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IRS Guidance Encourages Use of Annuities in Retirement Plans

    Client Alerts
  • February 17, 2012

On February 2, 2012, the IRS issued regulatory guidance promoting lifetime income options for defined contribution plans, individual retirement accounts ("IRAs"), and defined benefit plans. This guidance is intended to allow retirement plans to offer lifetime income benefits to protect employees against the risk of outliving one's assets. The guidance includes the following:

Proposed regulations to encourage partial annuity distributions from defined benefit plans. Proposed rules seek to encourage defined benefit plan participants who more often than not elect lump sum distributions, to elect to receive a portion of their accrued benefit as an annuity, and the other portion as a lump sum payment. Under current regulations, if a participant elects both a partial annuity and lump sum payment, statutory actuarial assumptions must be used to calculate both forms of distribution.  If the new regulations become final, plans would only be required to use the statutory assumption to calculate lump sum payments, and could use the plan's regular conversion factor to calculate the partial annuity.

Proposed regulations to facilitate use of longevity annuities for defined contribution plans and IRAs. These regulations would modify the required minimum distribution rules allowing participants to use retirement plan account balances to purchase longevity annuities. A longevity annuity is an annuity with an income stream that begins at an advanced age, such as age 80. This type of annuity is an effective tool to manage longevity risk since the low cost of such annuities allow retirees to keep and maintain control over a larger portion of their retirement portfolio.

Currently, longevity annuities are not attractive options within a qualified benefit plan or IRA because of the required minimum distribution rules, which require distributions to commence at age 70 ½. Under the proposed regulations, any portion of a defined contribution plan or IRA invested in a longevity annuity would be disregarded for purposes of calculating required minimum distributions.

Revenue ruling clarifying spousal consent rules for defined contribution plans with deferred annuities. Revenue Ruling 2012-is designed to eliminate the uncertainty about how the spousal consent rules apply when employees purchase deferred annuities from their plans. Plan sponsors have been hesitant to offer certain annuity options (i.e., longevity annuities) in their defined contribution plans because of uncertainty whether failure to receive spousal consent would require the participant's account to be paid as a qualified pre-retirement survivor annuity ("QPSA") upon the participant's death to the surviving spouse. This IRS guidance states that when the participant invests in a deferred annuity, the participant's account is not subject to the QPSA requirement until the participant affirmatively elects to commence an immediate annuity distribution.

Revenue ruling addressing rollovers from defined contribution plans to defined benefit plans. This revenue ruling allows participants receiving a lump sum distribution from a defined contribution plan to transfer all or a portion of that lump sum payment to their employer's defined benefit plan (if permitted under the terms of the plan). The lump sum benefit would then be payable as an annuity in an actuarially equivalent manner under the terms of the defined benefit plan.