Longevity annuities are contracts that provide life annuity payments typically commencing at age 80 or 85; in many (but not all) cases, that is the only benefit the contract provides. As such, these contracts may offer cost-effective “tail risk” protection for a retirement plan participant’s decumulation strategy. However, that contract design – in particular, the economic value of the future annuity payments that are not available for distribution prior to the specified age, and the possibility of a “doughnut hole” in distributions if a plan participant’s other plan balances are exhausted prior to that age – raises questions under the required minimum distribution (RMD) rules for account balance plans, which mandate that the RMD be based on the entire account balance.
Regulations published on July 2, 2014, finalizing a February 2012 proposal and effective immediately, provide a method for compliance with the RMD requirements applicable to qualified defined contribution plans, individual retirement accounts (IRAs), and 403(b) and governmental 457(b) arrangements for “qualifying longevity annuity contracts” (QLACs). Under the regulations, the value of QLACs are excluded from the account balances used to determine RMDs, and QLAC distributions would be treated as meeting the RMD requirements. The final regulations substantially follow the approach of the proposed regulations, with a number of helpful refinements and clarifications provided in response to comments on the proposal.
QLAC definition. Generally to constitute a QLAC under the regulations:
- The amount of premiums paid for the contract may not exceed the lesser of $125,000 or 25% of the employee’s account balance on the date of payment.
The proposal capped QLAC premiums at $100,000. The increased dollar limit in the final regulation allows 25% of accounts up to $500,000 to be allocated to QLACs. The dollar limit will be indexed for a cost-of-living adjustment in the manner provided under Internal Revenue Code (Code) section 415(d), in $10,000 increments.
- The specified annuity starting date (ASD) must be no later than the first day of the month next following the employee’s attainment of age 85 (subject to any adjustments published from time to time by the Internal Revenue Service (IRS) for changes in mortality). After the ASD, the contract distributions must satisfy the RMD rules.
- The death benefit must be a life annuity.
- The QLAC may not be a variable contract, equity-indexed contract or similar contract, although the IRS is authorized to publish in the future guidance providing an exception to this limitation, and a contract providing for either dividends or cost-of-living adjustments as described in the RMD regulations is permissible.
- The QLAC may not provide a commutation benefit, cash surrender value or similar right, except as noted below.
- The QLAC must state in the contract form or in a rider or endorsement or in a group certificate, when issued, that it is intended to be a QLAC, except that contracts issued before 2016 have until December 31, 2016, to incorporate this language.
- The issuer of the QLAC must satisfy certain disclosure and annual reporting requirements.
Limitation on premiums. The 25% limit applies separately to each plan, including 403(b) plans, except that for IRAs it applies across all of the taxpayer’s IRAs (other than Roth IRAs). A QLAC may be held in any of the taxpayer’s permissible IRAs. Annuities purchased under a Roth IRA will not constitute a QLAC because Roth IRAs are not subject to the RMD requirements applicable prior to an employee’s death.
The $125,000 limit applies to all plans and is reduced by any premium payments an employee has previously made for the same contract or for any other contract under any other plan that is intended to be a QLAC.
For purposes of determining whether premiums exceed the dollar or percentage limitation, an IRA provider may generally rely on an IRA owner’s representation, unless the issuer has actual knowledge to the contrary.
The final regulations include several helpful refinements to the premium limitation:
- The premium limitation is applied as of the last plan valuation date preceding the premium payment, increased by contributions and decreased by distributions made after the valuation date but before the date the premium is paid.
- The value of the QLAC is included in the account balance for purposes of applying the 25% limit (but not for purposes of calculating RMDs).
- In an important change from the proposal, any premium in excess of the limit that is returned to the non-QLAC portion of the plan prior to the end of the calendar year following the calendar year in which the excess was paid will not cause the contract to fail as a QLAC. Otherwise, an excess premium disqualifies a QLAC as of the date that premium is paid.
Maximum age at commencement. The regulations allow a participant to elect an earlier ASD than age 85 if the QLAC provides such an option. However, QLACs are not required to permit commencement prior to age 85.
Permissible benefits after the death of the employee. As in the proposal, the final regulations permit a QLAC to provide a life annuity after the employee’s death. Thus, a contract that permits payment in the form of a life annuity with a period certain upon death would not be a QLAC.
- If the sole beneficiary under the QLAC is the employee’s surviving spouse, the only benefit permitted to be paid after death is a life annuity payable to the surviving spouse that does not exceed 100% of the annuity payment payable to the employee. The regulations provide an exception that will apply when necessary to comply with the qualified preretirement survivor annuity rules.
- In the case of a non-spouse beneficiary, to satisfy the minimum distribution incidental benefit requirements under Code section 401(a)(9)(G), the regulations provide that the life annuity upon death is not permitted to exceed an applicable percentage of the annuity payment payable to the employee. The applicable percentage is determined under one of two tables – the percentage described in the existing table in Treas. Reg. § 1.401(a)(9)-6, A-2(c) or a new table set forth in the final regulations. The first table is only available if no death benefits are payable to a non-spouse beneficiary in any case in which the employee selects an ASD that is earlier than the specified ASD and dies less than 90 days after making that election, even if the employee’s death occurs after the selected ASD. The new table under the regulations is available when the contract provides a pre-annuity-starting-date death benefit to a designated non-spouse beneficiary.
In addition, in response to comments, the final regulations also permit a QLAC to provide, either before or after the ASD, a return of premium benefit (premiums paid less QLAC distributions) on the death of the employee in a single life QLAC or, if coverage is also provided for a surviving spouse, on the death of both the employee and the spouse. This death benefit must be paid in a single sum no later than the end of the calendar year after the calendar year of the employee’s and/or spouse’s death as applicable. This payment is not eligible for rollover.
Disclosure and annual reporting requirements. The final regulation omits the initial disclosure of the proposal, in light of otherwise applicable disclosure requirements under state and federal law, but retains the requirement of an annual report to the employee (by January 31 of the following year) and the IRS (by a filing date to be specified by the IRS) under Code section 6047(d) including at least:
- A statement that the contract is intended to be a QLAC;
- Identifying information about the contract issuer;
- Identifying information about the contract owner;
- If the QLAC is purchased pursuant to a plan, identifying information about the plan;
- If payments have not commenced, the ASD, the amount of the periodic annuity payable on that date, and whether that date may be accelerated;
- The date and amount of premiums paid during the calendar year;
- The total premiums paid for the contract through the end of the calendar year;
- The fair market value of the QLAC as of the end of the calendar year; and
- Other information that the IRS may require.
The IRS will prescribe a form for this purpose. Reports must be filed starting with the first calendar year for which a premium is paid and ending with year in which the employee attains age 85 (or other adjusted age) or dies, except that if the surviving spouse is the sole beneficiary, reporting must continue until the surviving spouse starts receiving payments or dies.
Defined benefit plans. Treasury requested further commentary on the possible replication of the QLAC structure in defined benefit plans, including as an alternative to a lump sum distribution, and deferred consideration of those issues for potential future guidance.