On July 29, 2008, the Treasury Department and Internal Revenue Service published final regulations providing for the valuation of annuities involved in Roth IRA conversions. The regulations were issued in temporary and proposed form in August 2005 (click here for our alert on this earlier guidance), and refined on an interim basis in Rev. Proc. 2006-13, 2006-1 C.B. 315 (click here for our alert on this revenue procedure). The final regulations adopt the refined guidance previously issued, with certain modifications.
Thus, the final regulations provide that if a traditional (non-Roth) IRA annuity (either a section 408(b) individual retirement annuity, or a nonqualified annuity held as an investment of a section 408(a) IRA trust or custodial account) is involved in a Roth IRA conversion:
- In general, the fair market value of the annuity on the date of conversion is treated as distributed to the IRA owner for tax purposes. (If the annuity is fully surrendered and extinguished in connection with the conversion, with no retained or transferred rights surviving the surrender, the surrender proceeds rather than the fair market value become the taxable amount.)
- That fair market value is determined under one of three methods, the first two of which are derived from the methodology that applies for gift tax purposes:
- If the insurance company currently sells comparable contracts – and if the conversion occurs "soon after" the contract was issued (a concept not elaborated in the regulation), the actual contract is itself the benchmark"comparable contract" – the purchase price for such a comparable contract is the fair market value (the "comparable contract" method).
- If there is no comparable contract, the fair market value is approximated based on the interpolated terminal reserve of the contract at the date of the conversion, plus the proportionate part of the gross premium last paid before the date of the conversion which covers the period extending beyond that date.
- Alternatively, the fair market value of an annuity contract is permitted to be determined using the “accumulation method” provided in Treas. Reg. §1.401(a)(9)-6, A-12, except that (i) all front-end loads and other non-recurring charges assessed in the 12 months immediately preceding the conversion must be added to the account value, (ii) future distributions are not to be assumed in the determination of the actuarial present value of additional benefits, and (iii) the exclusions provided under §1.401(a)(9)-6, A-12(c)(1) and (c)(2) are not to be taken into account.
- The regulation permits the IRS to issue guidance approving additional methods.
- If a method does not reflect the “full value” of the annuity because it has an “unusual nature,” that method may not be used.
The final regulations are effective for annuities distributed or deemed distributed from traditional IRAs in a Roth conversion on or after August 19, 2005, except that if the distribution occurs or is deemed to occur before 2009, the valuation may instead be based on the temporary regulations or Rev. Proc. 2006-13 (including the special rule for 2005 conversions in the temporary regulations).