period not exceeding the joint life and last survivor expectancy of A and A's

spouse, benefits are not treated as having begun in accordance with section 401(a)(9)(A)(ii)

until April 1, 2009 (the April 1 following the calendar year in which A attains age 70 1/2).

Consequently, if A dies before April 1, 2009 (A's required beginning date), distributions after

A's death must be made in accordance with section 401(a)(9)(B)(ii) or (iii) and (iv) and

§1.401(a)(9)–3, and not section 401(a)(9)(B)(i). This is the case without regard to whether the

plan has distributed the minimum distribution for the first distribution calendar year (as defined

in A–1(b) of §1.401(a)(9)–5) before A's death.

(b) If a plan provides, in accordance with A–2(e) of this section, that the required beginning

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date for purposes of section 401(a)(9) for all employees is April 1 of the calendar year following

the calendar year in which an employee attains age 70 1/2, an employee who dies on or after

the required beginning date determined under the plan terms is treated as dying after the

employee's distributions have begun for purposes of this A–6 even though the employee dies

before the April 1 following the calendar year in which the employee retires.

§ 1.401(a)(9)-3 Death before required beginning date.

Q–1. If an employee dies before the employee's required beginning date, how must the

employee's entire interest be distributed in order to satisfy section 401(a)(9)?

A–1. (a) Except as otherwise provided in A–10 of §1.401(a)(9)–6, if an employee dies before

the employee's required beginning date (and, thus, before distributions are treated as having

begun in accordance with section 401(a)(9)(A)(ii)), distribution of the employee's entire interest

must be made in accordance with one of the methods described in section 401(a)(9)(B)(ii) or

(iii) and (iv). One method (the 5-year rule in section 401(a)(9)(B)(ii)) requires that the entire

interest of the employee be distributed within 5 years of the employee's death regardless of

who or what entity receives the distribution. Another method (the life expectancy rule in section

401(a)(9)(B)(iii) and (iv)) requires that any portion of an employee's interest payable to (or for

the benefit of) a designated beneficiary be distributed, commencing within one year of the

employee's death, over the life of such beneficiary (or over a period not extending beyond the

life expectancy of such beneficiary). Section 401(a)(9)(B)(iv) provides special rules where the

designated beneficiary is the surviving spouse of the employee, including a special

commencement date for distributions under section 401(a)(9)(B)(iii) to the surviving spouse.

(b) See A–4 of this section for the rules for determining which of the methods described in

paragraph (a) of this A–1 applies. See A–3 of this section to determine when distributions

under the exception to the 5-year rule in section 401(a)(9)(B)(iii) and (iv) must commence. See

A–2 of this section to determine when the 5-year period in section 401(a)(9)(B)(ii) ends. For

distributions using the life expectancy rule in section 401(a)(9)(B)(iii) and (iv), see

§1.401(a)(9)–4 in order to determine the designated beneficiary under section 401(a)(9)(B)(iii)

and (iv), see §1.401(a)(9)–5 for the rules for determining the required minimum distribution

under a defined contribution plan, and see §1.401(a)(9)–6 for required minimum distributions

under defined benefit plans.

Page 111 of 239

Q–2. By when must the employee's entire interest be distributed in order to satisfy the 5-year

rule in section 401(a)(9)(B)(ii)?

A–2. In order to satisfy the 5-year rule in section 401(a)(9)(B)(ii), the employee's entire interest

must be distributed by the end of the calendar year which contains the fifth anniversary of the

date of the employee's death. For example, if an employee dies on January 1, 2003, the entire

interest must be distributed by the end of 2008, in order to satisfy the 5-year rule in section

401(a)(9)(B)(ii).

Q–3. When are distributions required to commence in order to satisfy the life expectancy rule

in section 401(a)(9)(B)(iii) and (iv)?

A–3. (a) Nonspouse beneficiary. In order to satisfy the life expectancy rule in section

401(a)(9)(B)(iii), if the designated beneficiary is not the employee's surviving spouse,

distributions must commence on or before the end of the calendar year immediately following

the calendar year in which the employee died. This rule also applies to the distribution of the

entire remaining benefit if another individual is a designated beneficiary in addition to the

employee's surviving spouse. See A–2 and A–3 of §1.401(a)(9)–8, however, if the employee's

benefit is divided into separate accounts.

(b) Spousal beneficiary. In order to satisfy the rule in section 401(a)(9)(B)(iii) and (iv), if the

sole designated beneficiary is the employee's surviving spouse, distributions must commence

on or before the later of— (1) The end of the calendar year immediately following the calendar

year in which the employee died; and (2) The end of the calendar year in which the employee

would have attained age 70 1/2.

Q–4. How is it determined whether the 5-year rule in section 401(a)(9)(B)(ii) or the life

expectancy rule in section 401(a)(9)(B)(iii) and (iv) applies to a distribution?

A–4. (a) No plan provision. If a plan does not adopt an optional provision described in

paragraph (b) or (c) of this A–4 specifying the method of distribution after the death of an

employee, distribution must be made as follows:

(1) If the employee has a designated beneficiary, as determined under §1.401(a)(9)–4,

distributions are to be made in accordance with the life expectancy rule in section

401(a)(9)(B)(iii) and (iv).

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(2) If the employee has no designated beneficiary, distributions are to be made in accordance

with the 5-year rule in section 401(a)(9)(B)(ii).

(b) Optional plan provisions. A plan may adopt a provision specifying either that the 5-year rule

in section 401(a)(9)(B)(ii) will apply to certain distributions after the death of an employee even

if the employee has a designated beneficiary or that distribution in every case will be made in

accordance with the 5-year rule in section 401(a)(9)(B)(ii). Further, a plan need not have the

same method of distribution for the benefits of all employees in order to satisfy section

401(a)(9).

(c) Elections. A plan may adopt a provision that permits employees (or beneficiaries) to elect

on an individual basis whether the 5-year rule in section 401(a)(9)(B)(ii) or the life expectancy

rule in section 401(a)(9)(B)(iii) and (iv) applies to distributions after the death of an employee

who has a designated beneficiary. Such an election must be made no later than the earlier of

the end of the calendar year in which distribution would be required to commence in order to

satisfy the requirements for the life expectancy rule in section 401(a)(9)(B)(iii) and (iv) (see A–

3 of this section for the determination of such calendar year) or the end of the calendar year

which contains the fifth anniversary of the date of death of the employee. As of the last date

the election may be made, the election must be irrevocable with respect to the beneficiary (and

all subsequent beneficiaries) and must apply to all subsequent calendar years. If a plan

provides for the election, the plan may also specify the method of distribution that applies if

neither the employee nor the beneficiary makes the election. If neither the employee nor the

beneficiary elects a method and the plan does not specify which method applies, distribution

must be made in accordance with paragraph (a) of this A–4.

Q–5. If the employee's surviving spouse is the employee's sole designated beneficiary and

such spouse dies after the employee, but before distributions have begun to the surviving

spouse under section 401(a)(9)(B)(iii) and (iv), how is the employee's interest to be

distributed?

A–5. Pursuant to section 401(a)(9)(B)(iv)(II), if the surviving spouse is the employee's sole

designated beneficiary and dies after the employee, but before distributions to such spouse

have begun under section 401(a)(9)(B)(iii) and (iv), the 5-year rule in section 401(a)(9)(B)(ii)

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and the life expectancy rule in section 401(a)(9)(B)(iii) are to be applied as if the surviving

spouse were the employee. In applying this rule, the date of death of the surviving spouse

shall be substituted for the date of death of the employee. However, in such case, the rules in

section 401(a)(9)(B)(iv) are not available to the surviving spouse of the deceased employee's

surviving spouse.

Q–6. For purposes of section 401(a)(9)(B)(iv)(II), when are distributions considered to have

begun to the surviving spouse?

A–6. Distributions are considered to have begun to the surviving spouse of an employee, for

purposes of section 401(a)(9)(B)(iv)(II), on the date, determined in accordance with A–3 of this

section, on which distributions are required to commence to the surviving spouse, even though

payments have actually been made before that date. See A–11 of §1.401(a)(9)–6 for a special

rule for annuities.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 33293, June 15,

2004]

§1.401(a)(9)-4 Determination of the Designated Beneficiary

Q–1. Who is a designated beneficiary under section 401(a)(9)(E)?

A–1. A designated beneficiary is an individual who is designated as a beneficiary under the

plan. An individual may be designated as a beneficiary under the plan either by the terms of

the plan or, if the plan so provides, by an affirmative election by the employee (or the

employee's surviving spouse) specifying the beneficiary. A beneficiary designated as such

under the plan is an individual who is entitled to a portion of an employee's benefit, contingent

on the employee's death or another specified event. For example, if a distribution is in the form

of a Joint and Survivor annuity over the life of the employee and another individual, the plan

does not satisfy section 401(a)(9) unless such other individual is a designated beneficiary

under the plan. A designated beneficiary need not be specified by name in the plan or by the

employee to the plan in order to be a designated beneficiary so long as the individual who is to

be the beneficiary is identifiable under the plan. The members of a class of beneficiaries

capable of expansion or contraction will be treated as being identifiable if it is possible, to

identify the class member with the shortest life expectancy. The fact that an employee's

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interest under the plan passes to a certain individual under a will or otherwise under applicable

state law does not make that individual a designated beneficiary unless the individual is

designated as a beneficiary under the plan. See A–6 of §1.401(a)(9)–8 for rules which apply to

qualified domestic relation orders.

Q–2. Must an employee (or the employee's spouse) make an affirmative election specifying a

beneficiary for a person to be a designated beneficiary under section 40l(a)(9)(E)?

A–2. No, a designated beneficiary is an individual who is designated as a beneficiary under the

plan whether or not the designation under the plan was made by the employee. The choice of

beneficiary is subject to the requirements of sections 401(a)(11), 414(p), and 417.

Q–3. May a person other than an individual be considered to be a designated beneficiary for

purposes of section 401(a)(9)?

A–3. No, only individuals may be designated beneficiaries for purposes of section 401(a)(9). A

person that is not an individual, such as the employee's estate, may not be a designated

beneficiary. If a person other than an individual is designated as a beneficiary of an employee's

benefit, the employee will be treated as having no designated beneficiary for purposes of

section 401(a)(9), even if there are also individuals designated as beneficiaries. However, see

A–5 of this section for special rules that apply to trusts and A–2 and A–3 of §1.401(a)(9)–8 for

rules that apply to separate accounts.

Q–4. When is the designated beneficiary determined?

A–4. (a) General rule. In order to be a designated beneficiary, an individual must be a

beneficiary as of the date of death. Except as provided in paragraph (b) and §1.401(a)(9)–6,

the employee's designated beneficiary will be determined based on the beneficiaries

designated as of the date of death who remain beneficiaries as of September 30 of the

calendar year following the calendar year of the employee's death. Consequently, except as

provided in §1.401(a)(9)–6, any person who was a beneficiary as of the date of the employee's

death, but is not a beneficiary as of that September 30 (e.g., because the person receives the

entire benefit to which the person is entitled before that September 30), is not taken into

account in determining the employee's designated beneficiary for purposes of determining the

distribution period for required minimum distributions after the employee's death. Accordingly,

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if a person disclaims entitlement to the employee's benefit, pursuant to a disclaimer that

satisfies section 2518 by that September 30 thereby allowing other beneficiaries to receive the

benefit in lieu of that person, the disclaiming person is not taken into account in determining

the employee's designated beneficiary.

(b) Surviving spouse. As provided in A–5 of §1.401(a)(9)–3, if the employee's spouse is the

sole designated beneficiary as of September 30 of the calendar year following the calendar

year of the employee's death, and the surviving spouse dies after the employee and before the

date on which distributions have begun to the surviving spouse under section 401(a)(9)(B)(iii)

and (iv), the rule in section 40l(a)(9)(B)(iv)(II) will apply. Thus, for example, the relevant

designated beneficiary for determining the distribution period after the death of the surviving

spouse is the designated beneficiary of the surviving spouse. Similarly, such designated

beneficiary will be determined based on the beneficiaries designated as of the date of the

surviving spouse's death and who remain beneficiaries as of September 30 of the calendar

year following the calendar year of the surviving spouse's death. Further, if, as of that

September 30, there is no designated beneficiary under the plan with respect to that surviving

spouse, distribution must be made in accordance with the 5-year rule in section 401(a)(9)(B)(ii)

and A–2 of §1.401(a)(9)–3.

(c) Deceased beneficiary. For purposes of this A–4, an individual who is a beneficiary as of the

date of the employee's death and dies prior to September 30 of the calendar year following the

calendar year of the employee's death without disclaiming continues to be treated as a

beneficiary as of the September 30 of the calendar year following the calendar year of the

employee's death in determining the employee's designated beneficiary for purposes of

determining the distribution period for required minimum distributions after the employee's

death, without regard to the identity of the successor beneficiary who is entitled to distributions

as the beneficiary of the deceased beneficiary. The same rule applies in the case of

distributions to which A–5 of §1.401(a)(9)–3 applies so that, if an individual is designated as a

beneficiary of an employee's surviving spouse as of the spouse's date of death and dies prior

to September 30 of the year following the year of the surviving spouse's death, that individual

will continue to be treated as a designated beneficiary.

Page 116 of 239

Q–5. If a trust is named as a beneficiary of an employee, will the beneficiaries of the trust with

respect to the trust's interest in the employee's benefit be treated as having been designated

as beneficiaries of the employee under the plan for purposes of determining the distribution

period under section 401(a)(9)?

A–5. (a) If the requirements of paragraph (b) of this A–5 are met with respect to a trust that is

named as the beneficiary of an employee under the plan, the beneficiaries of the trust (and not

the trust itself) will be treated as having been designated as beneficiaries of the employee

under the plan for purposes of determining the distribution period under section 401(a)(9).

(b) The requirements of this paragraph (b) are met if, during any period during which required

minimum distributions are being determined by treating the beneficiaries of the trust as

designated beneficiaries of the employee, the following requirements are met—

(1) The trust is a valid trust under state law, or would be but for the fact that there is no corpus.

(2) The trust is irrevocable or will, by its terms, become irrevocable upon the death of the

employee.

(3) The beneficiaries of the trust who are beneficiaries with respect to the trust's interest in the

employee's benefit are identifiable within the meaning of A–1 of this section from the trust

instrument.

(4) The documentation described in A–6 of this section has been provided to the plan

administrator.

(c) In the case of payments to a trust having more than one beneficiary, see A–7 of

§1.401(a)(9)–5 for the rules for determining the designated beneficiary whose life expectancy

will be used to determine the distribution period and A–3 of this section for the rules that apply

if a person other than an individual is designated as a beneficiary of an employee's benefit.

However, the separate account rules under A–2 of §1.401(a)(9)–8 are not available to

beneficiaries of a trust with respect to the trust's interest in the employee's benefit.

(d) If the beneficiary of the trust named as beneficiary of the employee's interest is another

trust, the beneficiaries of the other trust will be treated as being designated as beneficiaries of

the first trust, and thus, having been designated by the employee under the plan for purposes

of determining the distribution period under section 401(a)(9)(A)(ii), provided that the

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requirements of paragraph (b) of this A–5 are satisfied with respect to such other trust in

addition to the trust named as beneficiary

Q–6. If a trust is named as a beneficiary of an employee, what documentation must be

provided to the plan administrator?

A–6. (a) Required minimum distributions before death. If an employee designates a trust as

the beneficiary of his or her entire benefit and the employee's spouse is the sole beneficiary of

the trust, in order to satisfy the documentation requirements of this A–6 so that the spouse can

be treated as the sole designated beneficiary of the employee's benefits (if the other

requirements of paragraph (b) of A–5 of this section are satisfied), the employee must either—

(1) Provide to the plan administrator a copy of the trust instrument and agree that if the trust

instrument is amended at any time in the future, the employee will, within a reasonable time,

provide to the plan administrator a copy of each such amendment; or

(2) Provide to the plan administrator a list of all of the beneficiaries of the trust (including

contingent and remaindermen beneficiaries with a description of the conditions on their

entitlement sufficient to establish that the spouse is the sole beneficiary) for purposes of

section 401(a)(9); certify that, to the best of the employee's knowledge, this list is correct and

complete and that the requirements of paragraph (b)(1), (2), and (3) of A–5 of this section are

satisfied; agree that, if the trust instrument is amended at any time in the future, the employee

will, within a reasonable time, provide to the plan administrator corrected certifications to the

extent that the amendment changes any information previously certified; and agree to provide

a copy of the trust instrument to the plan administrator upon demand.

(b) Required minimum distributions after death. In order to satisfy the documentation

requirement of this A–6 for required minimum distributions after the death of the

employee (or spouse in a case to which A–5 of §1.401(a)(9)–3 applies), by October 31

of the calendar year immediately following the calendar year in which the employee

died, the trustee of the trust must either—

(1) Provide the plan administrator with a final list of all beneficiaries of the trust

(including contingent and remaindermen beneficiaries with a description of the

conditions on their entitlement) as of September 30 of the calendar year following the

calendar year of the employee's death; certify that, to the best of the trustee's

Page 118 of 239

knowledge, this list is correct and complete and that the requirements of paragraph

(b)(1), (2), and (3) of A–5 of this section are satisfied; and agree to provide a copy of the

trust instrument to the plan administrator upon demand; or

(2) Provide the plan administrator with a copy of the actual trust document for the trust

that is named as a beneficiary of the employee under the plan as of the employee's date

of death.

(c) Relief for discrepancy between trust instrument and employee certifications or earlier

trust instruments.

(1) If required minimum distributions are determined based on the information provided

to the plan administrator in certifications or trust instruments described in paragraph (a)

or (b) of this A–6, a plan will not fail to satisfy section 401(a)(9) merely because the

actual terms of the trust instrument are inconsistent with the information in those

certifications or trust instruments previously provided to the plan administrator, but only

if the plan administrator reasonably relied on the information provided and the required

minimum distributions for calendar years after the calendar year in which the

discrepancy is discovered are determined based on the actual terms of the trust

instrument.

(2) For purposes of determining the amount of the excise tax under section 4974, the

required minimum distribution is determined for any year based on the actual terms of

the trust in effect during the year.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 33293, June

15, 2004]

§1.401(a)(9)-5 Required Minimum Distributions From Defined Contribution Plans

Q–1. If an employee's benefit is in the form of an individual account under a defined

contribution plan, what is the amount required to be distributed for each calendar year?

A–1. (a) General rule. If an employee's accrued benefit is in the form of an individual account

under a defined contribution plan, the minimum amount required to be distributed for each

distribution calendar year, as defined in paragraph (b) of this A–1, is equal to the quotient

obtained by dividing the account (determined under A–3 of this section) by the applicable

distribution period (determined under A–4 or A–5 of this section, whichever is applicable).

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However, the required minimum distribution amount will never exceed the entire account

balance on the date of the distribution. See A–8 of this section for rules that apply if a portion

of the employee's account is not vested. Further, the minimum distribution required to be

distributed on or before an employee's required beginning date is always determined under

section 401(a)(9)(A)(ii) and this A–1 and not section 401(a)(9)(A)(i).

(b) Distribution calendar year. A calendar year for which a minimum distribution is required is a

distribution calendar year. If an employee's required beginning date is April 1 of the calendar

year following the calendar year in which the employee attains age 70 1/2, the employee's first

distribution calendar year is the year the employee attains age 70 1/2. If an employee's

required beginning date is April 1 of the calendar year following the calendar year in which the

employee retires, the employee's first distribution calendar year is the calendar year in which

the employee retires. In the case of distributions to be made in accordance with the life

expectancy rule in §1.401(a)(9)–3 and in section 401(a)(9)(B)(iii) and (iv), the first distribution

calendar year is the calendar year containing the date described in A–3(a) or A–3(b) of

§1.401(a)(9)–3, whichever is applicable.

(c) Time for distributions. The distribution required to be made on or before the employee's

required beginning date shall be treated as the distribution required for the employee's first

distribution calendar year (as defined in paragraph (b) of this A–1). The required minimum

distribution for other distribution calendar years, including the required minimum distribution for

the distribution calendar year in which the employee's required beginning date occurs, must be

made on or before the end of that distribution calendar year.

(d) Minimum distribution incidental benefit requirement. If distributions of an employee's

account balance under a defined contribution plan are made in accordance with this section,

the minimum distribution incidental benefit requirement of section 401(a)(9)(G) is satisfied.

Further, with respect to the retirement benefits provided by that account balance, to the extent

the incidental benefit requirement of §1.401–1(b)(1)(i) requires a distribution, that requirement

is deemed to be satisfied if distributions satisfy the minimum distribution incidental benefit

requirement of section 401(a)(9)(G) and this section.

(e) Annuity contracts. Instead of satisfying this A–1, the minimum distribution requirement may

Page 120 of 239

be satisfied by the purchase of an annuity contract from an insurance company in accordance

with A–4 of §1.401(a)(9)-6 with the employee's entire individual account. If such an annuity is

purchased after distributions are required to commence (the required beginning date, in the

case of distributions commencing before death, or the date determined under A–3 of

§1.401(a)(9)-3, in the case of distributions commencing after death), payments under the

annuity contract purchased will satisfy section 401(a)(9) for distribution calendar years after the

calendar year of the purchase if payments under the annuity contract are made in accordance

with §1.401(a)(9)-6T. In such a case, payments under the annuity contract will be treated as

distributions from the individual account for purposes of determining if the individual account

satisfies section 401(a)(9) for the calendar year of the purchase. An employee may also

purchase an annuity contract with a portion of the employee's account under the rules of A–

2(a)(3) of §1.401(a)(9)-8.

Q–2. If an employee's benefit is in the form of an individual account and, in any calendar year,

the amount distributed exceeds the minimum required, will credit be given in subsequent

calendar years for such excess distribution?

A–2. If, for any distribution calendar year, the amount distributed exceeds the minimum

required, no credit will be given in subsequent calendar years for such excess distribution.

Q–3. What is the amount of the account of an employee used for determining the employee's

required minimum distribution in the case of an individual account?

A–3. (a) In the case of an individual account, the benefit used in determining the required

minimum distribution for a distribution calendar year is the account balance as of the last

valuation date in the calendar year immediately preceding that distribution calendar year

(valuation calendar year) adjusted in accordance with paragraphs (b), (c), and (d) of this A–3.

(b) The account balance is increased by the amount of any contributions or forfeitures

allocated to the account balance as of dates in the valuation calendar year after the valuation

date. For this purpose, contributions that are allocated to the account balance as of dates in

the valuation calendar year after the valuation date, but that are not actually made during the

valuation calendar year, are permitted to be excluded.

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(c) The account balance is decreased by distributions made in the valuation calendar year

after the valuation date.

(d) The account balance does not include the value of any qualifying longevity annuity contract

(QLAC), defined in A-17 of §1.401(a)(9)-6, that is held under the plan. This paragraph (d)

applies only to contracts purchased on or after July 2, 2014.

(e) If an amount is distributed by one plan and rolled over to another plan (receiving plan), A–2

of §1.401(a)(9)-7 provides additional rules for determining the benefit and required minimum

distribution under the receiving plan. If an amount is transferred from one plan (transferor plan)

to another plan (transferee plan), A–3 and A–4 of §1.401(a)(9)-7 provide additional rules for

determining the amount of the required minimum distribution and the benefit under both the

transferor and transferee plans.

Q–4. For required minimum distributions during an employee's lifetime, what is the applicable

distribution period?

A–4. (a) General rule. Except as provided in paragraph (b) of this A–4, the applicable

distribution period for required minimum distributions for distribution calendar years up to and

including the distribution calendar year that includes the employee's date of death is

determined using the Uniform Lifetime Table in A–2 of §1.401(a)(9)-9 for the employee's age

as of the employee's birthday in the relevant distribution calendar year. If an employee dies on

or after the required beginning date, the distribution period applicable for calculating the

amount that must be distributed during the distribution calendar year that includes the

employee's death is determined as if the employee had lived throughout that year. Thus, a

minimum required distribution, determined as if the employee had lived throughout that year, is

required for the year of the employee's death and that amount must be distributed to a

beneficiary to the extent it has not already been distributed to the employee.

(b) Spouse is sole beneficiary —

(1) General rule. Except as otherwise provided in paragraph (b)(2) of this A–4, if the sole

designated beneficiary of an employee is the employee's surviving spouse, for required

minimum distributions during the employee's lifetime, the applicable distribution period is the

longer of the distribution period determined in accordance with paragraph (a) of this A–4 or the

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joint life expectancy of the employee and spouse using the employee's and spouse's attained

ages as of the employee's and the spouse's birthdays in the distribution calendar year. The

spouse is sole designated beneficiary for purposes of determining the applicable distribution

period for a distribution calendar year during the employee's lifetime only if the spouse is the

sole beneficiary of the employee's entire interest at all times during the distribution calendar

year.

(2) Change in marital status. If the employee and the employee's spouse are married on

January 1 of a distribution calendar year, but do not remain married throughout that year (i.e.,

the employee or the employee's spouse die or they become divorced during that year), the

employee will not fail to have a spouse as the employee's sole beneficiary for that year merely

because they are not married throughout that year. If an employee's spouse predeceases the

employee, the spouse will not fail to be the employee's sole beneficiary for the distribution

calendar year that includes the date of the spouse's death solely because, for the period

remaining in that year after the spouse's death, someone other than the spouse is named as

beneficiary. However, the change in beneficiary due to the death or divorce of the spouse will

be effective for purposes of determining the applicable distribution period under section

401(a)(9) in the distribution calendar year following the distribution calendar year that includes

the date of the spouse's death or divorce.

Q–5. For required minimum distributions after an employee's death, what is the applicable

distribution period?

A–5. (a) Death on or after the employee's required beginning date. If an employee dies after

distribution has begun as determined under A–6 of §1.401(a)(9)–2 (generally on or after the

employee's required beginning date), in order to satisfy section 401(a)(9)(B)(i), the applicable

distribution period for distribution calendar years after the distribution calendar year containing

the employee's date of death is either—

(1) If the employee has a designated beneficiary as of the date determined under A–4 of

§1.401(a)(9)–4, the longer of—

(i) The remaining life expectancy of the employee's designated beneficiary determined

in accordance with paragraph (c)(1) or (2) of this A–5; and

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(ii) The remaining life expectancy of the employee determined in accordance with

paragraph (c)(3) of this A–5; or

(2) If the employee does not have a designated beneficiary as of the date determined under A–

4 of §1.401(a)(9)–4, the remaining life expectancy of the employee determined in accordance

with paragraph (c)(3) of this A–5.

(b) Death before an employee's required beginning date. If an employee dies before

distribution has begun, as determined under A–5 of §1.401(a)(9)–2 (generally before the

employee's required beginning date), in order to satisfy section 401(a)(9)(B)(iii) or (iv) and the

life expectancy rule described in A–1 of §1.401(a)(9)–3, the applicable distribution period for

distribution calendar years after the distribution calendar year containing the employee's date

of death is determined in accordance with paragraph (c) of this A–5. See A–4 of §1.401(a)(9)–

3 to determine when the 5-year rule in section 401(a)(9)(B)(ii) applies (e.g., there is no

designated beneficiary or the 5-year rule is elected or specified by plan provision).

(c) Life expectancy —

(1) Nonspouse designated beneficiary. Except as otherwise provided in paragraph (c)(2),

the applicable distribution period measured by the beneficiary's remaining life

expectancy is determined using the beneficiary's age as of the beneficiary's birthday in

the calendar year immediately following the calendar year of the employee's death. In

subsequent calendar years, the applicable distribution period is reduced by one for each

calendar year that has elapsed after the calendar year immediately following the

calendar year of the employee's death.

(2) Spouse designated beneficiary. If the surviving spouse of the employee is the

employee's sole beneficiary, the applicable distribution period is measured by the

surviving spouse's life expectancy using the surviving spouse's birthday for each

distribution calendar year after the calendar year of the employee's death up through

the calendar year of the spouse's death. For calendar years after the calendar year of

the spouse's death, the applicable distribution period is the life expectancy of the

spouse using the age of the spouse as of the spouse's birthday in the calendar year of

the spouse's death, reduced by one for each calendar year that has elapsed after the

calendar year of the spouse's death.

Page 124 of 239

(3) No designated beneficiary. If the employee does not have a designated beneficiary, the

applicable distribution period measured by the employee's remaining life expectancy is

the life expectancy of the employee using the age of the employee as of the employee's

birthday in the calendar year of the employee's death. In subsequent calendar years the

applicable distribution period is reduced by one for each calendar year that has elapsed

after the calendar year of the employee's death.

Q–6. What life expectancies must be used for purposes of determining required minimum

distributions under section 401(a)(9)?

A–6. Life expectancies for purposes of determining required minimum distributions under

section 401(a)(9) must be computed using the Single Life Table in A–1 of §1.401(a)(9)–9 and

the Joint and Last Survivor Table in A–3 of §1.401(a)(9)–9.

Q–7. If an employee has more than one designated beneficiary, which designated beneficiary's

life expectancy will be used to determine the applicable distribution period?

A–7. (a) General rule —

(1) Except as otherwise provided in paragraph (c) of this A–7, if more than one individual is

designated as a beneficiary with respect to an employee as of the applicable date for

determining the designated beneficiary under A–4 of §1.401(a)(9)–4, the designated

beneficiary with the shortest life expectancy will be the designated beneficiary for

purposes of determining the applicable distribution period.

(2) See A–3 of §1.401(a)(9)-4 for rules that apply if a person other than an individual is

designated as a beneficiary and see A–2 and A–3 of §1.401(a)(9)-8 for special rules

that apply if an employee's benefit under a plan is divided into separate accounts and

the beneficiaries with respect to a separate account differ from the beneficiaries of

another separate account.

(b) Contingent beneficiary. Except as provided in paragraph (c)(1) of this A–7, if a beneficiary's

entitlement to an employee's benefit after the employee's death is a contingent right, such

contingent beneficiary is nevertheless considered to be a beneficiary for purposes of

determining whether a person other than an individual is designated as a beneficiary (resulting

in the employee being treated as having no designated beneficiary under the rules of A–3 of

§1.401(a)(9)-4) and which designated beneficiary has the shortest life expectancy under

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paragraph (a) of this A–7.

(c) Successor beneficiary —

(1) A person will not be considered a beneficiary for purposes of determining who is the

beneficiary with the shortest life expectancy under paragraph (a) of this A–7, or whether a

person who is not an individual is a beneficiary, merely because the person could become the

successor to the interest of one of the employee's beneficiaries after that beneficiary's death.

However, the preceding sentence does not apply to a person who has any right (including a

contingent right) to an employee's benefit beyond being a mere potential successor to the

interest of one of the employee's beneficiaries upon that beneficiary's death. Thus, for

example, if the first beneficiary has a right to all income with respect to an employee's

individual account during that beneficiary's life and a second beneficiary has a right to the

principal but only after the death of the first income beneficiary (any portion of the principal

distributed during the life of the first income beneficiary to be held in trust until that first

beneficiary's death), both beneficiaries must be taken into account in determining the

beneficiary with the shortest life expectancy and whether only individuals are beneficiaries.

(2) If the individual beneficiary whose life expectancy is being used to calculate the distribution

period dies after September 30 of the calendar year following the calendar year of the

employee's death, such beneficiary's remaining life expectancy will be used to determine the

distribution period without regard to the life expectancy of the subsequent beneficiary.

(3) This paragraph (c) is illustrated by the following examples:

Example 1.

(i) Employer M maintains a defined contribution plan, Plan X. Employee A, an employee of

M, died in 2005 at the age of 55, survived by spouse, B, who was 50 years old. Prior to

A's death, M had established an account balance for A in Plan X. A's account balance is

invested only in productive assets. A named a testamentary trust (Trust P) established

under A's will as the beneficiary of all amounts payable from A's account in Plan X after

A's death. A copy of the Trust P and a list of the trust beneficiaries were provided to the

plan administrator of Plan X by October 31 of the calendar year following the calendar

year of A's death. As of the date of A's death, the Trust P was irrevocable and was a

valid trust under the laws of the state of A's domicile. A's account balance in Plan X was

includible in A's gross estate under §2039.

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(ii) Under the terms of Trust P, all trust income is payable annually to B, and no one has the

power to appoint Trust P principal to any person other than B. A's children, who are all

younger than B, are the sole remainder beneficiaries of the Trust P. No other person

has a beneficial interest in Trust P. Under the terms of the Trust P, B has the power,

exercisable annually, to compel the trustee to withdraw from A's account balance in

Plan X an amount equal to the income earned on the assets held in A's account in Plan

X during the calendar year and to distribute that amount through Trust P to B. Plan X

contains no prohibition on withdrawal from A's account of amounts in excess of the

annual required minimum distributions under section 401(a)(9). In accordance with the

terms of Plan X, the trustee of Trust P elects, in order to satisfy section 401(a)(9), to

receive annual required minimum distributions using the life expectancy rule in section

401(a)(9)(B)(iii) for distributions over a distribution period equal to B's life expectancy. If

B exercises the withdrawal power, the trustee must withdraw from A's account under

Plan X the greater of the amount of income earned in the account during the calendar

year or the required minimum distribution. However, under the terms of Trust P, and

applicable state law, only the portion of the Plan X distribution received by the trustee

equal to the income earned by A's account in Plan X is required to be distributed to B

(along with any other trust income.)

(iii) Because some amounts distributed from A's account in Plan X to Trust P may be

accumulated in Trust P during B's lifetime for the benefit of A's children, as

remaindermen beneficiaries of Trust P, even though access to those amounts are

delayed until after B's death, A's children are beneficiaries of A's account in Plan X in

addition to B and B is not the sole designated beneficiary of A's account. Thus the

designated beneficiary used to determine the distribution period from A's account in

Plan X is the beneficiary with the shortest life expectancy. B's life expectancy is the

shortest of all the potential beneficiaries of the testamentary trust's interest in A's

account in Plan X (including remainder beneficiaries). Thus, the distribution period for

purposes of section 401(a)(9)(B)(iii) is B's life expectancy. Because B is not the sole

designated beneficiary of the testamentary trust's interest in A's account in Plan X, the

special rule in 401(a)(9)(B)(iv) is not available and the annual required minimum

distributions from the account to Trust M must begin no later than the end of the

calendar year immediately following the calendar year of A's death.

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Example 2.

(i) The facts are the same as Example 1 except that the testamentary trust instrument

provides that all amounts distributed from A's account in Plan X to the trustee while B is

alive will be paid directly to B upon receipt by the trustee of Trust P.

(ii) In this case, B is the sole designated beneficiary of A's account in Plan X for purposes of

determining the designated beneficiary under section 401(a)(9)(B)(iii) and (iv). No

amounts distributed from A's account in Plan X to Trust P are accumulated in Trust P

during B's lifetime for the benefit of any other beneficiary. Therefore, the residuary

beneficiaries of Trust P are mere potential successors to B's interest in Plan X. Because

B is the sole beneficiary of the testamentary trust's interest in A's account in Plan X, the

annual required minimum distributions from A's account to Trust P must begin no later

than the end of the calendar year in which A would have attained age 70 1/2, rather

than the calendar year immediately following the calendar year of A's death.

Q–8. If a portion of an employee's individual account is not vested as of the employee's

required beginning date, how is the determination of the required minimum distribution

affected?

A–8. If the employee's benefit is in the form of an individual account, the benefit used to

determine the required minimum distribution for any distribution calendar year will be

determined in accordance with A–1 of this section without regard to whether or not all of the

employee's benefit is vested. If any portion of the employee's benefit is not vested,

distributions will be treated as being paid from the vested portion of the benefit first. If, as of the

end of a distribution calendar year (or as of the employee's required beginning date, in the

case of the employee's first distribution calendar year), the total amount of the employee's

vested benefit is less than the required minimum distribution for the calendar year, only the

vested portion, if any, of the employee's benefit is required to be distributed by the end of the

calendar year (or, if applicable, by the employee's required beginning date). However, the

required minimum distribution for the subsequent distribution calendar year must be increased

by the sum of amounts not distributed in prior calendar years because the employee's vested

benefit was less than the required minimum distribution.

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Q–9. Which amounts distributed from an individual account are taken into account in

determining whether section 401(a)(9) is satisfied and which amounts are not taken into

account in determining whether section 401(a)(9) is satisfied?

A–9. (a) General rule. Except as provided in paragraph (b), all amounts distributed from an

individual account are distributions that are taken into account in determining whether section

401(a)(9) is satisfied, regardless of whether the amount is includible in income. Thus, for

example, amounts that are excluded from income as recovery of investment in the contract

under section 72 are taken into account for purposes of determining whether section 401(a)(9)

is satisfied for a distribution calendar year. Similarly, amounts excluded from income as net

unrealized appreciation on employer securities also are amounts distributed for purposes of

determining if section 401(a)(9) is satisfied.

(b) Exceptions. The following amounts are not taken into account in determining whether the

required minimum amount has been distributed for a calendar year:

(1) Elective deferrals (as defined in section 402(g)(3)) and employee contributions that,

pursuant to rules prescribed by the Commissioner in revenue rulings, notices, or other

guidance published in the Internal Revenue Bulletin (see §601.601(d)(2) of this

chapter), are returned to the employee (together with the income allocable thereto) in

order to comply with the section 415 limitations.

(2) Corrective distributions of excess deferrals as described in §1.402(g)-1(e)(3), together

with the income allocable to these distributions.

(3) Corrective distributions of excess contributions under a qualified cash or deferred

arrangement under section 401(k)(8) and excess aggregate contributions under section

401(m)(6), together with the income allocable to these distributions.

(4) Loans that are treated as deemed distributions pursuant to section 72(p).

(5) Dividends described in section 404(k) that are paid on employer securities. (Amounts

paid to the plan that, pursuant to section 404(k)(2)(A)(iii)(II), are included in the account

balance and subsequently distributed from the account lose their character as

dividends).

(6) The costs of life insurance coverage (P.S. 58 costs).

(7) Similar items designated by the Commissioner in revenue rulings, notices, and other

guidance published in the Internal Revenue Bulletin. See §601.601(d)(2)(ii)(b) of this

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chapter.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 33293, June

15, 2004; T.D. 9319, 72 FR 16894, Apr. 5, 2007;T.D. 9673, 79 FR 37639, July 2, 2014]

§1.401(a)(9)-6 Required Minimum Distributions for Defined Benefit Plans and Annuity

Contracts

Q–1. How must distributions under a defined benefit plan be paid in order to satisfy section

401(a)(9)?

A–1. (a) General rules. In order to satisfy section 401(a)(9), except as otherwise provided in

this section, distributions of the employee's entire interest under a defined benefit plan must be

paid in the form of periodic annuity payments for the employee's life (or the joint lives of the

employee and beneficiary) or over a period certain that does not exceed the maximum length

of the period certain determined in accordance with A–3 of this section. The interval between

payments for the annuity must be uniform over the entire distribution period and must not

exceed one year. Once payments have commenced over a period, the period may only be

changed in accordance with A–13 of this section. Life (or Joint and Survivor) annuity payments

must satisfy the minimum distribution incidental benefit requirements of A–2 of this section.

Except as otherwise provided in this section (such as permitted increases described in A–14 of

this section), all payments (whether paid over an employee's life, joint lives, or a period certain)

also must be nonincreasing.

(b) Life annuity with period certain. The annuity may be a life annuity (or Joint and Survivor

annuity) with a period certain if the life (or lives, if applicable) and period certain each meet the

requirements of paragraph (a) of this A–1. For purposes of this section, if distributions are

permitted to be made over the lives of the employee and the designated beneficiary,

references to a life annuity include a Joint and Survivor annuity.

(c) Annuity commencement.

(1) Annuity payments must commence on or before the employee's required beginning date

(within the meaning of A–2 of §1.401(a)(9)–2). The first payment, which must be made

on or before the employee's required beginning date, must be the payment which is

required for one payment interval. The second payment need not be made until the end

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of the next payment interval even if that payment interval ends in the next calendar

year. Similarly, in the case of distributions commencing after death in accordance with

section 401(a)(9)(B)(iii) and (iv), the first payment, which must be made on or before the

date determined under A–3(a) or (b) (whichever is applicable) of §1.401(a)(9)–3, must

be the payment which is required for one payment interval. Payment intervals are the

periods for which payments are received, e.g., bimonthly, monthly, semi-annually, or

annually. All benefit accruals as of the last day of the first distribution calendar year

must be included in the calculation of the amount of annuity payments for payment

intervals ending on or after the employee's required beginning date.

(2) This paragraph (c) is illustrated by the following example:

Example. A defined benefit plan (Plan X) provides monthly annuity payments of $500

for the life of unmarried participants with a 10-year period certain. An unmarried, retired

participant (A) in Plan X attains age 70 1/2 in 2005. In order to meet the requirements of

this paragraph, the first monthly payment of $500 must be made on behalf of A on or

before April 1, 2006, and the payments must continue to be made in monthly payments

of $500 thereafter for the life and 10-year period certain.

(d) Single sum distributions. In the case of a single sum distribution of an employee's

entire accrued benefit during a distribution calendar year, the amount that is the

required minimum distribution for the distribution calendar year (and thus not eligible for

rollover under section 402(c)) is determined using either the rule in paragraph (d)(1) or

the rule in paragraph (d)(2) of this A–1.

(1) The portion of the single sum distribution that is a required minimum distribution is

determined by treating the single sum distribution as a distribution from an individual

account plan and treating the amount of the single sum distribution as the employee's

account balance as of the end of the relevant valuation calendar year. If the single sum

distribution is being made in the calendar year containing the required beginning date

and the required minimum distribution for the employee's first distribution calendar year

has not been distributed, the portion of the single sum distribution that represents the

required minimum distribution for the employee's first and second distribution calendar

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years is not eligible for rollover.

(2) The portion of the single sum distribution that is a required minimum distribution is

permitted to be determined by expressing the employee's benefit as an annuity that

would satisfy this section with an annuity starting date as of the first day of the

distribution calendar year for which the required minimum distribution is being

determined, and treating one year of annuity payments as the required minimum

distribution for that year, and not eligible for rollover. If the single sum distribution is

being made in the calendar year containing the required beginning date and the

required minimum distribution for the employee's first distribution calendar year has not

been made, the benefit must be expressed as an annuity with an annuity starting date

as of the first day of the first distribution calendar year and the payments for the first two

distribution calendar years would be treated as required minimum distributions, and not

eligible for rollover.

(e) Death benefits. The rule in paragraph (a) of this A–1, prohibiting increasing payments

under an annuity applies to payments made upon the death of an employee. However, for

purposes of this section, an ancillary death benefit described in this paragraph (e) may be

disregarded in applying that rule. Such an ancillary death benefit is excluded in determining

an employee's entire interest and the rules prohibiting increasing payments do not apply to

such an ancillary death benefit. A death benefit with respect to an employee's benefit is an

ancillary death benefit for purposes of this A–1 if—

(1) It is not paid as part of the employee's accrued benefit or under any optional form of the

employee's benefit; and

(2) The death benefit, together with any other potential payments with respect to the

employee's benefit that may be provided to a survivor, satisfy the incidental benefit

requirement of §1.401–1(b)(1)(i).

(f) Additional guidance. Additional guidance regarding how distributions under a defined benefit

plan must be paid in order to satisfy section 401(a)(9) may be issued by the Commissioner in

revenue rulings, notices, or other guidance published in the Internal Revenue Bulletin. See

§601.601(d)(2)(ii)(b) of this chapter.

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Q–2. How must distributions in the form of a life (or Joint and Survivor) annuity be made in

order to satisfy the minimum distribution incidental benefit (MDIB) requirement of section

401(a)(9)(G) and the distribution component of the incidental benefit requirement of §1.401–

1(b)(1)(i)?

A–2. (a) Life annuity for employee. If the employee's benefit is paid in the form of a life annuity

for the life of the employee satisfying section 401(a)(9) without regard to the MDIB

requirement, the MDIB requirement of section 401(a)(9)(G) will be satisfied.

(b) Joint and survivor annuity, spouse beneficiary. If the employee's sole beneficiary, as of the

annuity starting date for annuity payments, is the employee's spouse and the distributions

satisfy section 401(a)(9) without regard to the MDIB requirement, the distributions to the

employee will be deemed to satisfy the MDIB requirement of section 401(a)(9)(G). For

example, if an employee's benefit is being distributed in the form of a Joint and Survivor

annuity for the lives of the employee and the employee's spouse and the spouse is the sole

beneficiary of the employee, the amount of the periodic payment payable to the spouse would

not violate the MDIB requirement if it was 100 percent of the annuity payment payable to the

employee, regardless of the difference in the ages between the employee and the employee's

spouse.

(c) Joint and survivor annuity, nonspouse beneficiary —(1) Explanation of rule. If distributions

commence under a distribution option that is in the form of a Joint and Survivor annuity for the

joint lives of the employee and a beneficiary other than the employee's spouse, the minimum

distribution incidental benefit requirement will not be satisfied as of the date distributions

commence unless under the distribution option, the annuity payments to be made on and after

the employee's required beginning date will satisfy the conditions of this paragraph (c). The

periodic annuity payment payable to the survivor must not at any time on and after the

employee's required beginning date exceed the applicable percentage of the annuity payment

payable to the employee using the table in paragraph (c)(2) of this A–2. The applicable

percentage is based on the adjusted employee/beneficiary age difference. The adjusted

employee/beneficiary age difference is determined by first calculating the excess of the age of

the employee over the age of the beneficiary based on their ages on their birthdays in a

calendar year. Then, if the employee is younger than age 70, the age difference determined in

the previous sentence is reduced by the number of years that the employee is younger than

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age 70 on the employee's birthday in the calendar year that contains the annuity starting date.

In the case of an annuity that provides for increasing payments, the requirement of this

paragraph (c) will not be violated merely because benefit payments to the beneficiary increase,

provided the increase is determined in the same manner for the employee and the beneficiary.

(2)Table

(3) Example. This paragraph (c) is illustrated by the following example:

Example. Distributions commence on January 1, 2003 to an employee (Z), born March 1,

1937, after retirement at age 65. Z's daughter (Y), born February 5, 1967, is Z's beneficiary.

The distributions are in the form of a Joint and Survivor annuity for the lives of Z and Y with

payments of $500 a month to Z and upon Z's death of $500 a month to Y, i.e., the projected

monthly payment to Y is 100 percent of the monthly amount payable to Z. Accordingly, under

A–10 of this section, compliance with the rules of this section is determined as of the annuity

starting date. The adjusted employee/beneficiary age difference is calculated by taking the

excess of the employee's age over the beneficiary's age and subtracting the number of years

the employee is younger than age 70. In this case, Z is 30 years older than Y and is

commencing benefit 4 years before attaining age 70 so the adjusted employee beneficiary age

difference is 26 years. Under the table in the paragraph (c)(2) of this A–2, the applicable

percentage for a 26-year adjusted employee/beneficiary age difference is 64 percent. As of

January 1, 2003 (the annuity starting date) the plan does not satisfy the MDIB requirement

because, as of such date, the distribution option provides that, as of Z's required beginning

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date, the monthly payment to Y upon Z's death will exceed 66 percent of Z's monthly payment.

(d) Period certain and annuity features. If a distribution form includes a period certain, the

amount of the annuity payments payable to the beneficiary need not be reduced during the

period certain, but in the case of a Joint and Survivor annuity with a period certain, the amount

of the annuity payments payable to the beneficiary must satisfy paragraph (c) of this A–2 after

the expiration of the period certain.

e) Deemed satisfaction of incidental benefit rule. Except in the case of distributions with

respect to an employee's benefit that include an ancillary death benefit described in paragraph

A–1(e) of this section, to the extent the incidental benefit requirement of §1.401–1(b)(1)(i)

requires a distribution, that requirement is deemed to be satisfied if distributions satisfy the

minimum distribution incidental benefit requirement of this A–2. If the employee's benefits

include an ancillary death benefit described in paragraph A–1(e) of this section, the benefits

(including the ancillary death benefit) must be distributed in accordance with the incidental

benefit requirement described in §1.401–1(b)(1)(i) and the benefits (excluding the ancillary

death benefit) must also satisfy the minimum distribution incidental benefit requirement of this

A–2.

Q–3. How long is a period certain under a defined benefit plan permitted to extend?

A–3. (a) Distributions commencing during the employee's life. The period certain for any

annuity distributions commencing during the life of the employee with an annuity starting date

on or after the employee's required beginning date generally is not permitted to exceed the

applicable distribution period for the employee (determined in accordance with the Uniform

Lifetime Table in A–2 of §1.401(a)(9)–9) for the calendar year that contains the annuity starting

date. See A–10 of this section for the rule for annuity payments with an annuity starting date

before the required beginning date. However, if the employee's sole beneficiary is the

employee's spouse, the period certain is permitted to be as long as the joint life and last

survivor expectancy of the employee and the employee's spouse, if longer than the applicable

distribution period for the employee, provided the period certain is not provided in conjunction

with a life annuity under A–1(b) of this section.

(b) Distributions commencing after the employee's death.

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(1) If annuity distributions commence after the death of the employee under the life

expectancy rule (under section 401(a)(9)(B)(iii) or (iv)), the period certain for any

distributions commencing after death cannot exceed the applicable distribution period

determined under A–5(b) of §1.401(a)(9)–5 for the distribution calendar year that

contains the annuity starting date.

(2) If the annuity starting date is in a calendar year before the first distribution calendar year,

the period certain may not exceed the life expectancy of the designated beneficiary

using the beneficiary's age in the year that contains the annuity starting date.

Q–4. Will a plan fail to satisfy section 401(a)(9) merely because distributions are made from an

annuity contract which is purchased from an insurance company?

A–4. A plan will not fail to satisfy section 401(a)(9) merely because distributions are made from

an annuity contract which is purchased with the employee's benefit by the plan from an

insurance company, as long as the payments satisfy the requirements of this section. If the

annuity contract is purchased after the required beginning date, the first payment interval must

begin on or before the purchase date and the payment required for one payment interval must

be made no later than the end of such payment interval. If the payments actually made under

the annuity contract do not meet the requirements of section 401(a)(9), the plan fails to satisfy

section 401(a)(9). See also A–14 of this section permitting certain increases under annuity

contracts.

Q–5. In the case of annuity distributions under a defined benefit plan, how must additional

benefits that accrue after the employee's first distribution calendar year be distributed in order

to satisfy section 401(a)(9)?

A–5. (a) In the case of annuity distributions under a defined benefit plan, if any additional

benefits accrue in a calendar year after the employee's first distribution calendar year,

distribution of the amount that accrues in the calendar year must commence in accordance

with A–1 of this section beginning with the first payment interval ending in the calendar year

immediately following the calendar year in which such amount accrues.

(b) A plan will not fail to satisfy section 401(a)(9) merely because there is an administrative

delay in the commencement of the distribution of the additional benefits accrued in a calendar

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year, provided that the actual payment of such amount commences as soon as practicable.

However, payment must commence no later than the end of the first calendar year following

the calendar year in which the additional benefit accrues, and the total amount paid during

such first calendar year must be no less than the total amount that was required to be paid

during that year under A–5(a) of this section.

Q–6. If a portion of an employee's benefit is not vested as of December 31 of a distribution

calendar year, how is the determination of the required minimum distribution affected?

A–6. In the case of annuity distributions from a defined benefit plan, if any portion of the

employee's benefit is not vested as of December 31 of a distribution calendar year, the portion

that is not vested as of such date will be treated as not having accrued for purposes of

determining the required minimum distribution for that distribution calendar year. When an

additional portion of the employee's benefit becomes vested, such portion will be treated as an

additional accrual. See A–5 of this section for the rules for distributing benefits which accrue

under a defined benefit plan after the employee's first distribution calendar year.

Q–7. If an employee (other than a 5-percent owner) retires after the calendar year in which the

employee attains age 70 1/2, for what period must the employee's accrued benefit under a

defined benefit plan be actuarially increased?

A–7. (a) Actuarial increase starting date. If an employee (other than a 5-percent owner) retires

after the calendar year in which the employee attains age 70 1/2, in order to satisfy section

401(a)(9)(C)(iii), the employee's accrued benefit under a defined benefit plan must be

actuarially increased to take into account any period after age 70 ½ in which the employee was

not receiving any benefits under the plan. The actuarial increase required to satisfy section

401(a)(9)(C)(iii) must be provided for the period starting on the April 1 following the calendar

year in which the employee attains age 70 1/2, or January 1, 1997, if later.

(b) Actuarial increase ending date. The period for which the actuarial increase must be

provided ends on the date on which benefits commence after retirement in an amount

sufficient to satisfy section 401(a)(9).

(c) Nonapplication to plan providing same required beginning date for all employees. If, as

permitted under A–2(e) of §1.401(a)(9)–2, a plan provides that the required beginning date for

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purposes of section 401(a)(9) for all employees is April 1 of the calendar year following the

calendar year in which the employee attains age 70 1/2 (regardless of whether the employee is

a 5-percent owner) and the plan makes distributions in an amount sufficient to satisfy section

401(a)(9) using that required beginning date, no actuarial increase is required under section

401(a)(9)(C)(iii).

(d) Nonapplication to governmental and church plans. The actuarial increase required under

this A–7 does not apply to a governmental plan (within the meaning of section 414(d)) or a

church plan. For purposes of this paragraph, the term church plan means a plan maintained by

a church for church employees, and the term church means any church (as defined in section

3121(w)(3)(A)) or qualified church-controlled organization (as defined in section

3121(w)(3)(B)).

Q–8. What amount of actuarial increase is required under section 401(a)(9)(C)(iii)?

A–8. In order to satisfy section 401(a)(9)(C)(iii), the retirement benefits payable with respect to

an employee as of the end of the period for actuarial increases (described in A–7 of this

section) must be no less than: the actuarial equivalent of the employee's retirement benefits

that would have been payable as of the date the actuarial increase must commence under

paragraph (a) of A–7 of this section if benefits had commenced on that date; plus the actuarial

equivalent of any additional benefits accrued after that date; reduced by the actuarial

equivalent of any distributions made with respect to the employee's retirement benefits after

that date. Actuarial equivalence is determined using the plan's assumptions for determining

actuarial equivalence for purposes of satisfying section 411.

Q–9. How does the actuarial increase required under section 401(a)(9)(C)(iii) relate to the

actuarial increase required under section 411?

A–9. In order for any of an employee's accrued benefit to be nonforfeitable as required under

section 411, a defined benefit plan must make an actuarial adjustment to an accrued benefit,

the payment of which is deferred past normal retirement age. The only exception to this rule is

that generally no actuarial adjustment is required to reflect the period during which a benefit is

suspended as permitted under section 203(a)(3)(B) of the Employee Retirement Income

Security Act of 1974 (ERISA) (88 Stat. 829). The actuarial increase required under section

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401(a)(9)(C)(iii) for the period described in A–7 of this section is generally the same as, and

not in addition to, the actuarial increase required for the same period under section 411 to

reflect any delay in the payment of retirement benefits after normal retirement age. However,

unlike the actuarial increase required under section 411, the actuarial increase required under

section 401(a)(9)(C)(iii) must be provided even during any period during which an employee's

benefit has been suspended in accordance with ERISA section 203(a)(3)(B).

Q–10. What rule applies if distributions commence to an employee on a date before the

employee's required beginning date over a period permitted under section 401(a)(9)(A)(ii) and

the distribution form is an annuity under which distributions are made in accordance with the

provisions of A–1 of this section?

A–10. (a) General rule. If distributions commence to an employee on a date before the

employee's required beginning date over a period permitted under section 401(a)(9)(A)(ii) and

the distribution form is an annuity under which distributions are made in accordance with the

provisions of A–1 of this section, the annuity starting date will be treated as the required

beginning date for purposes of applying the rules of this section and §1.401(a)(9)–2. Thus, for

example, the designated beneficiary distributions will be determined as of the annuity starting

date. Similarly, if the employee dies after the annuity starting date but before the required

beginning date determined under A–2 of §1.401(a)(9)–2, after the employee's death, the

remaining portion of the employee's interest must continue to be distributed in accordance with

this section over the remaining period over which distributions commenced. The rules in

§1.401(a)(9)–3 and section 401(a)(9)(B)(ii) or (iii) and (iv) do not apply.

(b) Period certain. If, as of the employee's birthday in the year that contains the annuity starting

date, the age of the employee is under 70, the following rule applies in applying the rule in

paragraph (a) of A–3 of this section. The applicable distribution period for the employee is the

distribution period for age 70, determined in accordance with the Uniform Lifetime Table in A–2

of §1.401(a)(9)–9, plus the excess of 70 over the age of the employee as of the employee's

birthday in the year that contains the annuity starting date.

(c) Adjustment to employee/beneficiary age difference. See A–2(c)(1) of this section for the

determination of the adjusted employee/beneficiary age difference in the case of an employee

whose age on the annuity starting date is less than 70.

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Q–11. What rule applies if distributions commence to the surviving spouse of an employee

over a period permitted under section 401(a)(9)(B)(iii)(II) before the date on which distributions

are required to commence and the distribution form is an annuity under which distributions are

made as of the date distributions commence in accordance with the provisions of A–1 of this

section.

A–11. If distributions commence to the surviving spouse of an employee over a period

permitted under section 401(a)(9)(B)(iii)(II) before the date on which distributions are required

to commence and the distribution form is an annuity under which distributions are made as of

the date distributions commence in accordance with the provisions of A–1 of this section,

distributions will be considered to have begun on the actual commencement date for purposes

of section 401(a)(9)(B)(iv)(II). Consequently, in such case, A–5 of §1.401(a)(9)–3 and section

401(a)(9)(B)(ii) and (iii) will not apply upon the death of the surviving spouse as though the

surviving spouse were the employee. Instead, the annuity distributions must continue to be

made, in accordance with the provisions of A–1 of this section, over the remaining period over

which distributions commenced.

Q–12. In the case of an annuity contract under an individual account plan that has not yet been

annuitized, how is section 401(a)(9) satisfied with respect to the employee's or beneficiary's

entire interest under the annuity contract for the period prior to the date annuity payments so

commence?

A–12. (a) General rule. Prior to the date that an annuity contract under an individual account

plan is annuitized, the interest of an employee or beneficiary under that contract is treated as

an individual account for purposes of section 401(a)(9). Thus, the required minimum

distribution for any year with respect to that interest is determined under §1.401(a)(9)–5 rather

than this section. See A–1 of §1.401(a)(9)–5 for rules relating to the satisfaction of section

401(a)(9) in the year that annuity payments commence and A–2(a)(3) of §1.401(a)(9)–8.

(b) Entire interest. For purposes of applying the rules in §1.401(a)(9)–5, the entire interest

under the annuity contract as of December 31 of the relevant valuation calendar year is treated

as the account balance for the valuation calendar year described in A–3 of §1.401(a)(9)–5.

The entire interest under an annuity contract is the dollar amount credited to the employee or

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beneficiary under the contract plus the actuarial present value of any additional benefits (such

as survivor benefits in excess of the dollar amount credited to the employee or beneficiary) that

will be provided under the contract. However, paragraph (c) of this A–12 describes certain

additional benefits that may be disregarded in determining the employee's entire interest under

the annuity contract. The actuarial present value of any additional benefits described under this

A–12 is to be determined using reasonable actuarial assumptions, including reasonable

assumptions as to future distributions, and without regard to an individual's health.

(c) Exclusions.

(1) The actuarial present value of any additional benefits provided under an annuity contract

described in paragraph (b) of this A–12 may be disregarded if the sum of the dollar

amount credited to the employee or beneficiary under the contract and the actuarial

present value of the additional benefits is no more than 120 percent of the dollar amount

credited to the employee or beneficiary under the contract and the contract provides

only for the following additional benefits:

(i) Additional benefits that, in the case of a distribution, are reduced by an amount

sufficient to ensure that the ratio of such sum to the dollar amount credited does

not increase as a result of the distribution, and

(ii) An additional benefit that is the right to receive a final payment upon death that does

not exceed the excess of the premiums paid less the amount of prior

distributions.

(2) If the only additional benefit provided under the contract is the additional benefit

described in paragraph (c)(1)(ii) of this A–12, the additional benefit may be disregarded

regardless of its value in relation to the dollar amount credited to the employee or

beneficiary under the contract.

(3) The Commissioner in revenue rulings, notices, or other guidance published in the

Internal Revenue Bulletin (see §601.601(d)(2) of this chapter) may provide additional

guidance on additional benefits that may be disregarded.

(d) Examples. The following examples, which use a 5 percent interest rate and the Mortality

Table provided in Rev. Rul. 2001–62 (2001–2 C.B. 632), illustrate the application of the rules in

this A–12:

Example 1.

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(i) G is the owner of a variable annuity contract (Contract S) under an individual account

plan which has not been annuitized. Contract S provides a death benefit until the end of

the calendar year in which the owner attains the age of 84 equal to the greater of the

current Contract S notional account value (dollar amount credited to G under the

contract) and the largest notional account value at any previous policy anniversary

reduced proportionally for subsequent partial distributions (High Water Mark). Contract

S provides a death benefit in calendar years after the calendar year in which the owner

attains age 84 equal to the current notional account value. Contract S provides that

assets within the contract may be invested in a Fixed Account at a guaranteed rate of 2

percent. Contract S provides no other additional benefits.

(ii) At the end of 2008, when G has an attained age of 78 and 9 months the notional account

value of Contract S (after the distribution for 2008 of 4.93% of the notional account

value as of December 31, 2007) is $550,000, and the High Water Mark, before

adjustment for any withdrawals from Contract S in 2008 is $1,000,000. Thus, Contract S

will provide additional benefits ( i.e. the death benefits in excess of the notional account

value) through 2014, the year S turns 84. The actuarial present value of these additional

benefits at the end of 2008 is determined to be $84,300 (15 percent of the notional

account value). In making this determination, the following assumptions are made: on

the average, deaths occur mid-year; the investment return on his notional account value

is 2 percent per annum; and minimum required distributions (determined without regard

to additional benefits under the Contract S) are made at the end of each year. The

following table summarizes the actuarial methodology used in determining the actuarial

present value of the additional benefit.

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» $1,000,000 death benefit reduced 4.93 percent for withdrawal during 2008.

» Notional account value at end of prior year (after distribution) increased by 2

percent return for year.

» Average of $550,000 notional account value at end of prior year (after

distribution) and $561,000 notional account value at end of current year (before

distribution).

» December 31, 2008 notional account (before distribution) divided by Uniform

Lifetime Table age 79 factor of 19.5.

» One-quarter age 78 rate plus three-quarters age 79 rate.

» Five percent discounted 18 months (1.05∧(−1.5)).

» Blended age 79/age 80 mortality rate (.04946) multiplied by the $363,860 excess

of death benefit over the average notional account value (901,983 less 538,123)

multiplied by .95574 probability of survivorship to the start of 2010 multiplied by

18 month interest discount of .92943.

» Survivorship to start of preceding year (.95574) multiplied by probability of

survivorship during prior year (1–.04946).

(iii) Because Contract S provides that, in the case of a distribution, the value of the

additional death benefit (which is the only additional benefit available under the contract)

is reduced by an amount that is at least proportional to the reduction in the notional

account value and, at age 78 and 9 months, the sum of the notional account value (dollar

amount credited to the employee under the contract) and the actuarial present value of

the additional death benefit is no more than 120 percent of the notional account value,

the exclusion under paragraph (c)(2) of this A–12 is applicable for 2009. Therefore, for

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purposes of applying the rules in §1.401(a)(9)–5, the entire interest under Contract S

may be determined as the notional account value (i.e. without regard to the additional

death benefit).

Example 2. (i) The facts are the same as in (Example 1 except that the notional account

value is $450,000 at the end of 2008.) In this instance, the actuarial present value of the death

benefit in excess of the notional account value in 2008 is determined to be $108,669 (24

percent of the notional account value). The following table summarizes the actuarial

methodology used in determining the actuarial present value of the additional benefit.

(ii) Because the sum of the notional account balance and the actuarial present value of the

additional death benefit is more than 120 percent of the notional account value, the exclusion

under paragraph (b)(1) of this A–12 does not apply for 2009. Therefore, for purposes of

applying the rules in §1.401(a)(9)–5, the entire interest under Contract S must include the

actuarial present value of the additional death benefit.

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Q–13: When can an annuity payment period be changed?

A–13. (a) In general. An annuity payment period may be changed in accordance with the

provisions set forth in paragraph (b) of this A–13 or in association with an annuity payment

increase described in A–14 of this section.

(b) Reannuitization. If, in a stream of annuity payments that otherwise satisfies section

401(a)(9), the annuity payment period is changed and the annuity payments are modified in

association with that change, this modification will not cause the distributions to fail to satisfy

section 401(a)(9) provided the conditions set forth in paragraph (c) of this A–13 are satisfied,

and either—

(1) The modification occurs at the time that the employee retires or in connection with a plan

termination;

(2) The annuity payments prior to modification are annuity payments paid over a period

certain without life contingencies; or

(3) The annuity payments after modification are paid under a qualified Joint and Survivor

annuity over the joint lives of the employee and a designated beneficiary, the

employee's spouse is the sole designated beneficiary, and the modification occurs in

connection with the employee becoming married to such spouse.

(c) Conditions. In order to modify a stream of annuity payments in accordance with paragraph

(b) of this A–13, the following conditions must be satisfied—

(1) The future payments under the modified stream satisfy section 401(a)(9) and this section

(determined by treating the date of the change as a new annuity starting date and the

actuarial present value of the remaining payments prior to modification as the entire

interest of the participant);

(2) For purposes of sections 415 and 417, the modification is treated as a new annuity

starting date;

(3) After taking into account the modification, the annuity stream satisfies section 415

(determined at the original annuity starting date, using the interest rates and mortality

tables applicable to such date); and

(4) The end point of the period certain, if any, for any modified payment period is not later

than the end point available under section 401(a)(9) to the employee at the original

annuity starting date.

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(d) Examples. For the following examples in this A–13, assume that the Applicable Interest

Rate throughout the period from 2005 through 2008 is 5 percent and throughout 2009 is 4

percent, the Applicable Mortality Table throughout the period from 2005 to 2009 is the table

provided in Rev. Rul. 2001–62 (2001–C.B. 632) and the section 415 limit in 2005 at age 70 for

a straight life annuity is $255,344:

Example 1.

(i) A participant (D), who has 10 years of participation in a frozen defined benefit plan (Plan

W), attains age 70 1/2 in 2005. D is not retired and elects to receive distributions from

Plan W in the form of a straight life (i.e. level payment) annuity with annual payments of

$240,000 per year beginning in 2005 at a date when D has an attained age of 70. Plan

W offers non-retired employees in pay status the opportunity to modify their annuity

payments due to an associated change in the payment period at retirement. Plan W

treats the date of the change in payment period as a new annuity starting date for the

purposes of sections 415 and 417. Thus, for example, the plan provides a new qualified

and joint survivor annuity election and obtains spousal consent.

(ii) Plan W determines modifications of annuity payment amounts at retirement such that the

present value of future new annuity payment amounts (taking into account the new

associated payment period) is actuarially equivalent to the present value of future pre-

modification annuity payments (taking into account the pre-modification annuity

payment period). Actuarial equivalency for this purpose is determined using the

Applicable Interest Rate and the Applicable Mortality Table as of the date of

modification.

(iii) D retires in 2009 at the age of 74 and, after receiving four annual payments of $240,000,

elects to receive his remaining distributions from Plan W in the form of an immediate

final lump sum payment (calculated at 4 percent interest) of $2,399,809.

(iv) Because payment of retirement benefits in the form of an immediate final lump sum

payment satisfies (in terms of form) section 401(a)(9), the condition under paragraph

(c)(1) of this A–13 is met.

(v) Because Plan W treats a modification of an annuity payment stream at retirement as a

new annuity starting date for purposes of sections 415 and 417, the condition under

paragraph (c)(2) of this A–13 is met.

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(vi) After taking into account the modification, the annuity stream determined as of the

original annuity starting date consists of annual payments beginning at age 70 of

$240,000, $240,000, $240,000, $240,000, and $2,399,809. This benefit stream is

actuarially equivalent to a straight life annuity at age 70 of $250,182, an amount less

than the section 415 limit determined at the original annuity starting date, using the

interest and mortality rates applicable to such date. Thus, the condition under paragraph

(c)(3) of this A–13 is met.

(vii) Thus, because a stream of annuity payments in the form of a straight life annuity

satisfies section 401(a)(9), and because each of the conditions under paragraph (c) of

this A–13 are satisfied, the modification of annuity payments to D described in this

example meets the requirements of this A–13.

Example 2. The facts are the same as in Example 1 except that the straight life annuity

payments are paid at a rate of $250,000 per year and after D retires the lump sum payment at

age 75 is $2,499,801. Thus, after taking into account the modification, the annuity stream

determined as of the original annuity starting date consists of annual payments beginning at

age 70 of $250,000, $250,000, $250,000, $250,000, and $2,499,801. This benefit stream is

actuarially equivalent to a straight life annuity at age 70 of $260,606, an amount greater than

the section 415 limit determined at the original annuity starting date, using the interest and

mortality rates applicable to such date. Thus, the lump sum payment to D fails to satisfy the

condition under paragraph (c)(3) of this A–13. Therefore, the lump sum payment to D fails to

meet the requirements of this A–13 and thus fails to satisfy the requirements of section

401(a)(9).

Example 3.

(i) A participant (E), who has 10 years of participation in a frozen defined benefit plan (Plan

X), attains age 70 1/2 and retires in 2005 at a date when his attained age is 70. E was

born in 1935. E elects to receive annual distributions from Plan X in the form of a 27

year period certain annuity ( i.e., a 27 year annuity payment period without a life

contingency) paid at a rate of $37,000 per year beginning in 2005 with future payments

increasing at a rate of 4 percent per year ( i.e., the 2006 payment will be $38,480, the

2007 payment will be $40,019 and so on). Plan X offers participants in pay status

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whose annuity payments are in the form of a term-certain annuity the opportunity to

modify their payment period at any time and treats such modifications as a new annuity

starting date for the purposes of sections 415 and 417. Thus, for example, the plan

provides a new qualified and joint survivor annuity election and obtains spousal

consent.

(ii) Plan X determines modifications of annuity payment amounts such that the present value

of future new annuity payment amounts (taking into account the new associated

payment period) is actuarially equivalent to the present value of future pre-modification

annuity payments (taking into account the pre-modification annuity payment period).

Actuarial equivalency for this purpose is determined using 5 percent and the Applicable

Mortality Table as of the date of modification.

(iii) In 2008, E, after receiving annual payments of $37,000, $38,480, and $40,019, elects to

receive his remaining distributions from Plan W in the form of a straight life annuity paid

with annual payments of $92,133 per year.

(iv) Because payment of retirement benefits in the form of a straight life annuity satisfies (in

terms of form) section 401(a)(9), the condition under paragraph (c)(1) of this A–13 is

met.

(v) Because Plan X treats a modification of an annuity payment stream at retirement as a

new annuity starting date for purposes of sections 415 and 417, the condition under

paragraph (c)(2) of this A–13 is met.

(vi) After taking into account the modification, the annuity stream determined as of the

original annuity starting date consists of annual payments beginning at age 70 of

$37,000, $38,480, $40,019, and a straight life annuity beginning at age 73 of $92,133.

This benefit stream is equivalent to a straight life annuity at age 70 of $82,539, an

amount less than the section 415 limit determined at the original annuity starting date,

using the interest and mortality rates applicable to such date. Thus, the condition under

paragraph (c)(3) of this A–13 is met.

(vii) Thus, because a stream of annuity payments in the form of a straight life annuity

satisfies section 401(a)(9), and because each of the conditions under paragraph (c) of

this A–13 are satisfied, the modification of annuity payments to E described in this

example meets the requirements of this A–13.

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Q–14. Are annuity payments permitted to increase?

A–14. (a) General rules. Except as otherwise provided in this section, all annuity payments

(whether paid over an employee's life, joint lives, or a period certain) must be nonincreasing or

increase only in accordance with one or more of the following—

(1) With an annual percentage increase that does not exceed the percentage increase in an

eligible cost-of-living index as defined in paragraph (b) of this A–14 for a 12-month

period ending in the year during which the increase occurs or the prior year;

(2) With a percentage increase that occurs at specified times ( e.g., at specified ages) and

does not exceed the cumulative total of annual percentage increases in an eligible cost-

of-living index as defined in paragraph (b) of this A–14 since the annuity starting date, or

if later, the date of the most recent percentage increase. However, in cases providing

such a cumulative increase, an actuarial increase may not be provided to reflect the fact

that increases were not provided in the interim years;

(3) To the extent of the reduction in the amount of the employee's payments to provide for a

survivor benefit, but only if there is no longer a survivor benefit because the beneficiary

whose life was being used to determine the period described in section 401(a)(9)(A)(ii)

over which payments were being made dies or is no longer the employee's beneficiary

pursuant to a qualified domestic relations order within the meaning of section 414(p);

(4) To pay increased benefits that result from a plan amendment;

(5) To allow a beneficiary to convert the survivor portion of a Joint and Survivor annuity into

a single sum distribution upon the employee's death; or

(6) To the extent increases are permitted in accordance with paragraph (c) or (d) of this A–

14.

(b) (1) For purposes of this A–14, an eligible cost-of-living index means an index described in

paragraphs (b)(2), (b)(3), or (b)(4) of this A–14.

(2) A consumer price index that is based on prices of all items (or all items excluding food

and energy) and issued by the Bureau of Labor Statistics, including an index for a

specific population (such as urban consumers or urban wage earners and clerical

workers) and an index for a geographic area or areas (such as a given metropolitan

area or state).

(3) A percentage adjustment based on a cost-of-living index described in paragraph (b)(2) of

this A–14, or a fixed percentage if less. In any year when the cost-of-living index is

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lower than the fixed percentage, the fixed percentage may be treated as an increase in

an eligible cost-of-living index, provided it does not exceed the sum of:

(i) The cost-of-living index for that year, and

(ii) The accumulated excess of the annual cost-of-living index from each prior year over

the fixed annual percentage used in that year (reduced by any amount previously

utilized under this paragraph (b)(3)(ii)).

(4) A percentage adjustment based on the increase in compensation for the position held by

the employee at the time of retirement, and provided under either the terms of a

governmental plan within the meaning of section 414(d) or under the terms of a

nongovernmental plan as in effect on April 17, 2002.

(c) Additional permitted increases for annuity payments under annuity contracts purchased

from insurance companies. In the case of annuity payments paid from an annuity contract

purchased from an insurance company, if the total future expected payments (determined in

accordance with paragraph (e)(3) of this A–14) exceed the total value being annuitized (within

the meaning of paragraph (e)(1) of this A–14) , the payments under the annuity will not fail to

satisfy the nonincreasing payment requirement in A–1(a) of this section merely because the

payments are increased in accordance with one or more of the following—

(1) By a constant percentage, applied not less frequently than annually;

(2) To provide a final payment upon the death of the employee that does not exceed the

excess of the total value being annuitized (within the meaning of paragraph (e)(1) of this

A–14) over the total of payments before the death of the employee;

(3) As a result of dividend payments or other payments that result from actuarial gains

(within the meaning of paragraph (e)(2) of this A–14), but only if actuarial gain is

measured no less frequently than annually and the resulting dividend payments or other

payments are either paid no later than the year following the year for which the actuarial

experience is measured or paid in the same form as the payment of the annuity over the

remaining period of the annuity (beginning no later than the year following the year for

which the actuarial experience is measured); and

(4) An acceleration of payments under the annuity (within the meaning of paragraph (e)(4)

of this A–14).

(d) Additional permitted increases for annuity payments from a qualified trust. In the case of

annuity payments paid under a defined benefit plan qualified under section 401(a) (other than

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annuity payments under an annuity contract purchased from an insurance company that

satisfy paragraph (c) of this section), the payments under the annuity will not fail to satisfy the

nonincreasing payment requirement in A–1(a) of this section merely because the payments

are increased in accordance with one of the following—

(1) By a constant percentage, applied not less frequently than annually, at a rate that is less

than 5 percent per year;

(2) To provide a final payment upon the death of the employee that does not exceed the

excess of the actuarial present value of the employee's accrued benefit (within the

meaning of section 411(a)(7)) calculated as the annuity starting date using the

applicable interest rate and the applicable mortality table under section 417(e) (or, if

greater, the total amount of employee contributions) over the total of payments before

the death of the employee; or

(3) As a result of dividend payments or other payments that result from actuarial gains

(within the meaning of paragraph (e)(2) of this A–14), but only if—

(i) Actuarial gain is measured no less frequently than annually;

(ii) The resulting dividend payments or other payments are either paid no later than the

year following the year for which the actuarial experience is measured or paid in

the same form as the payment of the annuity over the remaining period of the

annuity (beginning no later than the year following the year for which the actuarial

experience is measured);

(iii) The actuarial gain taken into account is limited to actuarial gain from investment

experience;

(iv) The assumed interest used to calculate such actuarial gains is not less than 3

percent; and

(v) The payments are not increasing by a constant percentage as described in

paragraph (d)(1) of this A–14.

(e) Definitions. For purposes of this A–14, the following definitions apply—

(1) Total value being annuitized means—

(i) In the case of annuity payments under a section 403(a) annuity plan or under a

deferred annuity purchased by a section 401(a) trust, the value of the employee's

entire interest (within the meaning of A–12 of this section) being annuitized

(valued as of the date annuity payments commence);

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(ii) In the case of annuity payments under an immediate annuity contract purchased by

a trust for a defined benefit plan qualified under section 401(a), the amount of the

premium used to purchase the contract; and

(iii) In the case of a defined contribution plan, the value of the employee's account

balance used to purchase an immediate annuity under the contract.

(2) Actuarial gain means the difference between an amount determined using the actuarial

assumptions ( i.e., investment return, mortality, expense, and other similar assumptions)

used to calculate the initial payments before adjustment for any increases and the

amount determined under the actual experience with respect to those factors. Actuarial

gain also includes differences between the amount determined using actuarial

assumptions when an annuity was purchased or commenced and such amount

determined using actuarial assumptions used in calculating payments at the time the

actuarial gain is determined.

(3) Total future expected payments means the total future payments expected to be made

under the annuity contract as of the date of the determination, calculated using the

Single Life Table in A–1 of §1.401(a)(9)–9 (or, if applicable, the Joint and Last Survivor

Table in A–3 of in §1.401(a)(9)–9) for annuitants who are still alive, without regard to

any increases in annuity payments after the date of determination, and taking into

account any remaining period certain.

(4) Acceleration of payments means a shortening of the payment period with respect to an

annuity or a full or partial commutation of the future annuity payments. An increase in

the payment amount will be treated as an acceleration of payments in the annuity only if

the total future expected payments under the annuity (including the amount of any

payment made as a result of the acceleration) is decreased as a result of the change in

payment period.

(f) Examples. Paragraph (c) of this A–14 is illustrated by the following examples:

Example 1. Variable annuity. A retired participant (Z1) in defined contribution plan X attains

age 70 on March 5, 2005, and thus, attains age 70 1/2 in 2005. Z1 elects to purchase annuity

Contract Y1 from Insurance Company W in 2005. Contract Y1 is a single life annuity contract

with a 10-year period certain. Contract Y1 provides for an initial annual payment calculated

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with an assumed interest rate (AIR) of 3 percent. Subsequent payments are determined by

multiplying the prior year's payment by a fraction the numerator of which is 1 plus the actual

return on the separate account assets underlying Contract Y1 since the preceding payment

and the denominator of which is 1 plus the AIR during that period. The value of Z1's account

balance in Plan X at the time of purchase is $105,000, and the purchase price of Contract Y1

is $105,000. Contract Y1 provides Z1 with an initial payment of $7,200 at the time of purchase

in 2005. The total future expected payments to Z1 under Contract Y1 are $122,400, calculated

as the initial payment of $7,200 multiplied by the age 70 life expectancy of 17 provided in the

Single Life Table in A–1 of §1.401(a)(9)–9. Because the total future expected payments on the

purchase date exceed the total value used to purchase Contract Y1 and payments may only

increase as a result of actuarial gain, with such increases, beginning no later than the next

year, paid in the same form as the payment of the annuity over the remaining period of the

annuity, distributions received by Z1 from Contract Y1 meet the requirements under paragraph

(c)(3) of this A–14.

Example 2. Participating annuity. A retired participant (Z2) in defined contribution plan X

attains age 70 on May 1, 2005, and thus, attains age 70 1/2 in 2005. Z2 elects to purchase

annuity Contract Y2 from Insurance Company W in 2005. Contract Y2 is a participating single

life annuity contract with a 10-year period certain. Contract Y2 provides for level annual

payments with dividends paid in a lump sum in the year after the year for which the actuarial

experience is measured or paid out levelly beginning in the year after the year for which the

actuarial gain is measured over the remaining lifetime and period certain, i.e., the period

certain ends at the same time as the original period certain. Dividends are determined annually

by the Board of Directors of Company W based upon a comparison of actual actuarial

experience to expected actuarial experience in the past year. The value of Z2's account

balance in Plan X at the time of purchase is $265,000, and the purchase price of Contract Y2

is $265,000. Contract Y2 provides Z2 with an initial payment of $16,000 in 2005. The total

future expected payments to Z2 under Contract Y2 are calculated as the annual initial payment

of $16,000 multiplied by the age 70 life expectancy of 17 provided in the Single Life Table in

A–1 of §1.401(a)(9)–9 for a total of $272,000. Because the total future expected payments on

the purchase date exceeds the total value used to purchase Contract Y2 and payments may

only increase as a result of actuarial gain, with such increases, beginning no later than the next

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year, paid in the same form as the payment of the annuity over the remaining period of the

annuity, distributions received by Z2 from Contract Y2 meet the requirements under paragraph

(c)(3) of this A–14.

Example 3. Participating annuity with dividend accumulation. The facts are the same as in

Example 2 except that the annuity provides a dividend accumulation option under which Z2

may defer receipt of the dividends to a time selected by Z2. Because the dividend

accumulation option permits dividends to be paid later than the end of the year following the

year for which the actuarial experience is measured or as a stream of payments that only

increase as a result of actuarial gain, with such increases beginning no later than the next

year, paid in the same form as the payment of the annuity over the remaining period of the

annuity in Example 2, the dividend accumulation option does not meet the requirements of

paragraph (c)(3) of this A–14. Neither does the dividend accumulation option fit within any of

the other increases described in paragraph (c) of this A–14. Accordingly, the dividend

accumulation option causes the contract, and consequently any distributions from the contract,

to fail to meet the requirements of this A–14 and thus fail to satisfy the requirements of section

401(a)(9).

Example 4. Participating annuity with dividends used to purchase additional death benefits.

The facts are the same as in Example 2 except that the annuity provides an option under

which actuarial gain under the contract is used to provide additional death benefit protection for

Z2. Because this option permits payments as a result of actuarial gain to be paid later than the

end of the year following the year for which the actuarial experience is measured or as a

stream of payments that only increase as a result of actuarial gain, with such increases

beginning no later than the next year, paid in the same form as the payment of the annuity

over the remaining period of the annuity in Example 2, the option does not meet the

requirements of paragraph (c)(3) of this A–14. Neither does the option fit within any of the

other increases described in paragraph (c) of this A–14. Accordingly, the addition of the option

causes the contract, and consequently any distributions from the contract, to fail to meet the

requirements of this A–14 and thus fail to satisfy the requirements of section 401(a)(9).

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Example 5. Annuity with a fixed percentage increase. A retired participant (Z3) in defined

contribution plan X attains age 70 1/2 in 2005. Z3 elects to purchase annuity contract Y3 from

Insurance Company W. Contract Y3 is a single life annuity contract with a 20-year period

certain (which does not exceed the maximum period certain permitted under A–3(a) of this

section) with fixed annual payments increasing 3 percent each year. The value of Z3's account

balance in Plan X at the time of purchase is $110,000, and the purchase price of Contract Y3

is $110,000. Contract Y3 provides Z3 with an initial payment of $6,000 at the time of purchase

in 2005. The total future expected payments to Z3 under Contract Y3 are $120,000, calculated

as the initial annual payment of $6,000 multiplied by the period certain of 20 years. Because

the total future expected payments on the purchase date exceed the total value used to

purchase Contract Y3 and payments only increase as a constant percentage applied not less

frequently than annually, distributions received by Z3 from Contract Y3 meet the requirements

under paragraph (c)(1) of this A–14.

Example 6. Annuity with excessive increases. The facts are the same as in Example 5 except

that the initial payment is $5,400 and the annual rate of increase is 4 percent. In this example,

the total future expected payments are $108,000, calculated as the initial payment of $5,400

multiplied by the period certain of 20 years. Because the total future expected payments are

less than the total value of $110,000 used to purchase Contract Y3, distributions received by

Z3 do not meet the requirements under paragraph (c) of this A–14 and thus fail to meet the

requirements of section 401(a)(9).

Example 7. Annuity with full commutation feature.

(i) A retired participant (Z4) in defined contribution Plan X attains age 78 in 2005. Z4 elects

to purchase Contract Y4 from Insurance Company W. Contract Y4 provides for a single

life annuity with a 10 year period certain (which does not exceed the maximum period

certain permitted under A–3(a) of this section) with annual payments. Contract Y4

provides that Z4 may cancel Contract Y4 at any time before Z4 attains age 84, and

receive, on his next payment due date, a final payment in an amount determined by

multiplying the initial payment amount by a factor obtained from Table M of Contract Y4

using the Y4's age as of Y4's birthday in the calendar year of the final payment. The

value of Z4's account balance in Plan X at the time of purchase is $450,000, and the

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purchase price of Contract Y4 is $450,000. Contract Y4 provides Z4 with an initial

payment in 2005 of $40,000. The factors in Table M are as follows:

(ii) The total future expected payments to Z4 under ContractY4 are $456,000, calculated as

the initial payment of 40,000 multiplied by the age 78 life expectancy of 11.4 provided in

the Single Life Table in A–1 of §1.401(a)(9)–9. Because the total future expected

payments on the purchase date exceed the total value being annuitized ( i.e., the

$450,000 used to purchase Contract Y4), the permitted increases set forth in paragraph

(c) of this A–14 are available. Furthermore, because the factors in Table M are less than

the life expectancy of each of the ages in the Single Life Table provided in A–1 of

§1.401(a)(9)–9, the final payment is always less than the total future expected

payments. Thus, the final payment is an acceleration of payments within the meaning of

paragraph (c)(4) of this A–14.

(iii) As an illustration of the above, if Participant Z4 were to elect to cancel Contract Y4 on

the day before he was to attain age 84, his contractual final payment would be

$320,000. This amount is determined as $40,000 (the annual payment amount due

under Contract Y4) multiplied by 8.0 (the factor in Table M for the next payment due

date, age 84). The total future expected payments under Contract Y4 at age 84 before

the final payment is $324,000, calculated as the initial payment amount multiplied by

8.1, the age 84 life expectancy provided in the Single Life Table in A–1 of §1.401(a)(9)–

9. Because $320,000 (the total future expected payments under the annuity contract,

including the amount of the final payment) is less than $324,000 (the total future

expected payments under the annuity contract, determined before the election), the final

payment is an acceleration of payments within the meaning of paragraph (c)(4) of this

A–14.

Page 156 of 239

Example 8. Annuity with partial commutation feature

(i) The facts are the same as in Example 7 except that the annuity provides Z4 may request,

at any time before Z4 attains age 84, an ad hoc payment on his next payment due date

with future payments reduced by an amount equal to the ad hoc payment divided by the

factor obtained from Table M (from Example 7) corresponding to Z4's age at the time of

the ad hoc payment. Because, at each age, the factors in Table M are less than the

corresponding life expectancies in the Single Life Table in A–1 of §1.401(a)(9)–9, total

future expected payments under Contract Y4 will decrease after an ad hoc payment.

Thus, ad hoc distributions received by Z4 from Contract Y4 will satisfy the requirements

under paragraph (c)(4) of this A–4.

(ii) As an illustration of paragraph (i) of this Example 8, if Z4 were to request, on the day

before he was to attain age 84, an ad hoc payment of $100,000 on his next payment

due date, his recalculated annual payment amount would be reduced to $27,500. This

amount is determined as $40,000 (the amount of Z4's next annual payment) reduced by

$12,500 (his $100,000 ad hoc payment divided by the Table M factor at age 84 of 8.0).

Thus, Z4's total future expected payments after the ad hoc payment (and including the

ad hoc payment) are equal to $322,750 ($100,000 plus $27,500 multiplied by the Single

Life Table value of 8.1). Note that this $322,750 amount is less than the amount of Z4's

total future expected payments before the ad hoc payment ($324,000, determined as

$40,000 multiplied by 8.1), and the requirements under paragraph (c)(4) of this A–4 are

satisfied.

Example 9. Annuity with excessive increases

(i) A retired participant (Z5) in defined contribution plan X attains age 70 1/2 in 2005. Z5

elects to purchase annuity Contract Y5 from Insurance Company W in 2005 with a

premium of $1,000,000. Contract Y5 is a single life annuity contract with a 20-year

period certain. Contract Y5 provides for an initial payment of $200,000, a second

payment one year from the time of purchase of $40,000, and 18 succeeding annual

payments each increasing at a constant percentage rate of 4.5 percent from the

preceding payment.

(ii) Contract Y5 fails to meet the requirements of section 401(a)(9) because the total future

expected payments without regard to any increases in the annuity payment, calculated

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as $200,000 in year one and $40,000 in each of years two through twenty, is only

$960,000 (i.e., an amount that does not exceed the total value used to purchase the

annuity).

Q–15: Are there special rules applicable to payments made under a defined benefit plan or

annuity contract to a surviving child?

A–15: Yes, pursuant to section 401(a)(9)(F), payments under a defined benefit plan or annuity

contract that are made to an employee's child until such child reaches the age of majority (or

dies, if earlier) may be treated, for purposes of section 401(a)(9), as if such payments were

made to the surviving spouse to the extent they become payable to the surviving spouse upon

cessation of the payments to the child. For purposes of the preceding sentence, a child may be

treated as having not reached the age of majority if the child has not completed a specified

course of education and is under the age of 26. In addition, a child who is disabled within the

meaning of section 72(m)(7) when the child reaches the age of majority may be treated as

having not reached the age of majority so long as the child continues to be disabled. Thus,

when payments described in this paragraph A–15 become payable to the surviving spouse

because the child attains the age of majority, recovers from a disabling illness, dies, or

completes a specified course of education, there is not an increase in benefits under A–1 of

this section. Likewise, the age of child receiving such payments is not taken into consideration

for purposes of the minimum incidental benefit requirement of A–2 of this section.

Q–16: What are the rules for determining required minimum distributions for defined benefit

plans and annuity contracts for calendar years 2003, 2004, and 2005?

A–16: A distribution from a defined benefit plan or annuity contract for calendar years 2003,

2004, and 2005 will not fail to satisfy section 401(a)(9) merely because the payments do not

satisfy A–1 through A–15 of this section, provided the payments satisfy section 401(a)(9)

based on a reasonable and good faith interpretation of the provisions of section 401(a)(9).

Q-17. What is a qualifying longevity annuity contract?

A-17. (a) Definition of qualifying longevity annuity contract. A qualifying longevity annuity

contract (QLAC) is an annuity contract that is purchased from an insurance company for an

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employee and that, in accordance with the rules of application of paragraph (d) of this A-17,

satisfies each of the following requirements—

(1) Premiums for the contract satisfy the requirements of paragraph (b) of this A-17;

(2) The contract provides that distributions under the contract must commence not later than a

specified annuity starting date that is no later than the first day of the month next following the

85th anniversary of the employee's birth;

(3) The contract provides that, after distributions under the contract commence, those

distributions must satisfy the requirements of this section (other than the requirement in A-1(c)

of this section that annuity payments commence on or before the required beginning date);

(4) The contract does not make available any commutation benefit, cash surrender right, or

other similar feature;

(5) No benefits are provided under the contract after the death of the employee other than the

benefits described in paragraph (c) of this A-17;

(6) When the contract is issued, the contract (or a rider or endorsement with respect to that

contract) states that the contract is intended to be a QLAC; and

(7) The contract is not a variable contract under section 817, an indexed contract, or a similar

contract, except to the extent provided by the Commissioner in revenue rulings, notices, or

other guidance published in the Internal Revenue Bulletin and made available by the

Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402 and

on the IRS Web site at http://www.irs.gov.

(b) Limitations on premiums—(1) In general. The premiums paid with respect to the contract

on a date satisfy the requirements of this paragraph (b) if they do not exceed the lesser of the

dollar limitation in paragraph (b)(2) of this A-17 or the percentage limitation in paragraph (b)(3)

of this A-17.

(2) Dollar limitation. The dollar limitation is an amount equal to the excess of—

(i) $125,000 (as adjusted under paragraph (d)(2) of this A-17), over

(ii) The sum of—

(A) The premiums paid before that date with respect to the contract, and

(B) The premiums paid on or before that date with respect to any other contract that is

intended to be a QLAC and that is purchased for the employee under the plan, or any other

plan, annuity, or account described in section 401(a), 403(a), 403(b), or 408 or eligible

governmental plan under section 457(b).

Page 159 of 239

(3) Percentage limitation. The percentage limitation is an amount equal to the excess of—

(i) 25 percent of the employee's account balance under the plan (including the value of any

QLAC held under the plan for the employee) as of that date, determined in accordance with

paragraph (d)(1)(iii) of this A-17, over

(ii) The sum of—

(A) The premiums paid before that date with respect to the contract, and

(B) The premiums paid on or before that date with respect to any other contract that is

intended to be a QLAC and that is held or was purchased for the employee under the plan.

(c) Payments after death of the employee—(1) Surviving spouse is sole beneficiary—(i) Death

on or after annuity starting date. If the employee dies on or after the annuity starting date for

the contract and the employee's surviving spouse is the sole beneficiary under the contract

then, except as provided in paragraph (c)(4) of this A-17, the only benefit permitted to be paid

after the employee's death is a life annuity payable to the surviving spouse where the periodic

annuity payment is not in excess of 100 percent of the periodic annuity payment that is

payable to the employee.

(ii) Death before annuity starting date—(A) Amount of annuity. If the employee dies before the

annuity starting date and the employee's surviving spouse is the sole beneficiary under the

contract then, except as provided in paragraph (c)(4) of this A-17, the only benefit permitted to

be paid after the employee's death is a life annuity payable to the surviving spouse where the

periodic annuity payment is not in excess of 100 percent of the periodic annuity payment that

would have been payable to the employee as of the date that benefits to the surviving spouse

commence. However, the annuity is permitted to exceed 100 percent of the periodic annuity

payment that would have been payable to the employee to the extent necessary to satisfy the

requirement to provide a qualified preretirement survivor annuity (as defined under section

417(c)(2) or ERISA section 205(e)(2)) pursuant to section 401(a)(11)(A)(ii) or ERISA section

205(a)(2).

(B) Commencement date for annuity. Any life annuity payable to the surviving spouse under

paragraph (c)(1)(ii)(A) of this A-17 must commence no later than the date on which the annuity

payable to the employee would have commenced under the contract if the employee had not

died.

(2) Surviving spouse is not sole beneficiary—(i) Death on or after annuity starting date. If the

employee dies on or after the annuity starting date for the contract and the employee's

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surviving spouse is not the sole beneficiary under the contract then, except as provided in

paragraph (c)(4) of this A-17, the only benefit permitted to be paid after the employee's death

is a life annuity payable to the designated beneficiary where the periodic annuity payment is

not in excess of the applicable percentage (determined under paragraph (c)(2)(iii) of this A-17)

of the periodic annuity payment that is payable to the employee.

(ii) Death before annuity starting date—(A) Amount of annuity. If the employee dies before the

annuity starting date and the employee's surviving spouse is not the sole beneficiary under the

contract then, except as provided in paragraph (c)(4) of this A-17, the only benefit permitted to

be paid after the employee's death is a life annuity payable to the designated beneficiary

where the periodic annuity payment is not in excess of the applicable percentage (determined

under paragraph (c)(2)(iii) of this A-17) of the periodic annuity payment that would have been

payable to the employee as of the date that benefits to the designated beneficiary commence

under this paragraph (c)(2)(ii).

(B) Commencement date for annuity. In any case in which the employee dies before the

annuity starting date, any life annuity payable to a designated beneficiary under this paragraph

(c)(2)(ii) must commence by the last day of the calendar year immediately following the

calendar year of the employee's death.

(iii) Applicable percentage—(A) Contracts without pre-annuity starting date death benefits. If,

as described in paragraph (c)(2)(iv) of this A-17, the contract does not provide for a pre-annuity

starting date non-spousal death benefit, the applicable percentage is the percentage described

in the table in A-2(c) of this section.

(B) Contracts with set beneficiary designation. If the contract provides for a set non-spousal

beneficiary designation as described in paragraph (c)(2)(v) (and is not a contract described in

paragraph (c)(2)(iv)) of this A-17, the applicable percentage is the percentage described in the

table set forth in paragraph (c)(2)(iii)(D) of this A-17. A contract is still considered to provide for

a set beneficiary designation even if the surviving spouse becomes the sole beneficiary before

the annuity starting date. In such a case, the requirements of paragraph (c)(1) of this A-17

apply and not the requirements of this paragraph (c)(2).

(C) Contracts providing for return of premium. If the contract provides for a return of premium

as described in paragraph (c)(4) of this A-17, the applicable percentage is 0.

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(D) Applicable percentage table. The applicable percentage is based on the adjusted

employee/beneficiary age difference, determined in the same manner as in A-2(c) of this

section.

Adjusted employee/beneficiary age difference Applicable percentage

2 years or less 100

3 88

4 78

5 70

6 63

7 57

8 52

9 48

10 44

11 41

12 38

13 36

14 34

15 32

16 30

17 28

18 27

19 26

20 25

21 24

22 23

23 22

24 21

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25 and greater 20

(iv) No pre-annuity starting date non-spousal death benefit. A contract is described in this

paragraph (c)(2)(iv) if the contract provides that no benefit is permitted to be paid to a

beneficiary other than the employee's surviving spouse after the employee's death—

(A) In any case in which the employee dies before the annuity starting date under the contract;

and

(B) In any case in which the employee selects an annuity starting date that is earlier than the

specified annuity starting date under the contract and the employee dies less than 90 days

after making that election.

(v) Contracts permitting set non-spousal beneficiary designation. A contract is described in this

paragraph (c)(2)(v) if the contract provides that if the beneficiary under the contract is not the

employee's surviving spouse, benefits are payable to the beneficiary only if the beneficiary was

irrevocably designated on or before the later of the date of purchase or the employee's

required beginning date.

(3) Calculation of early annuity payments. For purposes of paragraphs (c)(1)(ii) and (c)(2)(ii) of

this A-17, to the extent the contract does not provide an option for the employee to select an

annuity starting date that is earlier than the date on which the annuity payable to the employee

would have commenced under the contract if the employee had not died, the contract must

provide a way to determine the periodic annuity payment that would have been payable if the

employee were to have an option to accelerate the payments and the payments had

commenced to the employee immediately prior to the date that benefit payments to the

surviving spouse or designated beneficiary commence.

(4) Return of premiums—(i) In general. In lieu of a life annuity payable to a designated

beneficiary under paragraph (c)(1) or (2) of this A-17, a QLAC is permitted to provide for a

benefit to be paid to a beneficiary after the death of the employee in an amount equal to the

excess of—

(A) The premium payments made with respect to the QLAC over

(B) The payments already made under the QLAC.

(ii) Payments after death of surviving spouse. If a QLAC is providing a life annuity to a

surviving spouse (or will provide a life annuity to a surviving spouse) under paragraph (c)(1) of

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this A-17, it is also permitted to provide for a benefit paid to a beneficiary after the death of

both the employee and the spouse in an amount equal to the excess of—

(A) The premium payments made with respect to the QLAC over

(B) The payments already made under the QLAC.

(iii) Other rules—(A) Timing of return of premium payment following death of employee. A

return of premium payment under this paragraph (c)(4) must be paid no later than the end of

the calendar year following the calendar year in which the employee dies. If the employee's

death is after the required beginning date, the return of premium payment is treated as a

required minimum distribution for the year in which it is paid and is not eligible for rollover.

(B) Timing of return of premium payment following death of surviving spouse receiving life

annuity. If the return of premium payment is paid after the death of a surviving spouse who is

receiving a life annuity (or after the death of a surviving spouse who has not yet commenced

receiving a life annuity after the death of the employee), the return of premium payment under

this paragraph (c)(4) must be made no later than the end of the calendar year following the

calendar year in which the surviving spouse dies. If the surviving spouse's death is after the

required beginning date for the surviving spouse, then the return of premium payment is

treated as a required minimum distribution for the year in which it is paid and is not eligible for

rollover.

(5) Multiple beneficiaries. If an employee has more than one designated beneficiary under

a QLAC, the rules in A-2(a) of §1.401(a)(9)-8 apply for purposes of paragraphs (c)(1) and

(c)(2) of this A-17.

(d) Rules of application—(1) Rules relating to premiums—(i) Reliance on representations.

For purposes of the limitation on premiums described in paragraphs (b)(2) and (3) of this A-17,

unless the plan administrator has actual knowledge to the contrary, the plan administrator may

rely on an employee's representation (made in writing or such other form as may be prescribed

by the Commissioner) of the amount of the premiums described in paragraphs (b)(2)(ii)(B) and

(b)(3)(ii)(B) of this A-17, but only with respect to premiums that are not paid under a plan,

annuity, or contract that is maintained by the employer or an entity that is treated as a single

employer with the employer under section 414(b), (c), (m), or (o).

(ii) Consequences of excess premiums—(A) General Rule. If an annuity contract fails to

be a QLAC solely because a premium for the contract exceeds the limits under paragraph (b)

of this A-17, then the contract is not a QLAC beginning on the date that premium payment is

Page 164 of 239

made unless the excess premium is returned to the non-QLAC portion of the employee's

account in accordance with paragraph (d)(1)(ii)(B) of this A-17. If the contract fails to be a

QLAC, then the value of the contract may not be disregarded under A-3(d) of §1.401(a)(9)-5 as

of the date on which the contract ceases to be a QLAC.

(B) Correction in year following year of excess. If the excess premium is returned (either in

cash or in the form of a contract that is not intended to be a QLAC) to the non-QLAC portion of

the employee's account by the end of the calendar year following the calendar year in which

the excess premium was originally paid, then the contract will not be treated as exceeding the

limits under paragraph (b) of this A-17 at any time, and the value of the contract will not be

included in the employee's account balance under A-3(d) of §1.401(a)(9)-5. If the excess

premium (including the fair market value of an annuity contract that is not intended to be a

QLAC, if applicable) is returned to the non-QLAC portion of the employee's account after the

last valuation date for the calendar year in which the excess premium was originally paid, then

the employee's account balance for that calendar year must be increased to reflect that excess

premium in the same manner as an employee's account balance is increased under A-2 of

§1.401(a)(9)-7 to reflect a rollover received after the last valuation date.

(C) Return of excess premium not a commutation benefit. If the excess premium is

returned to the non-QLAC portion of the employee's account as described in paragraph

(d)(1)(ii)(B) of this A-17, it will not be treated as a violation of the requirement in paragraph

(a)(4) of this A-17 that the contract not provide a commutation benefit.

(iii) Application of 25-percent limit. For purposes of the 25-percent limit under paragraph

(b)(3) of this A-17, an employee's account balance on the date on which premiums for a

contract are paid is the account balance as of the last valuation date preceding the date of the

premium payment, adjusted as follows. The account balance is increased for contributions

allocated to the account during the period that begins after the valuation date and ends before

the date the premium is paid and decreased for distributions made from the account during

that period.

(2) Dollar and age limitations subject to adjustments—(i) Dollar limitation. In the case of

calendar years beginning on or after January 1, 2015, the $125,000 amount under paragraph

(b)(2)(i) of this A-17 will be adjusted at the same time and in the same manner as the limits are

adjusted under section 415(d), except that the base period shall be the calendar quarter

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beginning July 1, 2013, and any increase under this paragraph (d)(2)(i) that is not a multiple of

$10,000 will be rounded to the next lowest multiple of $10,000.

(ii) Age limitation. The maximum age set forth in paragraph (a)(2) of this A-17 may be

adjusted to reflect changes in mortality, with any such adjusted age to be prescribed by the

Commissioner in revenue rulings, notices, or other guidance published in the Internal Revenue

Bulletin and made available by the Superintendent of Documents, U.S. Government Printing

Office, Washington, DC 20402 and on the IRS Web site at http://www.irs.gov.

(iii) Prospective application of adjustments. If a contract fails to be a QLAC because it

does not satisfy the dollar limitation in paragraph (b)(2) of this A-17 or the age limitation in

paragraph (a)(2) of this A-17, any subsequent adjustment that is made pursuant to paragraph

(d)(2)(i) or paragraph (d)(2)(ii) of this A-17 will not cause the contract to become a QLAC.

(3) Determination of whether contract is intended to be a QLAC—(i) Structural deficiency.

If a contract fails to be a QLAC at any time for a reason other than an excess premium

described in paragraph (d)(1)(ii) of this A-17, then as of the date of purchase the contract will

not be treated as a QLAC (for purposes of A-3(d) of §1.401(a)(9)-5) or as a contract that is

intended to be a QLAC (for purposes of paragraph (b) of this A-17).

(ii) Roth IRAs. A contract that is purchased under a Roth IRA is not treated as a contract

that is intended to be a QLAC for purposes of applying the dollar and percentage limitation

rules in paragraphs (b)(2)(ii)(B) and (b)(3)(ii)(B) of this A-17. See A-14(d) of §1.408A-6. If a

QLAC is purchased or held under a plan, annuity, account, or traditional IRA, and that contract

is later rolled over or converted to a Roth IRA, the contract is not treated as a contract that is

intended to be a QLAC after the date of the rollover or conversion. Thus, premiums paid with

respect to the contract will not be taken into account under paragraph (b)(2)(ii)(B) or paragraph

(b)(3)(ii)(B) of this A-17 after the date of the rollover or conversion.

(4) Certain contracts not treated as similar contracts—(i) Participating annuity contract. An

annuity contract is not treated as a contract described in paragraph (a)(7) of this A-17 merely

because it provides for the payment of dividends described in A-14(c)(3) of §1.401(a)(9)-6.

(ii) Contracts with cost-of-living adjustments. An annuity contract is not treated as a

contract described in paragraph (a)(7) of this A-17 merely because it provides for a cost-of-

living adjustment as described in A-14(b) of §1.401(a)(9)-6.

(5) Group annuity contract certificates. The requirement under paragraph (a)(6) of this A-

17 that the contract state that it is intended to be a QLAC when issued is satisfied if a

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certificate is issued under a group annuity contract and the certificate, when issued, states that

the employee's interest under the group annuity contract is intended to be a QLAC.

(e) Effective/applicability date—(1) General applicability date. This A-17 and §1.403(b)-

6(e)(9) apply to contracts purchased on or after July 2, 2014 If on or after July 2, 2014 an

existing contract is exchanged for a contract that satisfies the requirements of this A-17, the

new contract will be treated as purchased on the date of the exchange and the fair market

value of the contract that is exchanged for a QLAC will be treated as a premium paid with

respect to the QLAC.

(2) Delayed applicability date for requirement that contract state that it is intended to be

QLAC. An annuity contract purchased before January 1, 2016, will not fail to be a QLAC

merely because the contract does not satisfy the requirement of paragraph (a)(6) of this A-17,

provided that—

(i) When the contract (or a certificate under a group annuity contract) is issued, the

employee is notified that the annuity contract is intended to be a QLAC; and

(ii) The contract is amended (or a rider, endorsement or amendment to the certificate is

issued) no later than December 31, 2016, to state that the annuity contract is intended to be a

QLAC.

[T.D. 9130, 69 FR 33293, June 15, 2004; 69 FR 68077, Nov. 23, 2004; T.D. 9459, 74 FR

45994, Sept. 8, 2009; T.D. 9673, 79 FR 37639, July 2, 2014; 79 FR 45683, Aug. 6, 2014]

§1.401(a)(9)-7 Rollovers and Transfers

Q–1. If an amount is distributed by one plan (distributing plan) and is rolled over to another

plan, is the required minimum distribution under the distributing plan affected by the rollover?

A–1. No, if an amount is distributed by one plan and is rolled over to another plan, the amount

distributed is still treated as a distribution by the distributing plan for purposes of section

401(a)(9), notwithstanding the rollover. See A–1 of §1.402(c)–2 for the definition of a rollover

and A–7 of §1.402(c)–2 for rules for determining the portion of any distribution that is not

eligible for rollover because it is a required minimum distribution.

Page 167 of 239

Q–2. If an amount is distributed by one plan (distributing plan) and is rolled over to another

plan (receiving plan), how are the benefit and the required minimum distribution under the

receiving plan affected?

A–2. If an amount is distributed by one plan (distributing plan) and is rolled over to another

plan (receiving plan), the benefit of the employee under the receiving plan is increased by the

amount rolled over for purposes of determining the required minimum distribution for the

calendar year immediately following the calendar year in which the amount rolled over is

distributed. If the amount rolled over is received after the last valuation date in the calendar

year under the receiving plan, the benefit of the employee as of such valuation date, adjusted

in accordance with A–3 of §1.401(a)(9)–5, will be increased by the rollover amount valued as

of the date of receipt. In addition, if the amount rolled over is received in a different calendar

year from the calendar year in which it is distributed, the amount rolled over is deemed to have

been received by the receiving plan in the calendar year in which it was distributed.

Q–3. In the case of a transfer of an amount of an employee's benefit from one plan (transferor

plan) to another plan (transferee plan), are there any special rules for satisfying section

401(a)(9) or determining the employee's benefit under the transferor plan?

A–3. (a) In the case of a transfer of an amount of an employee's benefit from one plan

(transferor plan) to another (transferee plan), the transfer is not treated as a distribution by the

transferor plan for purposes of section 401(a)(9). Instead, the benefit of the employee under

the transferor plan is decreased by the amount transferred. However, if any portion of an

employee's benefit is transferred in a distribution calendar year with respect to that employee,

in order to satisfy section 401(a)(9), the transferor plan must determine the amount of the

required minimum distribution with respect to that employee for the calendar year of the

transfer using the employee's benefit under the transferor plan before the transfer. Additionally,

if any portion of an employee's benefit is transferred in the employee's second distribution

calendar year but on or before the employee's required beginning date, in order to satisfy

section 401(a)(9), the transferor plan must determine the amount of the minimum distribution

requirement for the employee's first distribution calendar year based on the employee's benefit

under the transferor plan before the transfer. The transferor plan may satisfy the minimum

distribution requirement for the calendar year of the transfer (and the prior year if applicable)

by segregating the amount which must be distributed from the employee's benefit and not

Page 168 of 239

transferring that amount. Such amount may be retained by the transferor plan and must be

distributed on or before the date required under section 401(a)(9).

(b) For purposes of determining any required minimum distribution for the calendar year

immediately following the calendar year in which the transfer occurs, in the case of a transfer

after the last valuation date for the calendar year of the transfer under the transferor plan, the

benefit of the employee as of such valuation date, adjusted in accordance with A–3 of

§1.401(a)(9)–5, will be decreased by the amount transferred, valued as of the date of the

transfer.

Q–4. If an amount of an employee's benefit is transferred from one plan (transferor plan) to

another plan (transferee plan), how are the benefit and the required minimum distribution

under the transferee plan affected?

A–4. In the case of a transfer from one plan (transferor plan) to another (transferee plan), the

benefit of the employee under the transferee plan is increased by the amount transferred in the

same manner as if it were a plan receiving a rollover contribution under A–2 of this section.

Q–5. How is a spinoff, merger or consolidation (as defined in §1.414(l)–1) treated for purposes

of determining an employee's benefit and required minimum distribution under section

401(a)(9)?

A–5. For purposes of determining an employee's benefit and required minimum distribution

under section 401(a)(9), a spinoff, a merger, or a consolidation (as defined in §1.414(l)–1) will

be treated as a transfer of the benefits of the employees involved. Consequently, the benefit

and required minimum distribution of each employee involved under the transferor and

transferee plans will be determined in accordance with A–3 and A–4 of this section.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002]

§1.401(a)(9)-8 Special Rules

Q–1. What distribution rules apply if an employee is a participant in more than one plan?

A–1. If an employee is a participant in more than one plan, the plans in which the employee

participates are not permitted to be aggregated for purposes of testing whether the distribution

requirements of section 401(a)(9) are met. The distribution of the benefit of the employee

Page 169 of 239

under each plan must separately meet the requirements of section 401(a)(9). For this purpose,

a plan described in section 414(k) is treated as two separate plans, a defined contribution plan

to the extent benefits are based on an individual account and a defined benefit plan with

respect to the remaining benefits.

Q–2. If an employee's benefit under a defined contribution plan is divided into separate

accounts (or under a defined benefit plan is divided into segregated shares), do the distribution

rules in section 401(a)(9) and these regulations apply separately to each separate account?

A–2. (a) Defined contribution plan.

(1) Except as otherwise provided in this A–2, if an employee's benefit under a defined

contribution plan is divided into separate accounts under the plan, the separate

accounts will be aggregated for purposes of satisfying the rules in section 401(a)(9).

Thus, except as otherwise provided in this A–2, all separate accounts, including a

separate account for employee contributions under section 72(d)(2), will be aggregated

for purposes of section 401(a)(9).

(2) If the employee's benefit in a defined contribution plan is divided into separate accounts

and the beneficiaries with respect to one separate account differ from the beneficiaries

with respect to the other separate accounts of the employee under the plan, for years

subsequent to the calendar year containing the date as of which the separate accounts

were established, or date of death if later, such separate account under the plan is not

aggregated with the other separate accounts under the plan in order to determine

whether the distributions from such separate account under the plan satisfy section

401(a)(9). Instead, the rules in section 401(a)(9) separately apply to such separate

account under the plan. However, the applicable distribution period for each such

separate account is determined disregarding the other beneficiaries of the employee's

benefit only if the separate account is established on a date no later than the last day of

the year following the calendar year of the employee's death. For example, if, in the

case of a distribution described in section 401(a)(9)(B)(iii) and (iv), the only beneficiary

of a separate account under the plan established on a date no later than the end of the

year following the calendar year of the employee's death is the employee's surviving

spouse, and beneficiaries other than the surviving spouse are designated with respect

to the other separate accounts with respect to the employee, distribution of the spouse's

Page 170 of 239

separate account under the plan need not commence until the date determined under

the first sentence in A–3(b) of §1.401(a)(9)–3, even if distribution of the other separate

accounts under the plan must commence at an earlier date. Similarly, in the case of a

distribution after the death of an employee to which section 401(a)(9)(B)(i) does not

apply, distribution from a separate account of an employee established on a date no

later than the end of the year following the year of the employee's death may be made

over a beneficiary's life expectancy in accordance with section 401(a)(9)(B)(iii) and (iv)

even though distributions from other separate accounts under the plan with different

beneficiaries are being made in accordance with the 5-year rule in section

401(a)(9)(B)(ii).

(3) A portion of an employee's account balance under a defined contribution plan is

permitted to be used to purchase an annuity contract while another portion stays in the

account. In that case, the remaining account under the plan must be distributed in

accordance with §1.401(a)(9)–5 in order to satisfy section 401(a)(9) and the annuity

payments under the annuity contract must satisfy §1.401(a)(9)–6 in order to satisfy

section 401(a)(9).

(b) Defined benefit plan. The rules of paragraph (a)(2) and (3) of this A–2 also apply to

benefits under a defined benefit plan where the benefits under the plan are separated

into separate identifiable components which are separately distributed.

Q–3. What are separate accounts for purposes of section 401(a)(9)?

A–3. For purposes of section 401(a)(9), separate accounts in an employee's account are

separate portions of an employee's benefit reflecting the separate interests of the employee's

beneficiaries under the plan as of the date of the employee's death for which separate

accounting is maintained. The separate accounting must allocate all post-death investment

gains and losses, contributions, and forfeitures, for the period prior to the establishment of the

separate accounts on a pro rata basis in a reasonable and consistent manner among the

separate accounts. However, once the separate accounts are actually established, the

separate accounting can provide for separate investments for each separate account under

which gains and losses from the investment of the account are only allocated to that account,

or investment gain or losses can continue to be allocated among the separate accounts on a

Page 171 of 239

pro rata basis. A separate accounting must allocate any post-death distribution to the separate

account of the beneficiary receiving that distribution.

Q–4. If a distribution is required to be made to an employee by section 401(a)(9)(A) or is

required to be made to a surviving spouse under section 401(a)(9)(B), must the distribution be

made even if the employee, or spouse where applicable, fails to consent to a distribution while

a benefit is immediately distributable?

A–4. Yes, section 411(a)(11) and section 417(e) (see §§1.411(a)(11)–1(c)(2) and 1.417(e)–

1(c)) require employee and spousal consent to certain distributions of plan benefits while such

benefits are immediately distributable. If an employee's normal retirement age is later than the

employee's required beginning date and, therefore, benefits are still immediately distributable,

the plan must, nevertheless, distribute plan benefits to the employee (or where applicable, to

the spouse) in a manner that satisfies the requirements of section 401(a)(9). Section 401(a)(9)

must be satisfied even though the employee (or spouse, where applicable) fails to consent to

the distribution. In such a case, the plan may distribute in the form of a qualified Joint and

Survivor annuity (QJSA) or in the form of a qualified preretirement survivor annuity (QPSA), as

applicable, and the consent requirements of sections 411(a)(11) and 417(e) are deemed to be

satisfied if the plan has made reasonable efforts to obtain consent from the employee (or

spouse if applicable) and if the distribution otherwise meets the requirements of section 417. If,

because of section 401(a)(11)(B), the plan is not required to distribute in the form of a QJSA to

an employee or a QPSA to a surviving spouse, the plan may distribute the required minimum

distribution amount to satisfy section 401(a)(9) and the consent requirements of sections

411(a)(11) and 417(e) are deemed to be satisfied if the plan has made reasonable efforts to

obtain consent from the employee (or spouse if applicable) and if the distribution otherwise

meets the requirements of section 417.

Q–5. Who is an employee's spouse or surviving spouse for purposes of section 401(a)(9)?

A–5. Except as otherwise provided in A–6(a) of this section (in the case of distributions of a

portion of an employee's benefit payable to a former spouse of an employee pursuant to a

qualified domestic relations order), for purposes of section 401(a)(9), an individual is a spouse

or surviving spouse of an employee if such individual is treated as the employee's spouse

under applicable state law. In the case of distributions after the death of an employee, for

Page 172 of 239

purposes of determining whether, under the life expectancy rule in section 401(a)(9)(B)(iii) and

(iv), the provisions of section 401(a)(9)(B)(iv) apply, the spouse of the employee is determined

as of the date of death of the employee.

Q–6. In order to satisfy section 401(a)(9), are there any special rules which apply to the

distribution of all or a portion of an employee's benefit payable to an alternate payee pursuant

to a qualified domestic relations order as defined in section 414(p) (QDRO)?

A–6. (a) A former spouse to whom all or a portion of the employee's benefit is payable

pursuant to a QDRO will be treated as a spouse (including a surviving spouse) of the

employee for purposes of section 401(a)(9), including the minimum distribution incidental

benefit requirement, regardless of whether the QDRO specifically provides that the former

spouse is treated as the spouse for purposes of sections 401(a)(11) and 417.

(b)(1) If a QDRO provides that an employee's benefit is to be divided and a portion is to be

allocated to an alternate payee, such portion will be treated as a separate account (or

segregated share) which separately must satisfy the requirements of section 401(a)(9)

and may not be aggregated with other separate accounts (or segregated shares) of the

employee for purposes of satisfying section 401(a)(9). Except as otherwise provided in

paragraph (b)(2) of this A–6, distribution of such separate account allocated to an

alternate payee pursuant to a QDRO must be made in accordance with section

401(a)(9). For example, in general, distribution of such account will satisfy section

401(a)(9)(A) if required minimum distributions from such account during the employee's

lifetime begin not later than the employee's required beginning date and the required

minimum distribution is determined in accordance with §1.401(a)(9)–5 for each

distribution calendar year (using an applicable distribution period determined under A–4

of §1.401(a)(9)–5 for the employee in the distribution calendar year either using the

Uniform Lifetime Table in A–2 of §1.401(a)(9)–9 or using the joint life expectancy of the

employee and a spousal alternate payee in the distribution calendar year if the spousal

alternate payee is more than 10 years younger than the employee). The determination

of whether distribution from such account after the death of the employee to the

alternate payee will be made in accordance with section 401(a)(9)(B)(i) or section

401(a)(9)(B)(ii) or (iii) and (iv) will depend on whether distributions have begun as

determined under A–6 of §1.401(a)(9)–2 (which provides, in general, that distributions

Page 173 of 239

are not treated as having begun until the employee's required beginning date even

though payments may actually have begun before that date). For example, if the

alternate payee dies before the employee and distribution of the separate account

allocated to the alternate payee pursuant to the QDRO is to be made to the alternate

payee's beneficiary, such beneficiary may be treated as a designated beneficiary for

purposes of determining the minimum distribution required from such account after the

death of the employee if the beneficiary of the alternate payee is an individual and if

such beneficiary is a beneficiary under the plan or specified to or in the plan.

Specification in or pursuant to the QDRO is treated as specification to the plan.

(2) Distribution of the separate account allocated to an alternate payee pursuant to a QDRO

will satisfy the requirements of section 401(a)(9)(A)(ii) if such account is to be

distributed, beginning not later than the employee's required beginning date, over the

life of the alternate payee (or over a period not extending beyond the life expectancy of

the alternate payee). Also, if the plan permits the employee to elect whether distribution

upon the death of the employee will be made in accordance with the 5-year rule in

section 401(a)(9)(B)(ii) or the life expectancy rule in section 401(a)(9)(B)(iii) and (iv)

pursuant to A–4(c) of §1.401(a)(9)–3, such election is to be made only by the alternate

payee for purposes of distributing the separate account allocated to the alternate payee

pursuant to the QDRO. If the alternate payee dies after distribution of the separate

account allocated to the alternate payee pursuant to a QDRO has begun (determined

under A–6 of §1.401(a)(9)–2) but before the employee dies, distribution of the remaining

portion of that portion of the benefit allocated to the alternate payee must be made in

accordance with the rules in §1.401(a)(9)–5 or 1.401(a)(9)–6 for distributions during the

life of the employee. Only after the death of the employee is the amount of the required

minimum distribution determined in accordance with the rules of section 401(a)(9)(B).

(c) If a QDRO does not provide that an employee's benefit is to be divided but provides that

a portion of an employee's benefit (otherwise payable to the employee) is to be paid to

an alternate payee, such portion will not be treated as a separate account (or

segregated share) of the employee. Instead, such portion will be aggregated with any

amount distributed to the employee and will be treated as having been distributed to the

employee for purposes of determining whether section 401(a)(9) has been satisfied with

respect to that employee.

Page 174 of 239

Q–7. Will a plan fail to satisfy section 401(a)(9) merely because it fails to distribute an amount

otherwise required to be distributed by section 401(a)(9) during the period in which the issue of

whether a domestic relations order is a QDRO is being determined?

A–7. A plan will not fail to satisfy section 401(a)(9) merely because it fails to distribute an

amount otherwise required to be distributed by section 401(a)(9) during the period in which the

issue of whether a domestic relations order is a QDRO is being determined pursuant to section

414(p)(7), provided that the period does not extend beyond the 18-month period described in

section 414(p)(7)(E). To the extent that a distribution otherwise required under section

401(a)(9) is not made during this period, any segregated amounts, as defined in section

414(p)(7)(A), will be treated as though the amounts are not vested during the period and any

distributions with respect to such amounts must be made under the relevant rules for

nonvested benefits described in either A–8 of §1.401(a)(9)–5 or A–6 of §1.401(a)(9)–6, as

applicable.

Q–8. Will a plan fail to satisfy section 401(a)(9) where an individual's distribution from the plan

is less than the amount otherwise required to satisfy section 401(a)(9) because distributions

were being paid under an annuity contract issued by a life insurance company in state insurer

delinquency proceedings and have been reduced or suspended by reasons of such state

proceedings?

A–8. A plan will not fail to satisfy section 401(a)(9) merely because an individual's distribution

from the plan is less than the amount otherwise required to satisfy section 401(a)(9) because

distributions were being paid under an annuity contract issued by a life insurance company in

state insurer delinquency proceedings and have been reduced or suspended by reasons of

such state proceedings. To the extent that a distribution otherwise required under section

401(a)(9) is not made during the state insurer delinquency proceedings, this amount and any

additional amount accrued during this period will be treated as though such amounts are not

vested during the period and any distributions with respect to such amounts must be made

under the relevant rules for nonvested benefits described in either A–8 of §1.401(a)(9)–5 or A–

6 of §1.401(a)(9)–6, as applicable.

Page 175 of 239

Q–9. Will a plan fail to qualify as a pension plan within the meaning of section 401(a) solely

because the plan permits distributions to commence to an employee on or after April 1 of the

calendar year following the calendar year in which the employee attains age 70 ½ even though

the employee has not retired or attained the normal retirement age under the plan as of the

date on which such distributions commence?

A–9. No, a plan will not fail to qualify as a pension plan within the meaning of section 401(a)

solely because the plan permits distributions to commence to an employee on or after April 1

of the calendar year following the calendar year in which the employee attains age 70 1/2 even

though the employee has not retired or attained the normal retirement age under the plan as of

the date on which such distributions commence. This rule applies without regard to whether

the employee is a 5-percent owner with respect to the plan year ending in the calendar year in

which distributions commence.

Q–10. Is the distribution of an annuity contract a distribution for purposes of section 401(a)(9)?

A–10. No, the distribution of an annuity contract is not a distribution for purposes of section

401(a)(9).

Q–11. Will a payment by a plan after the death of an employee fail to be treated as a

distribution for purposes of section 401(a)(9) solely because it is made to an estate or a trust?

A–11. A payment by a plan after the death of an employee will not fail to be treated as a

distribution for purposes of section 401(a)(9) solely because it is made to an estate or a trust.

As a result, the estate or trust which receives a payment from a plan after the death of an

employee need not distribute the amount of such payment to the beneficiaries of the estate or

trust in accordance with section 401(a)(9)(B). Pursuant to A–3 of §1.401(a)(9)–4, an estate

may not be a designated beneficiary. Thus, pursuant to A–4 of §1.401(a)(9)–3, distribution to

the estate must satisfy the 5-year rule in section 401(a)(9)(B)(iii) if the distribution to the

employee had not begun (as defined in A–6 of §1.401(a)(9)–2) as of the employee's date of

death. However, see A–5 and A–6 of §1.401(a)(9)–4 for provisions under which beneficiaries

of a trust with respect to the trust's interest in an employee's benefit are treated as having been

designated as beneficiaries of the employee under the plan.

Page 176 of 239

Q–12. Will a plan fail to satisfy section 411(d)(6) if the plan is amended to eliminate the

availability of an optional form of benefit to the extent that the optional form does not satisfy

section 401(a)(9)?

A–12. No, pursuant to section 411(d)(6)(B), a plan will not fail to satisfy section 411(d)(6)

merely because the plan is amended to eliminate the availability of an optional form of benefit

to the extent that the optional form does not satisfy section 401(a)(9). (See also A–3 of

§1.401(a)(9)–1, which requires a plan to provide that, notwithstanding any other plan provision,

it will not distribute benefits under any option that does not satisfy section 401(a)(9).)

Q–13. Is a plan disqualified merely because it pays benefits under a designation made before

January 1, 1984, in accordance with section 242(b)(2) of the Tax Equity and Fiscal

Responsibility Act (TEFRA)?

A–13. No, even though the distribution requirements added by TEFRA were retroactively

repealed by the Tax Reform Act of 1984 (TRA of 1984), the transitional election rule in section

242(b) of TEFRA was preserved. Satisfaction of the spousal consent requirements of section

417(a) and (e) (added by the Retirement Equity Act of 1984) will not be considered a

revocation of the pre-1984 designation. However, sections 401(a)(11) and 417 must be

satisfied with respect to any distribution subject to those sections. The election provided in

section 242(b) of TEFRA is hereafter referred to as a section 242(b)(2) election.

Q–14. If an amount is transferred from one plan (transferor plan) to another plan (transferee

plan), may the transferee plan distribute the amount transferred in accordance with a section

242(b)(2) election made under either the transferor plan or under the transferee plan?

A–14.

(a) If an amount is transferred from one plan (transferor plan) to another plan (transferee

plan), the amount transferred may be distributed in accordance with a section 242(b)(2)

election made under the transferor plan if the employee did not elect to have the

amount transferred and if the amount transferred is separately accounted for by the

transferee plan. However, only the benefit attributable to the amount transferred, plus

earnings thereon, may be distributed in accordance with the section 242(b)(2) election

made under the transferor plan. If the employee elected to have the amount transferred,

Page 177 of 239

the transfer will be treated as a distribution and rollover of the amount transferred for

purposes of this section.

(b) In the case in which an amount is transferred from one plan to another plan, the amount

transferred may not be distributed in accordance with a section 242(b)(2) election made

under the transferee plan. If a section 242(b)(2) election was made under the transferee

plan, the amount transferred must be separately accounted for. If the amount

transferred is not separately accounted for under the transferee plan, the section

242(b)(2) election under the transferee plan is revoked and section 401(a)(9) will apply

to subsequent distributions by the transferee plan.

(c) A merger, spinoff, or consolidation, as defined in §1.414(l)–1(b), will be treated as a

transfer for purposes of the section 242(b)(2) election.

Q–15. If an amount is distributed by one plan (distributing plan) and rolled over into another

plan (receiving plan), may the receiving plan distribute the amount rolled over in accordance

with a section 242(b)(2) election made under either the distributing plan or the receiving plan?

A–15. No, if an amount is distributed by one plan (distributing plan) and rolled over into another

plan (receiving plan), the receiving plan must distribute the amount rolled over in accordance

with section 401(a)(9) whether or not the employee made a section 242(b)(2) election under

the distributing plan. Further, if the amount rolled over was not distributed in accordance with

the election, the election under the distributing plan is revoked and section 401(a)(9) will apply

to all subsequent distributions by the distributing plan. Finally, if the employee made a section

242(b)(2) election under the receiving plan and such election is still in effect, the amount rolled

over must be separately accounted for under the receiving plan and distributed in accordance

with section 401(a)(9). If amounts rolled over are not separately accounted for, any section

242(b)(2) election under the receiving plan is revoked and section 401(a)(9) will apply to

subsequent distributions by the receiving plan.

Q–16. May a section 242(b)(2) election be revoked after the date by which distributions are

required to commence in order to satisfy section 401(a)(9) and this section of the regulations?

A–16. Yes, a section 242(b)(2) election may be revoked after the date by which distributions

are required to commence in order to satisfy section 401(a)(9) and this section of the

regulations. However, if the section 242(b)(2) election is revoked after the date by which

Page 178 of 239

distributions are required to commence in order to satisfy section 401(a)(9) and this section of

the regulations and the total amount of the distributions which would have been required to be

made prior to the date of the revocation in order to satisfy section 401(a)(9), but for the section

242(b)(2) election, have not been made, the plan must distribute by the end of the calendar

year following the calendar year in which the revocation occurs the total amount not yet

distributed which was required to have been distributed to satisfy the requirements of section

401(a)(9) and continue distributions in accordance with such requirements.

[T.D. 8987, 67 FR 18994, Apr. 17, 2002, as amended by T.D. 9130, 69 FR 33293, 33302,

June 15, 2004]

§1.408–8 A–1(a) §1.408–8 A–1(b) §54.4974–2 A–3(a) §54.4974–2 A–4(b)(2)(i)

[Appendix I Source URL: US Government Printing Office Electronic Code of Federal

Regulations]

Page 179 of 239

Appendix II

Reminder:

IRS Bulletin No. 2004-26

HIGHLIGHTS OF THIS ISSUE: These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be relied upon as authoritative

interpretations.

INCOME TAX Rev. Rul. 2004–55, page 1081. Disability insurance benefits. This ruling

addresses the income tax treatment of short-term and long-term disability benefits under

sections 104(a)(3) and 105(a) of the Code.

Rev. Proc. 2004–37, page 1099. This procedure provides a method for determining the

source of a pension payment to a nonresident alien from a defined benefit plan where the trust

forming part of the plan is a trust created or organized in the United States that constitutes a

qualified trust under section 401(a) of the Code. Rev. Proc. 2004–7 amplified.

EMPLOYEE PLANS T.D. 9130, page 1082.

Final regulations concern required minimum distributions under section 401(a)(9) of the Code

for defined benefit plans and annuity contracts providing benefits under qualified plans,

individual retirement plans, and section 403(b) contracts. This document also contains a

change to the separate account rules in the final regulations concerning required minimum

distributions for defined contribution plans.

The IRS Bulletin that follows was issued, in part, as notification

of the finalized regulations applicable to (among other topics),

Traditional and Roth Independent Retirement Accounts (IRAs),

annuities and the laws applicable to them.

Page 180 of 239

EXEMPT ORGANIZATIONS

Announcement 2004–53, page 1105

A list is provided of organizations now classified as private foundations.

The IRS Mission Provide America’s taxpayers top quality service by helping them understand

and meet their tax responsibilities and by applying the tax law with integrity and fairness to all.

Introduction

The Internal Revenue Bulletin is the authoritative instrument of the Commissioner of Internal

Revenue for announcing official rulings and procedures of the Internal Revenue Service and

for publishing Treasury Decisions, Executive Orders, Tax Conventions, legislation, court

decisions, and other items of general interest. It is published weekly and may be obtained from

the Superintendent of Documents on a subscription basis. Bulletin contents are compiled

semiannually into Cumulative Bulletins, which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to

promote a uniform application of the tax laws, including all rulings that supersede, revoke,

modify, or amend any of those previously published in the Bulletin. All published rulings apply

retroactively unless otherwise indicated. Procedures relating solely to matters of internal

management are not published; however, statements of internal practices and procedures that

affect the rights and duties of taxpayers are published.

Revenue rulings represent the conclusions of the Service on the application of the law to the

pivotal facts stated in the revenue ruling. In those based on positions taken in rulings to

taxpayers or technical advice to Service field offices, identifying details and information of a

confidential nature are deleted to prevent unwarranted invasions of privacy and to comply with

statutory requirements.

Rulings and procedures reported in the Bulletin do not have the force and effect of Treasury

Department Regulations, but they may be used as precedents. Unpublished rulings will not be

relied on, used, or cited as precedents by Service personnel in the disposition of other cases.

In applying published rulings and procedures, the effect of subsequent legislation, regulations,

Page 181 of 239

court decisions, rulings, and procedures must be considered, and Service personnel and

others concerned are cautioned against reaching the same conclusions in other cases unless

the facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on provisions of the Internal Revenue Code of

1986.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A, Tax Conventions and Other

Related Items, and Subpart B, Legislation and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to these subjects are contained in the

other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative

Rulings. Bank Secrecy Act Administrative Rulings are issued by the Department of the

Treasury’s Office of the Assistant Secretary (Enforcement).

Part IV.—Items of General Interest.

This part includes notices of proposed rulemakings, disbarment and suspension lists, and

announcements. The last Bulletin for each month includes a cumulative index for the matters

published during the preceding months. These monthly indexes are cumulated on a

semiannual basis, and are published in the last Bulletin of each semiannual period.

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 104.—Compensation for Injuries or Sickness (Also section 105.)

Disability insurance benefits.

This ruling addresses the income tax treatment of short-term and long-term disability benefits

under sections 104(a)(3) and 105(a) of the Code.

Rev. Rul. 2004–55 ISSUE Under the Amended Plan described below, are long-term disability

benefits received by an employee who becomes disabled excludable from the employee’s

gross income under §104(a)(3) of the Internal Revenue Code?

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FACTS

The Employer provides long-term disability benefits to its eligible employees pursuant to a

written plan. Long-term disability benefits are provided through a group insurance policy with a

third-party insurance carrier. Under the terms of the plan, the Employer pays the entire

premium for the coverage and does not include the cost of the coverage in the employee’s

gross income (i.e., the premiums are paid on a pretax basis and are not reported on the

employee’s Form W-2 for that year).

The Employer amends the plan (the Amended Plan) to provide that the Employer will continue

to pay the long-term disability coverage on a pretax basis for eligible employees. However,

each eligible employee may also irrevocably elect to have the Employer pay for the long-term

disability coverage on an after-tax basis (i.e., elect to be taxed currently on the premiums paid

by the Employer). An employee’s election applies to the entire cost of the coverage that the

Employer pays to the third-party insurance carrier, so that an employee may not elect after-tax

treatment for only a portion of the premiums. If an employee elects after-tax treatment, the

Employer allocates the appropriate proportion of the group premium to that employee and

includes that amount in the employee’s gross income for the year in which the payments are

made (i.e., the premiums are reported on the employee’s Form W-2 for that year).

Under the Amended Plan, the employee’s election to pay for the cost of long-term disability

coverage on an after-tax basis is irrevocable once the plan year begins and must be made

prior to the beginning of the plan year in which the election becomes effective. The employee

has the ability to make a new irrevocable election for each plan year prior to the beginning of

that plan year. In lieu of a new election for each plan year, the Employer may provide that an

employee’s prior election, once made, continues from one year to the next unless affirmatively

changed before the beginning of the new plan year.

The Employer may also provide that the long-term disability premiums will automatically be

included in the employee’s gross income for the year unless the employee affirmatively elects

otherwise prior to the beginning of the new plan year. Under the Amended Plan, an employee

who becomes eligible for long-term disability coverage during a plan year (e.g., a newly hired

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employee) may make an irrevocable prospective election for the remainder of that plan year.

LAW AND ANALYSIS

Section 61(a)(1) and §1.61–21(a)(3) of the Income Tax Regulations provide that, except as

otherwise provided in Subtitle A, gross income includes compensation for services, including

fees, commissions, fringe benefits, and similar items.

Section 104(a)(3) states that except in the case of amounts attributable to (and not in excess

of) deductions allowed under § 213 for any prior taxable year, gross income does not include

amounts received through accident or health insurance (or through an arrangement having the

effect of accident or health insurance) for personal injuries or sickness (other than amounts

received by an employee to the extent such amounts are attributable to contributions by the

employer which were not includible in the gross income of the employee, or are paid by the

employer).

Section 1.104–1(d) states that if an individual purchases a policy of accident or health

insurance out of his own funds, amounts received thereunder for personal injuries or sickness

are excludable from his gross income under § 104(a)(3). Conversely, if an employer is either

the sole contributor to such a fund, or is the sole purchaser of a policy of accident or health

insurance for his employees (on either a group or individual basis), the exclusion provided

under § 104(a)(3) does not apply to any amounts received by his employees through such

fund or insurance.

Section 1.104–1(d) refers to § 1.105–1 for rules relating to the determination of the amount

attributable to employer contributions.

Section 1.105–1(b) provides that all amounts received by employees through an accident or

health plan, which is financed solely by their employer are subject to the provisions of § 105(a).

Under § 105(a), amounts received by an employee through accident or health insurance for

personal injuries or sickness must be included in gross income to the extent such amounts (1)

are attributable to contributions by the employer which were not includible in the gross income

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of the employee, or (2) are paid by the employer.

Section 1.105–1(c)(1) provides that in the case of amounts received by an employee through

an accident or health plan which is financed partially by his employer and partially by

contributions of the employee, § 105(a) applies to the extent that such payments are

attributable to contributions of the employer that were not includible in the employee’s gross

income.

The portion of the amounts which is attributable to the contributions of the employer shall be

determined in accordance with § 1.105–1(d) in the case of insured plans. Section 1.105–

1(c)(2) provides that a separate determination of the portion of the amounts received under the

accident or health plan which is attributable to the contributions of the employer shall be made

with respect to each class of employees in any case where the plan provides that some

classes of covered employees contribute but others do not, or that the employer will make

different contributions for different classes of employees, or that different classes of employees

will make different contributions, and where in any such case both the contributions of the

employer on account of each such class of employees and the contributions of such class of

employees can be ascertained.

Section 1.105–1(d)(2) provides that if the accident or health coverage is provided under or is

part of a group insurance policy purchased by contributions of the employer and of the

employees, and the net premiums for such coverage for a period of at least three policy years

are known at the beginning of the calendar year, the portion of any amount received by an

employee which is attributable to the contributions of the employer for such coverage shall be

an amount which bears the same ratio to the amount received as the portion of the net

premiums contributed by the employer for the last three policy years which are known at the

beginning of the calendar year bears to the total of the net premiums contributed by the

employer and all employees for such policy years. This provision is known as the “three-year

look back rule.”

The term “class of employees” as used in § 1.105–1(c)(2) is dependent solely on the

contribution method used by the plan. The regulations do not refer to length of service, duties,

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or other factors as determinative of a “class of employees.” Accordingly, under the Amended

Plan, the group of employees that elects after-tax treatment of the long-term disability

coverage is a separate class of employees under § 1.105–1(c)(2).

In addition, when a plan that provides long-term disability benefits is amended as described

above, the Amended Plan is a new plan in computing the contributions of the Employer and

the employees. With respect to each employee, the Amended Plan is financed either solely by

the Employer or solely by the employee. At no time is the coverage under the Amended Plan

financed by both Employer and employee contributions. Therefore, the Amended Plan is not a

contributory plan within the meaning of § 1.105–1(c)(1) and, because the Amended Plan is not

described in § 1.105–1(c)(1), the “three-year look back rule” set forth in § 1.105–1(d)(2) does

not apply.

Finally, the applicable statutes and regulations do not distinguish between short term and long-

term disability plans. Thus, if an employer offers both short-term and long-term disability plans

and permits employees to separately elect the contribution payment method for each plan, the

law does not require aggregation of the contributions paid for each plan in determining the

taxation of benefits. Benefits paid under a short-term or long-term disability plan will be taxed

according to the contribution payment election made for each type of coverage.

HOLDING

Under the Amended Plan, long-term disability benefits received by an employee who has

irrevocably elected, prior to the beginning of the plan year, to have the coverage paid by the

Employer on an after-tax basis for the plan year in which the employee becomes disabled are

attributable solely to after-tax employee contributions and are excludable from the employee’s

gross income under § 104(a)(3).

Under the Amended Plan, long-term disability benefits received by an employee whose

coverage is paid by the Employer on a pretax basis for the plan year in which the employee

becomes disabled are attributable solely to pretax Employer contributions and are includible in

the employee’s gross income under § 105(a).

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These holdings are equally applicable to short-term disability benefits.

DRAFTING INFORMATION

The principal author of this revenue ruling is Barbara E. Pie of the Office of Division

Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For further

information regarding this revenue ruling, contact Ms. Pie at (202) 622–6080 (not a toll-free

call).

Section 105.—Amounts Received Under Accident and Health Plans

This ruling addresses the income tax treatment of short-term and long-term disability benefits

under sections 104(a)(3) and 105(a) of the Code. See Rev. Rule. 2004-55, page 1081.

Section 401.—Qualified Pension, Profit-Sharing, and Stock Bonus Plans

26 CFR 1.401(a)(9)–6: Required minimum distributions for defined benefit plans and annuity

contracts.

T.D. 9130 DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR

Part 1 Required Distributions From Retirement Plans

AGENCY: Internal Revenue Service (IRS), Treasury

ACTION: Final regulations

SUMMARY: This document contains final regulations concerning required minimum

distributions under section 401(a)(9) for defined benefit plans and annuity contracts providing

benefits under qualified plans, individual retirement plans, and section 403(b) contracts. This

document also contains a change to the separate account rules in the final regulations

concerning required minimum distributions for defined contribution plans. These final

regulations provide the public with guidance necessary to comply with the law and will affect

administrators of, participants in, and beneficiaries of qualified plans; institutions that sponsor

and administer individual retirement plans, individuals who use individual retirement plans for

retirement income, and beneficiaries of individual retirement plans; and employees for whom

amounts are contributed to section 403(b) annuity contracts, custodial accounts, or retirement

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income accounts and beneficiaries of such contracts and accounts.

DATES: Effective Date: These regulations are effective June 15, 2004. Applicability Date:

These regulations apply for purposes of determining required minimum distributions for

calendar years beginning on or after January 1, 2003.

SUPPLEMENTARY INFORMATION:

Background

These final regulations amend 26 CFR part 1 relating to section 401(a)(9). The regulations

provide guidance on the minimum distribution requirements under section 401(a)(9) for plans

qualified under section 401(a) and for other arrangements that incorporate the section

401(a)(9) rules by reference. The section 401(a)(9) rules are incorporated by reference in

section 408(a)(6) and (b)(3) for individual retirement accounts and annuities (IRAs) (including

Roth IRAs, except as provided in section 408A(c)(5)), section 403(b)(10) for section 403(b)

annuity contracts, and section 457(d) for eligible deferred compensation plans.

Section 401(a)(9) provides rules for distributions during the life of the employee in section

401(a)(9)(A) and rules for distributions after the death of the employee in section 401(a)(9)(B).

Section 401(a)(9)(A)(ii) provides that the entire interest of an employee in a qualified plan must

be distributed, beginning not later than the employee’s required beginning date, in accordance

with regulations, over the life of the employee or over the lives of the employee and a

designated beneficiary (or over a period not extending beyond the life expectancy of the

employee and a designated beneficiary).

Section 401(a)(9)(C) defines required beginning date for employees (other than 5-percent

owners and IRA owners) as April 1 of the calendar year following the later of the calendar year

in which the employee attains age 70½ or the calendar year in which the employee retires. For

5-percent owners and IRA owners, the required beginning date is April 1 of the calendar year

following the calendar year in which the employee attains age 70½, even if the employee has

not retired.

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Section 401(a)(9)(D) provides that (except in the case of a life annuity) the life expectancy of

an employee and the employee’s spouse that is used to determine the period over which

payments must be made may be re-determined, but not more frequently than annually.

Section 401(a)(9)(E) provides that the term designated beneficiary means any individual

designated as a beneficiary by the employee.

Section 401(a)(9)(F) provides that, under regulations prescribed by the Secretary, any amount

paid to a child shall be treated as if it had been paid to the surviving spouse if such amount will

be become payable to the surviving spouse upon such child reaching the age of majority (or

other designated event permitted under regulations).

Section 401(a)(9)(G) provides that any distribution required to satisfy the incidental death

benefit requirement of section 401(a) is a required minimum distribution.

Section 401(a)(9) also provides that, if the employee dies after distributions have begun, the

employee’s interest must be distributed at least as rapidly as under the method used by the

employee.

Section 401(a)(9) further provides that, if the employee dies before required minimum

distributions have begun, the employee’s interest must be either distributed (in accordance

with regulations) over the life or life expectancy of the designated beneficiary with the

distributions beginning no later than 1 year after the date of the employee’s death, or

distributed within 5 years after the death of the employee.

However, under section 401(a)(9)(B)(iv), a surviving spouse may wait until the date the

employee would have attained age 70½ to begin taking required minimum distributions.

Comprehensive proposed regulations under section 401(a)(9) were first published in the

Federal Register on July 27, 1987 (EE–113–82, 1987–2 C.B. 881 [52 FR 28070]). Those

proposed regulations were amended in 1997 (REG–209463–82, 1988–1 C.B. 376 [62 FR

67780]) to address the limited issue of the rules that apply when a trust is designated as an

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employee’s beneficiary.

Comprehensive proposed regulations were reproposed in the Federal Register on January 17,

2001 (REG–130477–00/REG–130481–00, 2001–1 C.B. 865 [66 FR 3928]). The 2001

proposed regulations substantially revised and simplified the rules for defined contribution

plans but maintained the basic structure for defined benefit plans and requested additional

comments on the rules that should apply to those plans. With respect to annuity payments, the

2001 proposed regulations retained the basic structure of the 1987 proposed regulations and

the preamble indicated that the IRS and Treasury were continuing to study these rules and

specifically requested updated comments on current practices and issues relating to required

minimum distributions from annuity contracts.

Commentators on the 2001 proposed regulations provided information on the variety of annuity

contracts being developed and available as insurance company products for purchase with

separate accounts.

Final and temporary regulations relating to required minimum distributions from qualified plans,

individual retirement plans, and section 403(b) annuity contracts, custodial accounts, and

retirement income accounts were published in the Federal Register on April 17, 2002 (T.D.

8987, 2002–1 C.B. 852 [67 FR 18987]). Proposed regulations that cross-reference those

temporary regulations were published in the Proposed Rules section of the Federal Register

on April 17, 2002 (REG–108697–02, 2002–1 C.B. 918 [67 FR 18834]). The final and

temporary regulations were effective with the 2003 calendar year.

The 2002 regulations finalized the rules for defined contribution plans and the basic rules

regarding the determination of the required beginning date, determination of designated

beneficiary and other general rules that apply to both defined benefit and defined contribution

plans. The 2002 regulations also provided temporary regulations under §1.401(a)(9)–6T

relating to minimum distribution requirements for defined benefit plans and annuity contracts

purchased with an employee’s account balance under a defined contribution plan. In response

to the comments to the 2001 proposed regulations, the temporary regulations significantly

expanded the situations in which annuity payments under annuity contracts purchased with an

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employee’s benefit may provide for increasing payments, but this guidance was provided in

proposed and temporary form rather than final form in order to give taxpayers an opportunity to

comment on these changes.

A public hearing was held on the temporary and proposed regulations on October 9, 2002. At

the public hearing, and in comments on the temporary regulations, concerns were raised that

requiring compliance with certain of the rules in the temporary regulations in 2003 would not be

appropriate. Many of the comments relate to restrictions on variable annuity payments, and

certain other increasing annuity payments, set forth in A–1 of §1.401(a)(9)–6T. Commentators

also requested additional guidance in applying the rule in A–12 of §1.401(a)(9)–6T that

requires the entire interest under an annuity contract to include the actuarial value of other

benefits (such as minimum survivor benefits) provided under the contract and that the rule

requiring the inclusion of these values be delayed until the guidance is provided.

Finally, commentators requested that special consideration be provided to governmental plans.

In response to these comments and in order to provide adequate time to consider the issues

raised, the IRS issued Notice that, pending the issuance of further regulations, plans are

permitted to satisfy certain requirements in the 1987 or 2001 proposed regulations with respect

to variable annuity payments in lieu of complying with the corresponding requirements in the

2002 temporary regulations, and that the entire interest under an annuity contract (including an

annuity described in section 408(b) or section 403(b)) is permitted to be determined as the

dollar amount credited to the employee or beneficiary without regard to the actuarial value of

any other benefits (such as minimum survivor benefits) that will be provided under the contract.

Notice 2003–2 also provided that, pending the issuance of further regulations under section

401(a)(9), governmental plans are only required to satisfy a reasonable and good faith

interpretation of section 401(a)(9).

Finally, Notice 2003–2 provided that the transitional relief would continue at least through the

year in which additional regulations are published, with a later effective date for certain

governmental plans.

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In response to the comments received, these final regulations make a number of significant

modifications to the proposed and temporary regulations and adopt the regulations as

modified. They also make a minor modification to the rules in A–2 of §1.401(a)(9)–8 for

separate accounts. These final regulations contain rules relating to minimum distribution

requirements for defined benefit plans and annuity contracts purchased with an employee’s

account balance under a defined contribution plan. For purposes of this discussion of the

background of the regulations in this preamble, as well as the explanation of provisions below,

whenever the term employee is used, it is intended to include not only an employee but also

an IRA owner.

Explanation of Provisions

Overview

These final regulations retain the basic rules of the temporary regulations. For example,

distributions of an employee’s entire interest must be paid in the form of periodic annuity

payments for the employee’s or beneficiary’s life (or the joint lives of the employee and

beneficiary) or over a comparable period certain. The payments must be non increasing or

only increase as provided in the regulations. As provided in the temporary regulations, the

permitted increases under these final regulations include: adjustments to reflect increases in

the cost-of-living; any increase in benefits pursuant to a plan amendment; a pop up in

payments in the event of the death of the beneficiary or the divorce of the employee and

spouse; or return of employee contributions upon an employee’s death. In addition, for both

annuity contracts purchased from insurance companies and annuities paid from section 401(a)

qualified trusts, the regulations allow variable annuities and other regular increases, if certain

conditions are satisfied. The regulations also allow changes in distribution form in certain

circumstances.

These regulations retain many rules from the temporary regulations without modification.

These include, for example, rules regarding: the distribution of benefits that accrue after an

employee’s first distribution calendar year; the treatment of non-vested benefits; the actuarial

increase to an employee’s benefit that must be provided if the employee retires after the

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calendar year in which the employee attains age 70½; and benefits that commence in the form

of an annuity prior to an employee’s required beginning date.

Incidental Benefit Requirement

The basic purpose of the incidental benefit rule is to ensure that the payments under the

annuity are primarily to provide retirement benefits to the employee.

These final regulations retain the basic rule in the temporary regulations that, if distributions

commence under a distribution option that is in the form of a Joint and Survivor annuity where

the beneficiary is not the employee’s spouse, the incidental benefit requirement will not be

satisfied unless the payments to the beneficiary as a percentage of the payments to the

employee do not exceed the percentage provided in the table in the regulations. The

percentage is based on the number of years that the employee’s age exceeds the beneficiary’s

age, and the percentage decreases as the difference between the ages increases. This

reflects the fact that the greater the number of years younger a beneficiary is than the

employee, the greater the number of years of expected payments that will be made to the

beneficiary after the death of the employee.

Under the table in the temporary regulations, a plan may not provide a 100 percent survivor

benefit to an employee’s non-spouse beneficiary under a Joint and Survivor annuity if the

beneficiary is more than 10 years younger than the employee. Some commentators suggested

that an adjustment to the table is appropriate if the employee commences distributions before

70½. This is because, in such a case, more payments are expected to be made while the

employee is alive.

In response to these comments, the final regulations provide that, if an employee’s annuity

starting date is at an age younger than age 70, an adjustment is made to the

employee/beneficiary age difference.

This adjusted employee/beneficiary age difference is determined by decreasing the age

difference by the number of years the employee is younger than age 70 at the annuity starting

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date. The effect of this change is to permit a higher percentage after an employee’s death for

employees who commence benefits at earlier ages. Thus, for an employee age 55 at the time

of the employee’s annuity starting date, a joint and 100 percent survivor annuity can be

provided if the survivor is not more than 25 years younger than the employee.

Increasing annuities (including acceleration and cost-of-living increases)

These final regulations clarify that a plan may provide an annual increase that does not exceed

the increase in an eligible cost-of-living index for a 12-month period ending in the year during

which the increase occurs or the prior year. An eligible cost-of-living index is a consumer price

index (CPI) issued by the Bureau of Labor Statistics and based on prices of all items (or all

items excluding food and energy), including an index for a population of consumers (such as

urban consumers or urban wage earners and clerical workers) or geographic area or areas

(such as a given metropolitan area or state).

Under these regulations, a plan may provide for annual cost-of-living increases, or may provide

for less frequent cost-of-living increases that are cumulative since the most recent increase (or

the employee’s annuity starting date, if later), as long as there is no actuarial increase to reflect

having not provided increases in the interim years.

For a plan that provides annual increases, but provides a ceiling on the annual increase, and

thus does not allow a full cost-of-living increase in some years, the plan may allow an unused

portion of the cost-of-living increase to be provided in a subsequent year when the ceiling

exceeds the increase in the CPI for that year and still treat the increase in that subsequent

year as an increase that does not exceed an eligible cost-of-living index.

Finally, a plan can provide for annuity payments with a percentage adjustment based on the

increase in compensation for the position held by the employee at the time of retirement.

However, in the case of a nongovernmental plan, this form of adjustment is only permitted if it

is provided under the terms of the plan as in effect on April 17, 2002.

In addition to these permitted increases in the amount of annuity payments, the final

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regulations retain the rules in the temporary regulations allowing an annuity purchased from an

insurance company with an employee’s account balance under a defined contribution plan to

provide for variable and increasing payments and clarify that these rules apply to an annuity

contract purchased from an insurance company by a qualified trust for a defined benefit plan.

For an annuity contract purchased from an insurance company, these final regulations retain

the rule that the total expected future payments (disregarding any payment increases) as of

the annuity starting date must exceed the premium being annuitized. This rule insures that

annuity payments start at a high enough amount to prevent inappropriate deferral.

In response to comments asking for more flexibility in the rules relating to changes in

distribution amounts from an annuity contract purchased from an insurance company, the final

regulations replace the rule permitting partial and complete withdrawals with a broader rule

permitting all types of acceleration.

The final regulations allow any method that retains the same rate of increase in future

payments but results in the total future expected payments under the annuity (disregarding any

future payment increases and including the amount of any payment made as a result of the

acceleration) being decreased, thereby allowing acceleration in the form of a shorter period as

well as through withdrawals. In addition, the requirement that a total withdrawal option be

available has been eliminated.

These final regulations also permit defined benefit plans under a qualified trust to provide

variable or fixed-rate increasing annuities paid directly from the trust, but the control in the

regulations on the rate of increase for these annuities is different.

For these annuities, increases in payments solely to reflect better-than-assumed investment

performance are permitted but only if the assumed interest rate for calculating the initial level

of payments is at least 3 percent. Alternatively, fixed rate increases may be provided but only if

the rate of increase is less than 5 percent. Paralleling the payment of the undistributed

premium at death, the regulations allow a payment at death to the extent that the payments

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after annuitization are less than the present value of the employee’s accrued benefit as of the

annuity starting date calculated using the applicable interest and morality under section 417(e).

The rule allowing an acceleration of payments under an annuity has not been extended to

annuity payments from a qualified trust. However, as noted below, such plans are permitted to

allow changes in form of distribution in certain specific circumstances as described below. In

addition, if distribution is in the form of a Joint and Survivor annuity, the final regulations allow

the survivor to convert the survivor annuity into a lump sum upon the death of the employee.

Permitted Changes in Form of Distribution

Some commentators requested that employees and beneficiaries be permitted to change the

form of future distributions in response to changed circumstances, such as upon retirement or

death. In response to these comments, the regulations allow an employee or beneficiary to

change the form of future distributions in a number of circumstances provided certain

conditions are satisfied. First, if distribution is in the form of a period certain only annuity (i.e.,

an annuity with no life contingency), the individual may change the form of distribution

prospectively at any time. The employee or beneficiary also is permitted to change the form of

distribution prospectively upon an employee’s actual retirement or upon plan termination,

regardless of the form of annuity payments before retirement or plan termination. In addition,

an employee may change to a qualified Joint and Survivor annuity in connection with marriage.

In order to make these changes, the future payments must satisfy section 401(a)(9) (as though

payments first commenced on the new annuity starting date, treating the actuarial value of the

remaining payments as the employee’s or beneficiary’s entire interest). As a condition to

changes in the form of distribution, whether under a period certain only annuity or a life

contingent annuity, the stream of payments from the employee’s original annuity starting date

(both the payments before and after the change in form) must satisfy section 415 using the

interest rate assumption and applicable mortality table in effect as of the annuity starting date.

In addition, the end point of the new period certain, if any, may not be later the end point

available at the original annuity starting date. Furthermore, the plan must treat an individual

electing a new form of distribution under these rules as having a new annuity starting date for

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purposes of sections 415 and 417. Thus, the payments under the new form must satisfy

section 415 as of its new annuity starting date based on the applicable interest rate and

applicable mortality table for that date, taking into account prior payments.

Although not stated, for plans subject to section 411, any form of distribution or change in the

form of distribution must not result in an impermissible forfeiture of benefits.

A number of commentators requested that the final regulations provide the rule in prior

proposed regulations that allowed minimum distributions from a defined benefit plan to be

calculated using the rule for defined contribution plans in §1.401(a)(9)–5. The primary

argument for allowing this level of flexibility in calculating distribution amounts from year to

year is to allow employees to adjust to changed circumstances. The rules in these final

regulations allowing a change in distribution form upon retirement or plan termination, and at

any time when distribution is in the form of a term certain only, address this need.

Value Of Guarantees In Determining Account Value Prior To Annuitization

The final regulations retain the basic rule in the temporary regulations that, before

annuitization, the defined contribution plan rules apply. For this purpose, an employee’s entire

interest under an annuity contract is the dollar amount credited to the employee or beneficiary

under the contract plus the actuarial value of any additional benefits (such as survivor benefits

in excess of the account balance) that will be provided under the contract. A number of

commentators requested guidance on how this actuarial value is calculated and indicated that,

in certain circumstances it would be appropriate to disregard this additional value.

The IRS and Treasury believe that it is generally appropriate to reflect the value of additional

benefits under an annuity contract, just as the fair market value of all assets generally must be

reflected in valuing an account balance under a defined contribution plan. However, in

response to these comments, the final regulations allow the additional benefits to be

disregarded when there is a pro-rata reduction in the additional benefits for any withdrawal,

provided the actuarial present value of the additional benefits is not more than 20 percent of

the account balance. An example is provided that illustrates an acceptable method of

determining the value of an additional benefit that is a guaranteed death benefit. In addition, an

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exception is provided for an additional benefit in the form of a guaranteed return of premiums

upon death.

Certain Payments To Children

The final regulations provide rules governing when, pursuant to section 401(a)(9)(F), payment

of an employee’s accrued benefit to a child may be treated as if such payments were made to

a surviving spouse. Under the final regulations, payments under a defined benefit plan or

annuity contract that are made to an employee’s child until such child reaches the age of

majority (or dies, if earlier) may be treated, for purposes of section 401(a)(9), as if such

payments were made to the surviving spouse, provided they become payable to the surviving

spouse upon cessation of the payments to the child. In addition, for this purpose, a child may

be treated as having not reached the age of majority if the child has not completed a specified

course of education and is under the age of 26, or so long as the child is disabled.

Governmental Plans

A number of commentators raised concerns that governmental plans offer annuity distribution

options that are not permitted under the temporary regulations. Most of the suggestions made

by commentators on behalf of governmental plans were incorporated into the final regulations,

such as expanding the list of acceptable COLAs; permitting lump sum distributions to

beneficiaries; and providing for pop-up payments to a surviving spouse after the cessation of

payments to a child.

Nevertheless, some substantive changes recommended by or on behalf of governmental plans

were not made in the final regulations. In light of the difficulties a governmental plan faces in

changing its plan terms (e.g., in some states, the state constitution does not allow elimination

of existing distribution options) and the public oversight of such plans, these final regulations

provide a grandfather rule under which, in the case of an annuity distribution option provided

under the terms of a governmental plan as in effect on April 17, 2002, the plan will not fail to

satisfy section 401(a)(9) merely because the annuity payments do not satisfy the requirements

set forth in these regulations. However, a grandfathered distribution option must satisfy the

statutory requirements of section 401(a)(9), based on a reasonable and good faith

interpretation of that section.

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This grandfather rule only applies to existing plan provisions. Otherwise, the regulations

provide that annuity payments under governmental plans within the meaning of section 414(d)

must satisfy the rules for nongovernmental plans. Thus, any new distribution option in a

governmental plan or change in a distribution option must comply with the rules applicable to

nongovernmental plans under these final regulations.

Separate Accounts Under Defined Contribution Plans

Several comments have been received raising administrative concerns with the rule in the final

regulations applicable to defined contribution plans that recognizes separate accounts for

purposes of section 401(a)(9) only after the separate account is actually established. In

particular, concerns have been raised that, for employees who die late in a calendar year, it is

nearly impossible to set up separate accounts by the end of the year so that they can be used

to determine required minimum distributions for the year after death. In response to these

comments the regulations have been modified to provide that if separate accounts, determined

as of an employee’s date of death, are actually established by the end of the calendar year

following the year of an employee’s death, the separate accounts can be used to determine

required minimum distributions for the year following the year of the employee’s death. Under

the separate account rules, post-death investment experience must be shared on a pro-rata

basis until the date on which the separate accounts are actually established.

Effective Date

As provided in the temporary and proposed regulations, these final regulations apply for

purposes of determining required minimum distributions for calendar years beginning on or

after January 1, 2003. However, in order to fulfill the commitment in Notice 2003–2 to allow

plans to continue to use certain provisions from the pre-existing proposed regulations and to

provide plan sponsors sufficient time to make any adjustments in their plans needed to comply

with these regulations, a distribution from a defined benefit plan or annuity contract for

calendar years 2003, 2004, and 2005 will not fail to satisfy section 401(a)(9) merely because

the payments do not satisfy the rules in these final regulations, provided the payments satisfy

section 401(a)(9) based on a reasonable and good faith interpretation of the provisions of

section 401(a)(9). For a plan that satisfies the parallel provisions of the 1987 proposed

regulations, the 2001 proposed regulations, the 2002 temporary and proposed regulations, or

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these final regulations, a distribution will be deemed to satisfy a reasonable good faith

interpretation of section 401(a)(9).

For governmental plans, this reasonable good faith standard extends to the end of the

calendar year that contains the 90th day after the opening of the first legislative session of the

legislative body with the authority to amend the plan that begins on or after June 15, 2004, if

such 90th day is later than December 31, 2005.

Special Analyses

It has been determined that these final regulations are not a significant regulatory action as

defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also

has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter

5) does not apply to these regulations. Because §1.401(a)(9)–6 imposes no new collection of

information on small entities, a Regulatory Flexibility Analysis under the Regulatory Flexibility

Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, the proposed

regulations preceding these regulations were submitted to the Chief Counsel for Advocacy of

the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal authors of these regulations are Marjorie Hoffman and Cathy A. Vohs of the

Office of the Division Counsel/Associate Chief Counsel (Tax Exempt and Government

Entities). However, other personnel from the IRS and Treasury participated in the development

of these regulations.

Note to students: As part of this IRS Bulletin, all changes to the law regarding

required minimum distributions from IRA accounts are listed; each is indicated

as being added to or removed from the law’s text. The manner in which Title

26, Chapter I, Subchapter A, Part 1, §1.401(a)(9)-6 of the Code of Federal

Regulations was written in a Question/Answer format, with examples, in order

to avoid RMD complications or misunderstandings.

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Amendments to the Regulations Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 is amended by

removing the entry or “§1.401(a)(9)–6T” and adding an entry in numerical order to read, in

part, as follows: Authority: 26 U.S.C. 7805 * * * §1.401(a)(9)–6 is also issued under 26 U.S.C.

401(a)(9). * * * Par. 2. Remove “§1.401(a)(9)–6T” and replace it with §1.401(a)(9)–6 each time

it is used in the sections listed below:

§1.401(9)–0

§1.401(a)(9)–1 A–2(b)

§1.401(a)(9)–2 A–1(c)

§1.401(a)(9)–2 A–5

§1.401(a)(9)–2 A–6(a)

§1.401(a)(9)–3 A–1(a)

§1.401(a)(9)–3 A–1(b)

§1.401(a)(9)–3 A–6

§1.401(a)(9)–4 A–4(a)

§1.401(a)(9)–5 A–1(e)

§1.401(a)(9)–8 A–2(a)(3)

§1.401(a)(9)–8 A–6(b)(2)

§1.401(a)(9)–8 A–7

§1.401(a)(9)–8 A–8

§1.403(b)–3 A–1(c)(3)

§1.408–8 A–1(a)

§1.408–8 A–1(b)

§54.4974–2 A–3(a)

§54.4974–2 A–4(b)(2)(i)

Par. 3. Section 1.401(a)(9)–6 is added to read as follows:

§1.401(a)(9)–6 Required minimum distributions for defined benefit plans and annuity

contracts

Q–1. How must distributions under a defined benefit plan be paid in order to satisfy section

401(a)(9)?

A–1. (a) General rules. In order to satisfy section 401(a)(9), except as otherwise provided in

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this section, distributions of the employee’s entire interest under a defined benefit plan must be

paid in the form of periodic annuity payments for the employee’s life (or the joint lives of the

employee and beneficiary) or over a period certain that does not exceed the maximum length

of the period certain determined in accordance with A–3 of this section. The interval between

payments for the annuity must be uniform over the entire distribution period and must not

exceed one year.

Once payments have commenced over a period, the period may only be changed in

accordance with A–13 of this section. Life (or Joint and Survivor) annuity payments must

satisfy the minimum distribution incidental benefit requirements of A–2 of this section. Except

as otherwise provided in this section (such as permitted increases described in A–14 of this

section), all payments (whether paid over an employee’s life, joint lives, or a period certain)

also must be non-increasing.

(b) Life annuity with period certain. The annuity may be a life annuity (or Joint and Survivor

annuity) with a period certain if the life (or lives, if applicable) and period certain each meet the

requirements of paragraph (a) of this A–1. For purposes of this section, if distributions are

permitted to be made over the lives of the employee and the designated beneficiary,

references to a life annuity include a Joint and Survivor annuity.

(c) Annuity commencement. (1) Annuity payments must commence on or before the

employee’s required beginning date (within the meaning of A–2 of §1.401(a)(9)–2). The first

payment, which must be made on or before the employee’s required beginning date, must be

the payment which is required for one payment interval. The second payment need not be

made until the end of the next payment interval even if that payment interval ends in the next

calendar year. Similarly, in the case of distributions commencing after death in accordance

with section 401(a)(9)(B)(iii) and (iv), the first payment, which must be made on or before the

date determined under A–3(a) or (b) (whichever is applicable) of §1.401(a)(9)–3, must be the

payment which is required for one payment interval. Payment intervals are the periods for

which payments are received, e.g., bimonthly, monthly, semi-annually, or annually. All benefit

accruals as of the last day of the first distribution calendar year must be included in the

calculation of the amount of annuity payments for payment intervals ending on or after the

employee’s required beginning date.

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(2) This paragraph (c) is illustrated by the following example:

Example. A defined benefit plan (Plan X) provides monthly annuity payments of $500 for the

life of unmarried participants with a 10-year period certain. An unmarried, retired participant (A)

in Plan X attains age 70½ in 2005. In order to meet the requirements of this paragraph, the first

monthly payment of $500 must be made on behalf of A on or before April 1, 2006, and the

payments must continue to be made in monthly payments of $500 thereafter for the life and

10-year period certain.

(d) Single sum distributions. In the case of a single sum distribution of an employee’s entire

accrued benefit during a distribution calendar year, the amount that is the required minimum

distribution for the distribution calendar year (and thus not eligible for rollover under section

402(c)) is determined using either the rule in paragraph (d)(1) or the rule in paragraph (d)(2) of

this A–1.

(1) The portion of the single sum distribution that is a required minimum distribution is

determined by treating the single sum distribution as a distribution from an individual account

plan and treating the amount of the single sum distribution as the employee’s account balance

as of the end of the relevant valuation calendar year. If the single sum distribution is being

made in the calendar year containing the required beginning date and the required minimum

distribution for the employee’s first distribution calendar year has not been distributed, the

portion of the single sum distribution that represents the required minimum distribution for the

employee’s first and second distribution calendar years is not eligible for rollover.

(2) The portion of the single sum distribution that is a required minimum distribution is

permitted to be determined by expressing the employee’s benefit as an annuity that would

satisfy this section with an annuity starting date as of the first day of the distribution calendar

year for which the required minimum distribution is being determined, and treating one year of

annuity payments as the required minimum distribution for that year, and not eligible for

rollover. If the single sum distribution is being made in the calendar year containing the

required beginning date and the required minimum distribution for the employee’s first

distribution calendar year has not been made, the benefit must be expressed as an annuity

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with an annuity starting date as of the first day of the first distribution calendar year and the

payments for the first two distribution calendar years would be treated as required minimum

distributions, and not eligible for rollover.

(e) Death benefits. The rule in paragraph (a) of this A–1, prohibiting increasing payments

under an annuity applies to payments made upon the death of an employee. However, for

purposes of this section, an ancillary death benefit described in this paragraph (e) may be

disregarded in applying that rule. Such an ancillary death benefit is excluded in determining an

employee’s entire interest and the rules prohibiting increasing payments do not apply to such

an ancillary death benefit. A death benefit with respect to an employee’s benefit is an ancillary

death benefit for purposes of this A-1 if:

(1) It is not paid as part of the employee’s accrued benefit or under any optional form of the

employee’s benefit; and

(2) The death benefit, together with any other potential payments with respect to the

employee’s benefit that may be provided to a survivor, satisfy the incidental benefit

requirement of §1.401–1(b)(1)(i).

(f) Additional guidance. Additional guidance regarding how distributions under a defined benefit

plan must be paid in order to satisfy section 401(a)(9) may be issued by the Commissioner in

revenue rulings, notices, or other guidance published in the Internal Revenue Bulletin. See

§601.601(d)(2)(ii)(b) of this chapter.

Q–2. How must distributions in the form of a life (or Joint and Survivor) annuity be made in

order to satisfy the minimum distribution incidental benefit (MDIB) requirement of section

401(a)(9)(G) and the distribution component of the incidental benefit requirement of §1.401–

1(b)(1)(i)?

A–2. (a) Life annuity for employee. If the employee’s benefit is paid in the form of a life annuity

for the life of the employee satisfying section 401(a)(9) without regard to the MDIB

requirement, the MDIB requirement of section 401(a)(9)(G) will be satisfied.

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(b) Joint and survivor annuity, spouse beneficiary. If the employee’s sole beneficiary, as of the

annuity starting date for annuity payments, is the employee’s spouse and the distributions

satisfy section 401(a)(9) without regard to the MDIB requirement, the distributions to the

employee will be deemed to satisfy the MDIB requirement of section 401(a)(9)(G). For

example, if an employee’s benefit is being distributed in the form of a Joint and Survivor

annuity for the lives of the employee and the employee’s spouse and the spouse is the sole

beneficiary of the employee, the amount of the periodic payment payable to the spouse would

not violate the MDIB requirement if it was 100 percent of the annuity payment payable to the

employee, regardless of the difference in the ages between the employee and the employee’s

spouse.

(c) Joint and survivor annuity, non-spouse beneficiary—(1) Explanation of rule. If distributions

commence under a distribution option that is in the form of a Joint and Survivor annuity for the

joint lives of the employee and a beneficiary other than the employee’s spouse, the minimum

distribution incidental benefit requirement will not be satisfied as of the date distributions

commence unless under the distribution option, the annuity payments to be made on and after

the employee’s required beginning date will satisfy the conditions of this paragraph (c).

The periodic annuity payment payable to the survivor must not at any time on and after the

employee’s required beginning date exceed the applicable percentage of the annuity payment

payable to the employee using the table in paragraph (c)(2) of this A–2. The applicable

percentage is based on the adjusted employee/beneficiary age difference. The adjusted

employee/beneficiary age difference is determined by first calculating the excess of the age of

the employee over the age of the beneficiary based on their ages on their birthdays in a

calendar year. Then, if the employee is younger than age 70, the age difference determined in

the previous sentence is reduced by the number of years that the employee is younger than

age 70 on the employee’s birthday in the calendar year that contains the annuity starting date.

In the case of an annuity that provides for increasing payments, the requirement of this

paragraph (c) will not be violated merely because benefit payments to the beneficiary increase,

provided the increase is determined in the same manner for the employee and the beneficiary.

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(2) Table.

(3) Example. This paragraph (c) is illustrated by the following example: Distributions

commence on January 1, 2003, to an employee (Z), born March 1, 1937, after retirement at

age 65. Z’s daughter (Y), born February 5, 1967, is Z’s beneficiary. The distributions are in the

form of a Joint and Survivor annuity for the lives of Z and Y with payments of $500 a month to

Z and upon Z’s death of $500 a month to Y, i.e., the projected monthly payment to Y is 100

percent of the monthly amount payable to Z. Accordingly, under A–10 of this section,

compliance with the rules of this section is determined as of the annuity starting date. The

adjusted employee/beneficiary age difference is calculated by taking the excess of the

employee’s age over the beneficiary’s age and subtracting the number of years the employee

is younger than age 70. In this case, Z is 30 years older than Y and is commencing benefit 5

years before attaining age 70 so the adjusted employee/beneficiary age difference is 25 years.

Under the table in paragraph (c)(2) of this A–2, the applicable percentage for a 25-year

adjusted employee/beneficiary age difference is 66 percent. As of January 1, 2003 (the annuity

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starting date), the plan does not satisfy the MDIB requirement because, as of such date, the

distribution option provides that, as of Z’s required beginning date, the monthly payment to Y

upon Z’s death will exceed 66 percent of Z’s monthly payment.

(d) Period certain and annuity features.

If a distribution form includes a period certain, the amount of the annuity payments payable to

the beneficiary need not be reduced during the period certain, but in the case of a Joint and

Survivor annuity with a period certain, the amount of the annuity payments payable to the

beneficiary must satisfy paragraph (c) of this A–2 after the expiration of the period certain.

(e) Deemed satisfaction of incidental benefit rule. Except in the case of distributions with

respect to an employee’s benefit that include an ancillary death benefit described in paragraph

A–1(e) of this section, to the extent the incidental benefit requirement of §1.401–1(b)(1)(i)

requires a distribution, that requirement is deemed to be satisfied if distributions satisfy the

minimum distribution incidental benefit requirement of this A–2. If the employee’s benefits

include an ancillary death benefit described in paragraph A–1(e) of this section, the benefits

(including the ancillary death benefit) must be distributed in accordance with the incidental

benefit requirement described in §1.401–1(b)(1)(i) and the benefits (excluding the ancillary

death benefit) must also satisfy the minimum distribution incidental benefit requirement of this

A–2.

Q–3. How long is a period certain under a defined benefit plan permitted to extend?

A–3. (a) Distributions commencing during the employee’s life. The period certain for any

annuity distributions commencing during the life of the employee with an annuity starting date

on or after the employee’s required beginning date generally is not permitted to exceed the

applicable distribution period for the employee (determined in accordance with the Uniform

Lifetime Table in A–2 of §1.401(a)(9)–9) for the calendar year that contains the annuity starting

date. See A–10 of this section for the rule for annuity payments with an annuity starting date

before the required beginning date. However, if the employee’s sole beneficiary is the

employee’s spouse, the period certain is permitted to be as long as the joint life and last

survivor expectancy of the employee and the employee’s spouse, if longer than the applicable

distribution period for the employee, provided the period certain is not provided in conjunction

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with a life annuity under A–1(b) of this section.

(b) Distributions commencing after the employee’s death. (1) If annuity distributions commence

after the death of the employee under the life expectancy rule (under section 401(a)(9)(B)(iii)

or (iv)), the period certain for any distributions commencing after death cannot exceed the

applicable distribution period determined under A–5(b) of §1.401(a)(9)–5 for the distribution

calendar year that contains the annuity starting date.

(2) If the annuity starting date is in a calendar year before the first distribution calendar year,

the period certain may not exceed the life expectancy of the designated beneficiary using the

beneficiary’s age in the year that contains the annuity starting date.

Q–4. Will a plan fail to satisfy section 401(a)(9) merely because distributions are made from an

annuity contract that is purchased from an insurance company?

A–4. A plan will not fail to satisfy section 401(a)(9) merely because distributions are made from

an annuity contract that is purchased with the employee’s benefit by the plan from an

insurance company, as long as the payments satisfy the requirements of this section. If the

annuity contract is purchased after the required beginning date, the first payment interval must

begin on or before the purchase date and the payment required for one payment interval must

be made no later than the end of such payment interval. If the payments actually made under

the annuity contract do not meet the requirements of section 401(a)(9), the plan fails to satisfy

section 401(a)(9). See also A–14 of this section permitting certain increases under annuity

contracts.

Q–5. In the case of annuity distributions under a defined benefit plan, how must additional

benefits that accrue after the employee’s first distribution calendar year be distributed in order

to satisfy section 401(a)(9)?

A–5. (a) In the case of annuity distributions under a defined benefit plan, if any additional

benefits accrue in a calendar year after the employee’s first distribution calendar year,

distribution of the amount that accrues in the calendar year must commence in accordance

with A–1 of this section beginning with the first payment interval ending in the calendar year

immediately following the calendar year in which such amount accrues.

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(b) A plan will not fail to satisfy section 401(a)(9) merely because there is an administrative

delay in the commencement of the distribution of the additional benefits accrued in a calendar

year, provided that the actual payment of such amount commences as soon as practicable.

However, payment must commence no later than the end of the first calendar year following

the calendar year in which the additional benefit accrues, and the total amount paid during

such first calendar year must be no less than the total amount that was required to be paid

during that year under A–5(a) of this section.

Q–6. If a portion of an employee’s benefit is not vested as of December 31 of a distribution

calendar year, how is the determination of the required minimum distribution affected?

A–6. In the case of annuity distributions from a defined benefit plan, if any portion of the

employee’s benefit is not vested as of December 31 of a distribution calendar year, the portion

that is not vested as of such date will be treated as not having accrued for purposes of

determining the required minimum distribution for that distribution calendar year. When an

additional portion of the employee’s benefit becomes vested, such portion will be treated as an

additional accrual. See A–5 of this section for the rules for distributing benefits that accrue

under a defined benefit plan after the employee’s first distribution calendar year.

Q–7. If an employee (other than a 5-percent owner) retires after the calendar year in which the

employee attains age 70½, for what period must the employee’s accrued benefit under a

defined benefit plan be actuarially increased?

A–7. (a) Actuarial increase starting date. If an employee (other than a 5-percent owner) retires

after the calendar year in which the employee attains age 70½, in order to satisfy section

401(a)(9)(C)(iii), the employee’s accrued benefit under a defined benefit plan must be

actuarially increased to take into account any period after age 70½ in which the employee was

not receiving any benefits under the plan. The actuarial increase required to satisfy section

401(a)(9)(C)(iii) must be provided for the period starting on the April 1 following the calendar

year in which the employee attains age 70½, or January 1, 1997, if later.

(b) Actuarial increase ending date.

The period for which the actuarial increase must be provided ends on the date on which

benefits commence after retirement in an amount sufficient to satisfy section 401(a)(9).

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(c) Nonapplication to plan providing same required beginning date for all employees.

If, as permitted under A–2(e) of §1.401(a)(9)–2, a plan provides that the required beginning

date for purposes of section 401(a)(9) for all employees is April 1 of the calendar year following

the calendar year in which the employee attains age 70½ (regardless of whether the employee

is a 5-percent owner) and the plan makes distributions in an amount sufficient to satisfy section

401(a)(9) using that required beginning date, no actuarial increase is required under section

401(a)(9)(C)(iii).

(d) Nonapplication to governmental and church plans. The actuarial increase required under

this A–7 does not apply to a governmental plan (within the meaning of section 414(d)) or a

church plan. For purposes of this paragraph, the term church plan means a plan maintained by

a church for church employees, and the term church means any church (as defined in section

3121(w)(3)(A)) or qualified church-controlled organization (as defined in section

3121(w)(3)(B)).

Q–8. What amount of actuarial increase is required under section 401(a)(9)(C)(iii)?

A–8. In order to satisfy section 401(a)(9)(C)(iii), the retirement benefits payable with respect to

an employee as of the end of the period for actuarial increases (described in A–7 of this

section) must be no less than: the actuarial equivalent of the employee’s retirement benefits

that would have been payable as of the date the actuarial increase must commence under

paragraph (a) of A–7 of this section if benefits had commenced on that date; plus the actuarial

equivalent of any additional benefits accrued after that date; reduced by the actuarial

equivalent of any distributions made with respect to the employee’s retirement benefits after

that date. Actuarial equivalence is determined using the plan’s assumptions for determining

actuarial equivalence for purposes of satisfying section 411.

Q–9. How does the actuarial increase required under section 401(a)(9)(C)(iii) relate to the

actuarial increase required under section 411?

A–9. In order for any of an employee’s accrued benefit to be nonforfeitable as required under

section 411, a defined benefit plan must make an actuarial adjustment to an accrued benefit,

the payment of which is deferred past normal retirement age. The only exception to this rule is

that generally no actuarial adjustment is required to reflect the period during which a benefit is

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suspended as permitted under section 203(a)(3)(B) of the Employee Retirement Income

Security Act of 1974 (ERISA) (88 Stat. 829). The actuarial increase required under section

401(a)(9)(C)(iii) for the period described in A–7 of this section is generally the same as, and

not in addition to, the actuarial increase required for the same period under section 411 to

reflect any delay in the payment of retirement benefits after normal retirement age. However,

unlike the actuarial increase required under section 411, the actuarial increase required under

section 401(a)(9)(C)(iii) must be provided even during any period during which an employee’s

benefit has been suspended in accordance with ERISA section 203(a)(3)(B).

Q–10. What rule applies if distributions commence to an employee on a date before the

employee’s required beginning date over a period permitted under section 401(a)(9)(A)(ii) and

the distribution form is an annuity under which distributions are made in accordance with the

provisions of A–1 of this section?

A–10. (a) General rule. If distributions commence to an employee on a date before the

employee’s required beginning date over a period permitted under section 401(a)(9)(A)(ii) and

the distribution form is an annuity under which distributions are made in accordance with the

provisions of A–1 of this section, the annuity starting date will be treated as the required

beginning date for purposes of applying the rules of this section and §1.401(a)(9)–2. Thus, for

example, the designated beneficiary distributions will be determined as of the annuity starting

date. Similarly, if the employee dies after the annuity starting date but before the required

beginning date determined under A–2 of §1.401(a)(9)–2, after the employee’s death, the

remaining portion of the employee’s interest must continue to be distributed in accordance with

this section over the remaining period over which distributions commenced.

The rules in §1.401(a)(9)–3 and section 401(a)(9)(B)(ii) or (iii) and (iv) do not apply.

(b) Period certain. If, as of the employee’s birthday in the year that contains the annuity starting

date, the age of the employee is under 70, the following rule applies in applying the rule in

paragraph (a) of A–3 of this section. The applicable distribution period for the employee is the

distribution period for age 70, determined in accordance with the Uniform Lifetime Table in A–2

of §1.401(a)(9)–9, plus the excess of 70 over the age of the employee as of the employee’s

birthday in the year that contains the annuity starting date.

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(c) Adjustment to employee/beneficiary age difference. See A–2(c)(1) of this section for the

determination of the adjusted employee/beneficiary age difference in the case of an employee

whose age on the annuity starting date is less than 70.

Q–11. What rule applies if distributions commence to the surviving spouse of an employee

over a period permitted under section 401(a)(9)(B)(iii)(II) before the date on which distributions

are required to commence and the distribution form is an annuity under which distributions are

made as of the date distributions commence in accordance with the provisions of A–1 of this

section.

A–11. If distributions commence to the surviving spouse of an employee over a period

permitted under section 401(a)(9)(B)(iii)(II) before the date on which distributions are required

to commence and the distribution form is an annuity under which distributions are made as of

the date distributions commence in accordance with the provisions of A–1 of this section,

distributions will be considered to have begun on the actual commencement date for purposes

of section 401(a)(9)(B)(iv)(II).

Consequently, in such case, A–5 of §1.401(a)(9)–3 and section 401(a)(9)(B)(ii) and (iii) will not

apply upon the death of the surviving spouse as though the surviving spouse were the

employee. Instead, the annuity distributions must continue to be made, in accordance with the

provisions of A–1 of this section, over the remaining period over which distributions

commenced.

Q–12. In the case of an annuity contract under an individual account plan that has not yet been

annuitized, how is section 401(a)(9) satisfied with respect to the employee’s or beneficiary’s

entire interest under the annuity contract for the period prior to the date annuity payments so

commence?

A–12. (a) General rule. Prior to the date that an annuity contract under an individual account

plan is annuitized, the interest of an employee or beneficiary under that contract is treated as

an individual account for purposes of section 401(a)(9). Thus, the required minimum

distribution for any year with respect to that interest is determined under §1.401(a)(9)–5 rather

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than this section. See A–1 of §1.401(a)(9)–5 for rules relating to the satisfaction of section

401(a)(9) in the year that annuity payments commence and A–2(a)(3) of §1.401(a)(9)–8.

(b) Entire interest. For purposes of applying the rules in §1.401(a)(9)–5, the entire interest

under the annuity contract as of December 31 of the relevant valuation calendar year is treated

as the account balance for the valuation calendar year described in A–3 of §1.401(a)(9)–5.

The entire interest under an annuity contract is the dollar amount credited to the employee or

beneficiary under the contract plus the actuarial present value of any or beneficiary) that will be

provided under the contract. However, paragraph (c) of this A–12 describes certain additional

benefits that may be disregarded in determining the employee’s entire interest under the

annuity contract. The actuarial present value of any additional benefits described under this A–

12 is to be determined using reasonable actuarial assumptions, including reasonable

assumptions as to future distributions, and without regard to an individual’s health.

(c) Exclusions. (1) The actuarial present value of any additional benefits provided under an

annuity contract described in paragraph (b) of this A–12 may be disregarded if the sum of the

dollar amount credited to the employee or beneficiary under the contract and the actuarial

present value of the additional benefits is no more than 120 percent of the dollar amount

credited to the employee or beneficiary under the contract and the contract provides only for

the following additional benefits:

(i) Additional benefits that, in the case of a distribution, are reduced by an amount sufficient to

ensure that the ratio of such sum to the dollar amount credited does not increase as a result of

the distribution, and

(ii) An additional benefit that is the right to receive a final payment upon death that does not

exceed the excess of the premiums paid less the amount of prior distributions.

(2) If the only additional benefit provided under the contract is the additional benefit described

in paragraph (c)(1)(ii) of this A–14, the additional benefit may be disregarded regardless of its

value in relation to the dollar amount credited to the employee or beneficiary under the

contract.

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(3) The Commissioner in revenue rulings, notices, or other guidance published in the Internal

Revenue Bulletin (see §601.601(d)(2) of this chapter) may provide additional guidance on

additional benefits that may be disregarded.

(d) Examples. The following examples, which use a 5 percent interest rate and the Mortality

Table provided in Rev. Rule. 2001–62, 2001–2 C.B. 632, illustrate the application of the rules

in this A–12:

Example 1. (i) G is the owner of a variable annuity contract (Contract S) under an individual

account plan that has not been annuitized. Contract S provides a death benefit until the end of

the calendar year in which the owner attains the age of 84 equal to the greater of the current

Contract S notional account value (dollar amount credited to G under the contract) and the

largest notional account value at any previous policy anniversary reduced proportionally for

subsequent partial distributions (High Water Mark). Contract S provides a death benefit in

calendar years after the calendar year in which the owner attains age 84 equal to the current

notional account value. Contract S provides that assets within the contract may be invested in

a Fixed Account at a guaranteed rate of 2 percent. Contract S provides no other additional

benefits.

(ii) At the end of 2008, when G has an attained age of 78 and 9 months the notional account

value of Contract S (after the distribution for 2008 of 4.93%of the notional account value as of

December 31, 2007) is $550,000, and the High Water Mark, before adjustment for any

withdrawals from Contract S in 2008 is $1,000,000. Thus, Contract S will provide additional

benefits (i.e., the death benefits in excess of the notional account value) through 2014, the

year S turns 84. The actuarial present value of these additional benefits at the end of 2008 is

determined to be $84,300 (15 percent of the notional account value). In making this

determination, the following assumptions are made: on the average, deaths occur mid-year;

the investment return on his notional account value is 2 percent per annum; and minimum

required distributions (determined without regard to additional benefits under the Contract S)

are made at the end of each year. The following table summarizes the actuarial methodology

used in determining the actuarial present value of the additional benefit.

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1 $1,000,000 death benefit reduced 4.93 percent for withdrawal during 2008.

2 Notional account value at end of prior year (after distribution) increased by 2 percent return for year.

3 Average of $550,000 notional account value at end of prior year (after distribution) and $561,000 notional

account value at end of current year (before distribution).

4 December 31, 2008, notional account (before distribution) divided by Uniform Lifetime Table age 79 factor of

19.5.

5 One-quarter age 78 rate plus three-quarters age 79 rate.

6 Five percent discounted 18 months (1.05^(-1.5)).

7 Blended age 79/age 80 mortality rate (.04946) multiplied by the $363,860 excess of death benefit over the

average notional account value (901,983 less 538,123) multiplied by .95574 probability of survivorship to the

start of 2010 multiplied by 18 month interest discount of .92943.

8 Survivorship to start of preceding year (.95574) multiplied by probability of survivorship during prior year (1 -

.04946).

(iii) Because Contract S provides that, in the case of a distribution, the value of the additional

death benefit (which is the only additional benefit available under the contract) is reduced by

an amount that is at least proportional to the reduction in the notional account value and, at

age 78 and 9 months, the sum of the notional account value (dollar amount credited to the

employee under the contract) and the actuarial present value of the additional death benefit is

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no more than 120 percent of the notional account value, the exclusion under paragraph (c)(2)

of this A–12 is applicable for 2009. Therefore, for purposes of applying the rules in

§1.401(a)(9)–5, the entire interest under Contract S may be determined as the notional

account value (i.e., without regard to the additional death benefit).

Example 2. (i) The facts are the same as in Example 1 except that the notional account value

is $450,000 at the end of 2008. In this instance, the actuarial present value of the death benefit

in excess of the notional account value in 2008 is determined to be $108,669 (24 percent of

the notional account value). The following table summarizes the actuarial methodology used in

determining the actuarial present value of the additional benefit.

(ii) Because the sum of the notional account balance and the actuarial present value of the

additional death benefit is more than 120 percent of the notional account value, the exclusion

under paragraph (b)(1) of this A–12 does not apply for 2009. Therefore, for purposes of

applying the rules in §1.401(a)(9)–5, the entire interest under Contract S must include the

actuarial present value of the additional death benefit.

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Q–13. When can an annuity payment period be changed?

A–13. (a) In general. An annuity payment period may be changed in accordance with the

provisions set forth in paragraph (b) of this A–13 or in association with an annuity payment

increase described in A–14 of this section.

(b) Re-annuitization. If, in a stream of annuity payments that otherwise satisfies section

401(a)(9), the annuity payment period is changed and the annuity payments are modified in

association with that change, this modification will not cause the distributions to fail to satisfy

section 401(a)(9) provided the conditions set forth in paragraph (c) of this A–13 are satisfied,

and either —

(1) The modification occurs at the time that the employee retires or in connection with a plan

termination;

(2) The annuity payments prior to modification are annuity payments paid over a period certain

without life contingencies; or

(3) The annuity payments after modification are paid under a qualified Joint and Survivor

annuity over the joint lives of the employee and a designated beneficiary, the employee’s

spouse is the sole designated beneficiary, and the modification occurs in connection with the

employee becoming married to such spouse.

(c) Conditions. In order to modify a stream of annuity payments in accordance with paragraph

(b) of this A–13, the following conditions must be satisfied —

(1) The future payments under the modified stream satisfy section 401(a)(9) and this section

(determined by treating the date of the change as a new annuity starting date and the actuarial

present value of the remaining payments prior to modification as the entire interest of the

participant);

(2) For purposes of sections 415 and 417, the modification is treated as a new annuity starting

date;

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(3) After taking into account the modification, the annuity stream satisfies section 415

(determined at the original annuity starting date, using the interest rates and mortality tables

applicable to such date); and

(4) The end point of the period certain, if any, for any modified payment period is not later than

the end point available under section 401(a)(9) to the employee at the original annuity starting

date.

(d) Examples. For the following examples in this A–13, assume that the Applicable Interest

Rate throughout the period from 2005 through 2008 is 5 percent and throughout 2009 is 4

percent, the Applicable Mortality Table throughout the period from 2005 to 2009 is the table

provided in Rev. Rule. 2001–62, 2001–2 C.B. 632, and the section 415 limit in 2005 at age 70

for a straight life annuity is $255,344:

Example 1. (i) A participant (D), who has 10 years of participation in a frozen defined benefit

plan (Plan W), attains age 70½ in 2005. D is not retired and elects to receive distributions from

Plan W in the form of a straight life (i.e., level payment) annuity with annual payments of

$240,000 per year beginning in 2005 at a date when D has an attained age of 70. Plan W

offers non-retired employees in pay status the opportunity to modify their annuity payments

due to an associated change in the payment period at retirement Plan W treats the date of the

change in payment period as a new annuity starting date for the purposes of sections 415 and

417. Thus, for example, the plan provides a new qualified and joint survivor annuity election

and obtains spousal consent.

(ii) Plan W determines modifications of annuity payment amounts at retirement such that the

present value of future new annuity payment amounts (taking into account the new associated

payment period) is actuarially equivalent to the present value of future pre-modification annuity

payments (taking into account the pre-modification annuity payment period). Actuarial

equivalency for this purpose is determined using the Applicable Interest Rate and the

Applicable Mortality Table as of the date of modification.

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(iii) D retires in 2009 at the age of 74 and, after receiving four annual payments of $240,000,

elects to receive his remaining distributions from Plan W in the form of an immediate final lump

sum payment (calculated at 4 percent interest) of $2,399,809.

(iv) Because payment of retirement benefits in the form of an immediate final lump sum

payment satisfies (in terms of form) section 401(a)(9), the condition under paragraph (c)(1) of

this A–13 is met.

(v) Because Plan W treats a modification of an annuity payment stream at retirement as a new

annuity starting date for purposes of sections 415 and 417, the condition under paragraph

(c)(2) of this A–13 is met.

(vi) After taking into account the modification, the annuity stream determined as of the original

annuity starting date consists of annual payments beginning at age 70 of $240,000, $240,000,

$240,000, $240,000, and $2,399,809. This benefit stream is actuarially equivalent to a straight

life annuity at age 70 of $250,182, an amount less than the section 415 limit determined at the

original annuity starting date, using the interest and mortality rates applicable to such date.

Thus, the condition under paragraph (c)(3) of this A–13 is met.

(vii) Thus, because a stream of annuity payments in the form of a straight life annuity satisfies

section 401(a)(9), and because each of the conditions under paragraph (c) of this A–13 are

satisfied, the modification of annuity payments to D described in this example meets the

requirements of this A–13.

Example 2. The facts are the same as in Example 1 except that the straight life annuity

payments are paid at a rate of $250,000 per year and after D retires the lump sum payment at

age 75 is $2,499,801. Thus, after taking into account the modification, the annuity stream

determined as of the original annuity starting date consists of annual payments beginning at

age 70 of $250,000, $250,000, $250,000, $250,000, and $2,499,801. This benefit stream is

actuarially equivalent to a straight life annuity at age 70 of $260,606, an amount greater than

the section 415 limit determined at the original annuity starting date, using the interest and

mortality rates applicable to such date. Thus, the lump sum payment to D fails to satisfy the

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condition under paragraph (c)(3) of this A–13. Therefore, the lump sum payment to D fails to

meet the requirements of this A–13 and thus fails to satisfy the requirements of section

401(a)(9).

Example 3. (i) A participant (E), who has 10 years of participation in a frozen defined benefit

plan (Plan X), attains age 70½ and retires in 2005 at a date when his attained age is 70. E

elects to receive annual distributions from Plan X in the form of a 27 year period certain

annuity (i.e., a 27 year annuity payment period without a life contingency) paid at a rate of

$37,000 per year beginning in 2005 with future payments increasing at a rate of 4 percent per

year (i.e., the 2006 payment will be $38,480, the 2007 payment will be $40,019 and so on).

Plan X offers participants in pay status whose annuity payments are in the form of a term-

certain annuity the opportunity to modify their payment period at any time and treats such

modifications as a new annuity starting date for the purposes of sections 415 and 417. Thus,

for example, the plan provides a new qualified and joint survivor annuity election and obtains

spousal consent.

(ii) Plan X determines modifications of annuity payment amounts such that the present value of

future new annuity payment amounts (taking into account the new associated payment period)

is actuarially equivalent to the present value of future pre-modification annuity payments

(taking into account the pre-modification annuity payment period). Actuarial equivalency for

this purpose is determined using 5 percent and the Applicable Mortality Table as of the date of

modification.

(iii) In 2008, E, after receiving annual payments of $37,000, $38,480, and $40,019, elects to

receive his remaining distributions from Plan W in the form of a straight life annuity paid with

annual payments of $92,133 per year.

(iv) Because payment of retirement benefits in the form of a straight life annuity satisfies (in

terms of form) section 401(a)(9), the condition under paragraph (c)(1) of this A–13 is met.

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(v) Because Plan X treats a modification of an annuity payment stream at retirement as a new

annuity starting date for purposes of sections 415 and 417, the condition under paragraph

(c)(2) of this A–13 is met.

(vi) After taking into account the modification, the annuity stream determined as of the original

annuity starting date consists of annual payments beginning at age 70 of $37,000, $38,480,

$40,019, and this benefit stream is equivalent to a straight life annuity at age 70 of $82,539, an

amount less than the section 415 limit determined at the original annuity starting date, using

the interest and mortality rates applicable to such date. Thus, the condition under paragraph

(c)(3) of this A–13 is met.

(vii) Thus, because a stream of annuity payments in the form of a straight life annuity satisfies

section 401(a)(9), and because each of the conditions under paragraph (c) of this A–13 are

satisfied, the modification of annuity payments to E described in this example meets the

requirements of this A–13.

Q–14. Are annuity payments permitted to increase?

A–14. (a) General rules. Except as otherwise provided in this section, all annuity payments

(whether paid over an employee’s life, joint lives, or a period certain) must be non-increasing

or increase only in accordance with one of more of the following —

(1) With an annual percentage increase that does not exceed the percentage increase in an

eligible cost-of-living index as defined in paragraph (b) of this A–14 for a 12-month period

ending in the year during which the increase occurs or the prior year;

(2) With a percentage increase that occurs at specified times (e.g., at specified ages) and does

not exceed the cumulative total of annual percentage increases in an eligible cost-of-living

index as defined in paragraph (b) of this A–14 since the annuity starting date, or if later, the

date of the most recent percentage increase. However, in cases providing such a cumulative

increase, an actuarial increase may not be provided to reflect the fact that increases were not

provided in the interim years;

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(3) To the extent of the reduction in the amount of the employee’s payments to provide for a

survivor benefit, but only if there is no longer a survivor benefit because the beneficiary whose

life was being used to determine the period described in section 401(a)(9)(A)(ii) over which

payments were being made dies or is no longer the employee’s beneficiary pursuant to a

qualified domestic relations order within the meaning of section 414(p);

(4) To pay increased benefits that result from a plan amendment;

(5) To allow a beneficiary to convert the survivor portion of a Joint and Survivor annuity into a

single sum distribution upon the employee’s death; or

(6) To the extent increases are permitted in accordance with paragraph (c) or (d) of this A–14.

(b)(1) For purposes of this A–14, an eligible cost-of-living index means an index described in

paragraphs (b)(2), (b)(3), or (b)(4) of this A–14.

(2) A consumer price index that is based on prices of all items (or all items excluding food and

energy) and issued by the Bureau of Labor Statistics, including an index for a specific

population (such as urban consumers or urban wage earners and clerical workers) and an

index for a geographic area or areas (such as a given metropolitan area or state).

(3) A percentage adjustment based on a cost-of-living index described in paragraph (b)(2) of

this A–14, or a fixed percentage if less. In any year when the cost-of-living index is lower than

the fixed percentage, the fixed percentage may be treated as an increase in an eligible cost-of-

living index, provided it does not exceed the sum of:

(i) The cost-of-living index for that year, and

(ii) The accumulated excess of the annual cost-of-living index from each prior year over the

fixed annual percentage used in that year (reduced by any amount previously utilized under

this paragraph (b)(3)(ii)).

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(4) A percentage adjustment based on the increase in compensation for the position held by

the employee at the time of retirement, and provided under either the terms of a governmental

plan within the meaning of section 414(d) or under the terms of a nongovernmental plan as in

effect on April 17, 2002.

(c) Additional permitted increases for annuity payments under annuity contracts purchased

from insurance companies. In the case of annuity payments paid from an annuity contract

purchased from an insurance company, if the total future expected payments (determined in

accordance with paragraph (e)(3) of this A–14) exceed the total value being annuitized (within

the meaning of paragraph (e)(1) of this A–14) , the payments under the annuity will not fail to

satisfy the nonincreasing payment requirement in A–1(a) of this section merely because the

payments are increased in accordance with one or more of the following—

(1) By a constant percentage, applied not less frequently than annually;

(2) To provide a final payment upon the death of the employee that does not exceed the

excess of the total value being annuitized (within the meaning of paragraph (e)(1) of this A–14)

over the total of payments before the death of the employee;

(3) As a result of dividend payments or other payments that result from actuarial gains (within

the meaning of paragraph (e)(2) of this A–14), but only if actuarial gain is measured no less

frequently than annually and the resulting dividend payments or other payments are either paid

no later than the year following the year for which the actuarial experience is measured or paid

in the same form as the payment of the annuity over the remaining period of the annuity

(beginning no later than the year following the year for which the actuarial experience is

measured); and

(4) An acceleration of payments under the annuity (within the meaning of paragraph (e)(4) of

this A–14).

(d) Additional permitted increases for annuity payments from a qualified trust. In the case of

annuity payments paid under a defined benefit plan qualified under section 401(a) (other than

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annuity payments under an annuity contract purchased from an insurance company that

satisfy paragraph (c) of this section), the payments under the annuity will not fail to satisfy the

non-increasing payment requirement in A–1(a) of this section merely because the payments

are increased in accordance with one of the following —

1) By a constant percentage, applied not less frequently than annually, at a rate that is less

than 5 percent per year;

(2) To provide a final payment upon the death of the employee that does not exceed the

excess of the actuarial present value of the employee’s accrued benefit (within the meaning of

section 411(a)(7)) calculated as the annuity starting date using the applicable interest rate and

the applicable mortality table under section 417(e) (or, if greater, the total amount of employee

contributions) over the total of payments before the death of the employee; or

(3) As a result of dividend payments or other payments that result from actuarial gains (within

the meaning of paragraph (e)(2) of this A–14), but only if —

(i) Actuarial gain is measured no less frequently than annually;

(ii) The resulting dividend payments or other payments are either paid no later than the year

following the year for which the actuarial experience is measured or paid in the same form as

the payment of the annuity over the remaining period of the annuity (beginning no later than

the year following the year for which the actuarial experience is measured);

(iii) The actuarial gain taken into account is limited to actuarial gain from investment

experience;

(iv) The assumed interest used to calculate such actuarial gains is not less than 3 percent; and

(v) The payments are not increasing by a constant percentage as described in paragraph

(d)(1) of this A–14.

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(e) Definitions. For purposes of this A–14, the following definitions apply — (1) Total value

being annuitized means —

(i) In the case of annuity payments under a section 403(a) annuity plan or under a deferred

annuity purchased by a section 401(a) trust, the value of the employee’s entire interest (within

the meaning of A–12 of this section) being annuitized (valued as of the date annuity payments

commence);

(ii) In the case of annuity payments under an immediate annuity contract purchased by a trust

for a defined benefit plan qualified under section 401(a), the amount of the premium used to

purchase the contract; and

(iii) In the case of a defined contribution plan, the value of the employee’s account balance

used to purchase an immediate annuity under the contract.

(2) Actuarial gain means the difference between an amount determined using the actuarial

assumptions (i.e., investment return, mortality, expense, and other similar assumptions) used

to calculate the initial payments before adjustment for any increases and the amount

determined under the actual experience with respect to those factors. Actuarial gain also

includes differences between the amount determined using actuarial assumptions when an

annuity was purchased or commenced and such amount determined using actuarial

assumptions used in calculating payments at the time the actuarial gain is determined.

(3) Total future expected payments means the total future payments expected to be made

under the annuity contract as of the date of the determination, calculated using the Single Life

Table in A–1 of §1.401(a)(9)–9 (or, if applicable, the Joint and Last Survivor Table in A–3 in

§1.401(a)(9)–9) for annuitants who are still alive, without regard to any increases in annuity

payments after the date of determination, and taking into account any remaining period certain.

(4) Acceleration of payments means a shortening of the payment period with respect to an

annuity or a full or partial commutation of the future annuity payments. An increase in the

payment amount will be treated as an acceleration of payments in the annuity only if the total

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future expected payments under the annuity (including the amount of any payment made as a

result of the acceleration) is decreased as a result of the change in payment period.

(f) Examples. Paragraph (c) of this A–14 is illustrated by the following examples:

Example 1. Variable annuity. A retired participant (Z1) in defined contribution plan X attains

age 70 on March 5, 2005, and thus, attains age 70½ in 2005. Z1 elects to purchase annuity

Contract Y1 from Insurance Company Win 2005. Contract Y1 is a single life annuity contract

with a 1 year period certain. Contract Y1 provides for an initial annual payment calculated with

an assumed interest rate (AIR) of 3 percent. Subsequent payments are determined by

multiplying the prior year’s payment by a fraction the numerator of which is 1 plus the actual

return on the separate account assets underlying Contract Y1 since the preceding payment

and the denominator of which is 1 plus the AIR during that period. The value of Z1’s account

balance in Plan X at the time of purchase is $105,000, and the purchase price of Contract Y1

is $105,000. Contract Y1 provides Z1 with an initial payment of $7,200 at the time of purchase

in 2005. The total future expected payments to Z1 under Contract Y1 are $122,400, calculated

as the initial payment of $7,200 multiplied by the age 70 life expectancy of 17 provided in the

Single Life Table in A–1 of §1.401(a)(9)–9. Because the total future expected payments on the

purchase date exceed the total value used to purchase Contract Y1 and payments may only

increase as a result of actuarial gain, with such increases, beginning no later than the next

year, paid in the same form as the payment of the annuity over the remaining period of the

annuity, distributions received by Z1 from Contract Y1 meet the requirements under paragraph

(c)(3) of this A–14.

Example 2. Participating annuity. A retired participant (Z2) in defined contribution plan X

attains age 70 on May 1, 2005, and thus, attains age 70½ in 2005. Z2 elects to purchase

annuity Contract Y2 from Insurance Company Win 2005. Contract Y2 is a participating single

life annuity contract with a 10-year period certain. Contract Y2 provides for level annual

payments with dividends paid in a lump sum in the year after the year for which the actuarial

experience is measured or paid out levelly beginning in the year after the year for which the

actuarial gain is measured over the remaining lifetime and period certain, i.e., the period

certain ends at the same time as the original period certain. Dividends are determined annually

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by the Board of Directors of Company W based upon a comparison of actual actuarial

experience to expected actuarial experience in the past year. The value of Z2’s account

balance in Plan X at the time of purchase is $265,000, and the purchase price of Contract Y2

is $265,000. Contract Y2 provides Z2 with an initial payment of $16,000 in 2005. The total

future expected payments to Z2 under Contract Y2 are calculated as the annual initial payment

of $16,000 multiplied by the age 70 life expectancy of 17 provided in the Single Life Table in

A–1 of §1.401(a)(9)–9 for a total of $272,000. Because the total future expected payments on

the purchase date exceeds the total value used to purchase Contract Y2 and payments may

only increase as a result of actuarial gain, with such increases, beginning no later than the next

year, paid in the same form as the payment of the annuity over the remaining period of the

annuity, distributions received by Z2 from Contract Y2meet the requirements under paragraph

(c)(3) of this A–14.

Example 3. Participating annuity with dividend accumulation. The facts are the same as in

Example 2 except that the annuity provides a dividend accumulation option under which Z2

may defer receipt of the dividends to a time selected by Z2. Because the dividend

accumulation option permits dividends to be paid later than the end of the year following the

year for which the actuarial experience is measured or as a stream of payments that only

increase as a result of actuarial gain, with such increases beginning no later than the next

year, paid in the same form as the payment of the annuity over the remaining period of the

annuity in Example 2, the dividend accumulation option does not meet the requirements of

paragraph (c)(3) of this A–14. Neither does the dividend accumulation option fit within any of

the other increases described in paragraph (c) of this A–14. Accordingly, the dividend

accumulation option causes the contract, and consequently any distributions from the contract,

to fail to meet the requirements of this A–14 and thus fail to satisfy the requirements of section

401(a)(9).

Example 4. Participating annuity with dividends used to purchase additional death benefits.

The facts are the same as in Example 2 except that the annuity provides an option under

which actuarial gain under the contract is used to provide additional death benefit protection for

Z2. Because this option permits payments as a result of actuarial gain to be paid later than the

end of the year following the year for which the actuarial experience is measured or as a

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stream of payments that only increase as a result of actuarial gain, with such increases

beginning no later than the next year, paid in the same form as the payment of the annuity

over the remaining period of the annuity in Example 2, the option does not meet the

requirements of paragraph (c)(3) of this A–14. Neither does the option fit within any of the

other increases described in paragraph (c) of this A–14. Accordingly, the addition of the option

causes the contract, and consequently any distributions from the contract, to fail to meet the

requirements of this A–14 and thus fail to satisfy the requirements of section 401(a)(9).

Example 5. Annuity with a fixed percentage increase. A retired participant (Z3) in defined

contribution plan X attains age 70½ in 2005. Z3 elects to purchase annuity contract Y3 from

Insurance Company W. Contract Y3 is a single life annuity contract with a 20-year period

certain (which does not exceed the maximum period certain permitted under A–3(a) of this

section) with fixed annual payments increasing 3 percent each year. The value of Z3’s account

balance in Plan X at the time of purchase is $110,000, and the purchase price of Contract Y3

is $110,000. Contract Y3 provides Z3 with an initial payment of $6,000 at the time of purchase

in 2005. The total future expected payments to Z3 under Contract Y3 are $120,000, calculated

as the initial annual payment of $6,000 multiplied by the period certain of 20 years. Because

the total future expected payments on the purchase date exceed the total value used to

purchase Contract Y3 and payments only increase as a constant percentage applied not less

frequently than annually, distributions received by Z3 from Contract Y3 meet the requirements

under paragraph (c)(1) of this A–14.

Example 6. Annuity with excessive increases. The facts are the same as in Example 5 except

that the initial payment is $5,400 and the annual rate of increase is 4 percent. In this example,

the total future expected payments are $108,000, calculated as the initial payment of $5,400

multiplied by the period certain of 20 years. Because the total future expected payments are

less than the total value of $110,000 used to purchase Contract Y3, distributions received by

Z3 do not meet the requirements under paragraph (c) of this A–14 and thus fail to meet the

requirements of section 401(a)(9).

Example 7. Annuity with full commutation feature. A retired participant (Z4) in defined

contribution Plan X attains age 78 in 2005. Z4 elects to purchase Contract Y4 from Insurance

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Company W. Contract Y4 provides for a single life annuity with a 10 year period certain (which

does not exceed the maximum period certain permitted under A–3(a) of this section) with

annual payments. Contract Y4 provides that Z4 may cancel Contract Y4 at any time before Z4

attains age 84, and receive, on his next payment due date, a final payment in an amount

determined by multiplying the initial payment amount by a factor obtained from Table M of

Contract Y4 using the Y4’s age as of Y4’s birthday in the calendar year of the final payment.

The value of Z4’s account balance in Plan X at the time of purchase is $450,000, and the

purchase price of Contract Y4 is $450,000. Contract Y4 provides Z4 with an initial payment in

2005 of $40,000. The factors in Table M are as follows:

Age at Final Payment Factor

79 10.5

80 10.0

81 9.5

82 9.0

83 8.5

84 8.0

(ii) The total future expected payments to Z4 under Contract Y4 are $456,000, calculated as

the initial payment of 40,000 multiplied by the age 78 life expectancy of 11.4 provided in the

Single Life Table in A–1 of §1.401(a)(9)–9. Because the total future expected payments on the

purchase date exceed the total value being annuitized (i.e., the $450,000 used to purchase

Contract Y4), the permitted increases set forth in paragraph (c) of this A–14 are available.

Furthermore, because the factors in Table M are less than the life expectancy of each of the

ages in the Single Life Table provided in A–1 of §1.401(a)(9)–9, the final payment is always

less than the total future expected payments. Thus, the final payment is an acceleration of

payments within the meaning of paragraph (c)(4) of this A–14.

(iii) As an illustration of the above, if Participant Z4 were to elect to cancel Contract Y4 on the

day before he was to attain age 84, his contractual final payment would be $320,000. This

amount is determined as $40,000 (the annual payment amount due under Contract Y4)

multiplied by 8.0 (the factor in Table M for the next payment due date, age 84). The total future

Page 229 of 239

expected payments under Contract Y4 at age 84 before the final payment is $324,000,

calculated as the initial payment amount multiplied by 8.1, the age 84 life expectancy provided

in the Single Life Table in A–1 of §1.401(a)(9)–9. Because $320,000 (the contract, including

the amount of the final payment) is less than $324,000 (the total future expected payments

under the annuity contract, determined before the election), the final payment is an

acceleration of payments within the meaning of paragraph (c)(4) of this A–14.

Example 8. Annuity with partial commutation except that the annuity provides Z4 may request,

at any time before Z4 attains age 84, an ad hoc payment on his next payment due date with

future payments reduced by an amount equal to the ad hoc payment divided by the factor

obtained from Table M (from Example 7) corresponding to Z4’s age at the time of the ad hoc

payment. Because, at each age, the factors in Table M are less than the corresponding life

expectancies in the Single Life Table in A–1 of §1.401(a)(9)–9, total future expected payments

under Contract Y4 will decrease after an ad hoc payment. Thus, ad hoc distributions received

by Z4 from Contract Y4 will satisfy the requirements under paragraph (c)(4) of this A–4.

(ii) As an illustration of paragraph (i) of this Example 8, if Z4 were to request, on the day before

he was to attain age 84, an ad hoc payment of $100,000 on his next payment due date, his

recalculated annual payment amount would be reduced to $27,500. This amount is determined

as $40,000 (the amount of Z4’s next annual payment) reduced by $12,500 (his $100,000 ad

hoc payment divided by the Table M factor at age 84 of 8.0). Thus, Z4’s total future expected

payments after the ad hoc payment (and including the ad hoc payment) are equal to $322,750

($100,000 plus $27,500 multiplied by the Single Life Table value of 8.1). Note that this

$322,750 amount is less than the amount of Z4’s total future expected payments before the ad

hoc payment ($324,000, determined as $40,000 multiplied by 8.1), and the requirements under

paragraph (c)(4) of this A–4 are satisfied.

Example 9. Annuity with excessive increases. (i) A retired participant (Z5) in defined

contribution plan X attains age 70½ in 2005. Z5 elects to purchase annuity Contract Y5 from

Insurance Company W in 2005 with a premium of $1,000,000. Contract Y5 is a single life

annuity contract with a 20-year period certain. Contract Y5 provides for an initial payment of

$200,000, a second payment one year from the time of purchase of $40,000, and 18

Page 230 of 239

succeeding annual payments each increasing at a constant percentage rate of 4.5 percent

from the preceding payment.

(ii) Contract Y5 fails to meet the requirements of section 401(a)(9) because the total future

expected payments without regard to any increases in the annuity payment, calculated as

$200,000 in year one and $40,000 in each of years two through twenty, is only $960,000 (i.e.,

an amount that does not exceed the total value used to purchase the annuity).

Q–15. Are there special rules applicable to payments made under a defined benefit plan or

annuity contract to a surviving child?

A–15. Yes, Pursuant to section 401(a)(9)(F), payments under a defined benefit plan or annuity

contract that are made to an employee’s child until such child reaches the age of majority (or

dies, if earlier) may be treated, for purposes of section 401(a)(9), as if such payments were

made to the surviving spouse to the extent they become payable to the surviving spouse upon

cessation of the payments to the child. For purposes of the preceding sentence, a child may be

treated as having not reached the age of majority if the child has not completed a specified

course of education and is under the age of 26. In addition, a child who is disabled within the

meaning of section 72(m)(7) when the child reaches the age of majority may be treated as

having not reached the age of majority so long as the child continues to be disabled. Thus,

when payments described in this paragraph A–15 become payable to the surviving spouse

because the child attains the age of majority, recovers from a disabling illness, dies, or

completes a specified course of education, there is not an increase in benefits under A–1 of

this section. Likewise, the age of child receiving such payments is not taken into consideration

for purposes of the minimum incidental benefit requirement of A–2 of this section.

Q–16. Will a governmental plan within the meaning of section 414(d) fail to satisfy section

401(a)(9) if annuity payments under the plan do not satisfy this section?

A–16. (a) Except as provided in paragraph (b) of this A–16, annuity payments under a

governmental plan within the meaning of section 414(d) must satisfy this section.

(b) In the case of an annuity distribution option provided under the terms of a governmental

plan as in effect on April 17, 2002, the plan will not fail to satisfy section 401(a)(9) merely

Page 231 of 239

because the annuity payments do not satisfy the requirements A–1 through A–15 of this

section, provided the distribution option satisfies section 401(a)(9) based on a reasonable and

good faith interpretation of the provisions of section 401(a)(9).

Q–17. What are the rules for determining required minimum distributions for defined benefit

plans and annuity contracts for calendar years 2003, 2004, and 2005?

A–17. A distribution from a defined benefit plan or annuity contract for calendar years 2003,

2004, and 2005 will not fail to satisfy section 401(a)(9) merely because the payments do not

satisfy A–1 through A–16 of this section, provided the payments satisfy section 401(a)(9)

based on a reasonable and good faith interpretation of the provisions of section 401(a)(9). For

governmental plans, this reasonable good faith standard extends to the end of the calendar

year that contains the 90th day after the opening of the first legislative session of the legislative

body with the authority to amend the plan that begins on or after June 15, 2004, if such 90th

day is later than December 31, 2005.

§1.401(a)(9)–6T [Removed]

Par. 4. Section 1.401(a)(9)–6T is removed.

Par. 5. In §1.401(a)(9)–8 A–2, the first sentence in paragraph (a)(2) is revised to read as

follows:

§1.401(a)(9)–8 Special rules.

* * * * *

A–2 * * *

(a) * * *

(2) If the employee’s benefit in a defined contribution plan is divided into separate accounts

and the beneficiaries with respect to one separate account differ from the beneficiaries with

respect to the other separate accounts of the employee under the plan, for years subsequent

to the calendar year containing the date as of which the separate accounts were established,

or date of death if later, such separate account under the plan is not aggregated with the other

separate accounts under the plan in order to determine whether the distributions from such

separate account under the plan satisfy section 401(a)(9). * * *

Page 232 of 239

Deputy Commissioner for Services and Enforcement.

Approved June 1, 2004. Filed by the Office of the Federal Register on June 14, 2004 and

published in the issue of the Federal Register for June 15, 2004, 69 F.R. 33288.

Section 861.—Income From Sources Within the United States A revenue procedure

provides a method for allocating a pension payment to sources within and without the United

States when a domestic trust under a qualified defined benefit plan makes a payment with

respect to a nonresident alien participant and the actual amounts of employer contributions

made to the plan for the benefit of such participant are not known. See Rev. Proc. 2004-37,

page 1099.

Section 862.—Income From Sources Without the United States A revenue procedure

provides a method for allocating a pension payment to sources within and without the United

States when a domestic trust under a qualified defined benefit plan makes a payment with

respect to a nonresident alien participant and the actual amounts of employer contributions

made to the plan for the benefit of such participant are not known. See Rev. Proc. 2004-37,

page 1099.

Section 871.—Tax on Nonresident Alien Individuals A revenue procedure provides a

method for allocating a pension payment to sources within and without the United States when

a domestic trust under a qualified defined benefit plan makes a payment with respect to a

nonresident alien participant and the actual amounts of employer contributions made to the

plan for the benefit of such participant are not known. See Rev. Proc. 2004-37, page 1099.

Section 1441.—Withholding of Tax on Nonresident Aliens A revenue procedure provides a

method for allocating a pension payment to sources within and without the United States when

a domestic trust under a qualified defined benefit plan makes a payment with respect to a

nonresident alien participant and the actual amounts of employer contributions made to the

plan for the benefit of such participant are not known. See Rev. Proc. 2004-37, page 1099.

[Appendix II Source URL: IRS Bulletin June 28, 2004]

Page 233 of 239

Appendix III

§1.401(a)(9)-9 Life Expectancy and Distribution Period Tables

[Source URL: Electronic Code of Federal Regulations, Section 1.401(a)(9)-9]

2016 Single Life Table

Age

Life

expectancy

0 82.4

1 81.6

2 80.6

3 79.7

4 78.7

5 77.7

6 76.7

7 75.8

8 74.8

9 73.8

10 72.8

11 71.8

12 70.8

13 69.9

14 68.9

15 67.9

16 66.9

17 66.0

18 65.0

19 64.0

20 63.0

21 62.1

22 61.1

23 60.1

24 59.1

25 58.2

26 57.2

Page 234 of 239

27 56.2

28 55.3

29 54.3

30 53.3

31 52.4

32 51.4

33 50.4

34 49.4

35 48.5

36 47.5

37 46.5

38 45.6

39 44.6

40 43.6

41 42.7

42 41.7

43 40.7

44 39.8

45 38.8

46 37.9

47 37.0

48 36.0

49 35.1

50 34.2

51 33.3

52 32.3

53 31.4

54 30.5

55 29.6

56 28.7

57 27.9

58 27.0

59 26.1

60 25.2

61 24.4

62 23.5

Page 235 of 239

63 22.7

64 21.8

65 21.0

66 20.2

67 19.4

68 18.6

69 17.8

70 17.0

71 16.3

72 15.5

73 14.8

74 14.1

75 13.4

76 12.7

77 12.1

78 11.4

79 10.8

80 10.2

81 9.7

82 9.1

83 8.6

84 8.1

85 7.6

86 7.1

87 6.7

88 6.3

89 5.9

90 5.5

91 5.2

92 4.9

93 4.6

94 4.3

95 4.1

96 3.8

97 3.6

98 3.4

Page 236 of 239

99 3.1

100 2.9

101 2.7

102 2.5

103 2.3

104 2.1

105 1.9

106 1.7

107 1.5

108 1.4

109 1.2

110 1.1

111+ 1.0

2016 Uniform Lifetime Table

Age of

employee

Distribution

period

70 27.4

71 26.5

72 25.6

73 24.7

74 23.8

75 22.9

76 22.0

77 21.2

78 20.3

79 19.5

80 18.7

81 17.9

82 17.1

83 16.3

84 15.5

85 14.8

86 14.1

87 13.4

88 12.7

Page 237 of 239

89 12.0

90 11.4

91 10.8

92 10.2

93 9.6

94 9.1

95 8.6

96 8.1

97 7.6

98 7.1

99 6.7

100 6.3

101 5.9

102 5.5

103 5.2

104 4.9

105 4.5

106 4.2

107 3.9

108 3.7

109 3.4

110 3.1

111 2.9

112 2.6

113 2.4

114 2.1

115+ 1.9

[Source URL: Electronic Code of Federal Regulations, Section 1.401(a)(9)-9]

Page 238 of 239

Appendix IV – Federal Estate Tax Exemption, Gift Exclusions, and

Retirement Plan Contribution Limits

The IRS issues the allowable amounts for contributions, accumulations and distributions of

funds to and from traditional and Roth IRA accounts. The IRS publishes the limits and life

expectancy tables annually. The laws require you to apply the appropriate figures for the year

in which you require life expectancies, minimum and maximum funds into and out of IRA

accounts, etc., for the year in which you are planning.

Year Estate Tax Exemption Top Estate

Rate

Annual Gift

Exclusion

Amount

2007 $2,000,000 45% $12,000

2008 $2,000,000 45% $12,000

2009 $3,500,000 45% $13,000

2010 $5,000,000 or $0 35% or 0% $13,000

2011 $5,000,000 35% $13,000

2012 $5,120,000 35% $13,000

2013 $5,250,000 40% $14,000

2014 $5,340,000 40% $14,000

2015 $5,430,000 40% $14,000

2016 $5,450,000 40% $14,000

Continued …

Page 239 of 239

Type of Limitation 2016 2015 2014 2013 2012 2011

Elective Deferrals (401(k) and 403(b); not

including adjustments and catch-ups)

$18,000 $18,000 $17,500 $17,500 $17,000 $16,500

457(b)(2) and 457(c)(1) Limits (not including

catch-ups)

$18,000 $18,000 $17,500 $17,500 $17,000 $16,500

Section 414(v) Catch-Up Deferrals to 401(k),

403(b), 457(b), or SARSEP Plans 7

$6,000 $6,000 $5,500 $5,500 $5,500 $5,500

Individual Retirement Accounts (“IRAs”), for

individuals 49 and below

$5,500 $5,500 $5,500 $5,500 $5,000 $5,000

Individual Retirement Accounts (“IRAs”), for

individuals 50 and above

$6,500 $6,500 $6,500 $6,500 $6,000 $6,000

SIMPLE Retirement Accounts $12,500 $12,500 $12,000 $12,000 $11,500 $11,500

[Source URL: Employee Benefits Legal Resource Site]

Provided by Jackson National Life Distributors LLC

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