IRA participants can purchase longevity annuities

Final regulations issued on Wednesday (T.D. 9673) permit individual retirement account (IRA) participants to enter into contracts for annuities that begin at an advanced age (often called longevity annuities), using a certain amount of their account balances, without having these amounts count for calculating required minimum distributions from the IRAs under Regs. Sec. 1.401(a)(9)-6. The rules allow participants in qualified defined contribution plans, 403(b) and eligible governmental 457 plans as well as IRAs (but not Roth IRAs or defined benefit plans) to purchase these contracts, which are called qualifying longevity annuity contracts (QLACs).

QLACs are intended to allow participants to hedge against the risk of outliving their retirement savings. QLACs are required to begin distributions no later than the month after the participant’s 85th birthday, but can provide for an earlier starting date. Participants are permitted to exclude the value of the QLAC from the account balance that is used to determine required minimum distributions. (The maximum age for beginning distributions may be adjusted in the future to reflect changes in mortality.)

The premiums paid for the QLACs are limited to the lesser of $125,000 (adjusted for inflation) or 25% of the participant’s account balance at the date of payment. If the premiums (which are added together if multiple contracts are purchased) exceed these amounts, the contracts will not cease to be QLACs as long as the excess amounts are refunded in the next calendar year.

QLACs are permitted to pay benefits after the death of the participant, but those benefits are limited. If the sole beneficiary is a surviving spouse, the spouse is permitted to receive a life annuity, provided it does not exceed 100% of the annuity the participant received. However, the final regulations include a special exception that would allow a plan to comply with any applicable requirement to provide a qualified preretirement survivor annuity. If the surviving spouse is not the sole beneficiary, the payments are limited to an amount determined under Sec. 401(a)(9)(G).

To encourage retirees to purchase QLACs without worrying that they may not receive their investment back, the final regulations permit a QLAC to provide for a single-sum death benefit to be paid to a beneficiary in an amount equal to the excess of the QLAC premium payments over the payments made to the employee under the QLAC (a return of premium). If a QLAC is providing or will provide a life annuity to a surviving spouse, it may also provide a return of premium after both the employee and the spouse die. A return of premium payment must be paid no later than the end of the calendar year following the calendar year in which the employee dies or the surviving spouse dies, whichever applies. If the employee dies after the required beginning date, 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.

Because a QLAC is often purchased many years before its payments would begin, the rules require annual reporting to the IRS and the participant. The reports must begin in the calendar year in which the premiums are first paid and end with the earlier of the year the individual for whom the contract was purchased turns 85 or dies. However, if the individual who dies has a surviving spouse as the sole beneficiary, reporting must continue until the year the spouse’s distributions commence or the spouse dies, if earlier.

The new rules apply to QLACs purchased on or after July 2, 2014. To permit annuities purchased before these regulations became final to avoid surrender charges for contract reissuances, the final rules contain a transition rule allowing an existing contract to be exchanged for a contract that satisfies the requirements to be a QLAC. The new contract will be treated as purchased on the date of the exchange and therefore may qualify as a QLAC. The fair market value of the contract that is exchanged for a QLAC will be treated as a premium that counts toward the QLAC limit.

—Sally P. Schreiber (sschreiber@aicpa.org) is a JofA senior editor.