Outside Publication

New Qualified Plan Guidance Is Designed to Facilitate Lifetime Income Payment Options, Journal of Taxation, May 2012 Ed. (Thomson Reuters)

May 2012

The combination of increased retiree longevity and increased prices has resulted in many older Americans outliving their retirement savings. There are lifetime income payment options that would ameliorate this problem, but which are not offered by most defined benefit or defined contribution plans. New guidance would begin to make it easier for plan sponsors to incorporate these options.

Early in February, Treasury and the IRS released a package of Proposed Regulations and Revenue Rulings intended to encourage the use of lifetime income options by tax-qualified retirement plans and IRAs. The guidance is designed to broaden the range of payment options offered by plan sponsors and employers to participants, with the goal of increasing the use of lifetime income forms of payment-such as deferred or longevity annuities-to help retirees plan better for the risk of outliving or overspending their retirement savings.

The new initiative contains four items of guidance:

Prop. Reg. 1.417(e)-1 (REG-110980-10, 2/2/12): Proposed Regulations that would make it easier for defined benefit plans to offer

"bifurcated accrued benefits" that are paid partly as an annuity and partly as a more accelerated lump-sum benefit.

  • Prop. Regs. 1.401(a)(9)-5 and 1.401(a)(9)-6 (REG-115809-11, 2/2/12): Proposed Regulations that modify the required minimum distribution (RMD) rules to allow for participants in qualified defined contribution plans and IRAs to use their account balances to purchase "qualified longevity annuity contracts," which provide guaranteed income beginning at an advanced age.
  • Rev. Rul. 2012-3, 2012-8 IRB 383: Revenue Ruling clarifying the applicability of qualified joint and survivor annuity (QJSA) and qualified preretirement survivor annuity (QPSA) rules to deferred annuity contracts purchased under a qualified profit sharing plan.
  • Rev. Rul. 2012-4, 2012-8 IRB 386: Revenue Ruling clarifying how employees who participate in a defined contribution plan and a defined benefit plan sponsored by the same employer can use an amount "rolled over" from the defined contribution plan to the defined benefit plan to purchase a lower cost annuity from the defined benefit plan.

This administrative guidance was released shortly after President Obama's State of the Union address, and addresses the lack of guaranteed lifetime income options available to many retirees. In a report released simultaneously with the February 2 guidance, the Executive Office of the President, Council of Economic Advisers, cited the aggregate shift from traditional defined benefit plans to Section 401(k)-type plans and hybrid defined benefit plans, and the corresponding shift of investment and longevity risk from employers to workers, as a source of the diminished availability of lifetime income benefits. 1 The problem is exacerbated by the popularity of lump-sum payment options among participants. 2

The recent guidance is designed to reduce certain regulatory barriers that have, to date, limited lifetime income options. 3 By reducing these barriers to annuitization, the IRS hopes to encourage plan sponsors to offer the options and retirees to choose them. Retirees who select such options can better prepare themselves for the risk of outliving their savings, while better managing their retirement assets over a finite period.

The Service expects the 2/2/12 guidance to be followed by continued dialogue and further retirement income guidance from both Treasury and the Labor Department later in the year. 4 Public hearings on the Proposed Regulations are scheduled to be held on June 1.


Prop. Reg. 1.417(e)-1 provides guidance for the treatment of optional distribution forms that are paid partly as an annuity and partly in

a more accelerated form, such as a single-sum cash payment. By modifying the rules in existing Reg. 1.417(e)-1 regarding the minimum present value requirements for defined benefit plans, Treasury and the IRS seek to simplify the calculation of bifurcated benefits in an effort to encourage plans to offer split options featuring lifetime income.

Defined benefit plans typically offer participants a mutually exclusive choice between annuity options and lump-sum payment options. According to the government, this presents a less than optimal "choice architecture." 5 When choosing between an annuity or a lumpsum cash payment, many participants, reluctant to sacrifice liquidity for longevity, will opt for the lump sum. The Proposed Regulations make it easier for plans to offer each participant both the protection of a lifetime income stream and the liquidity of a lump-sum distribution.

Under the current Regulations, a plan offering a bifurcated payment option (consisting of a partial lump sum and partial annuity) would have to use the actuarial assumptions of Section 417(e)(3) to calculate both parts of the benefit. The inability to use the plan's regular conversion factors to determine the amount of the partial annuity is a practical administrative burden that may discourage plans from offering such bifurcated options.

The Proposed Regulations would provide an exception to this general rule for a bifurcated accrued benefit. Under the exception in Prop. Reg. 1.417(e)-1(d)(7) , if a participant selects two different distribution options with respect to separate portions of his accrued benefit, those two distribution options are treated separately for purposes of Section 417(e)(3) actuarial requirements. The plan would have to apply the Section 417(e)(3) actuarial assumptions only to the non-exempted portion of the benefit (e.g., the lump sum), rather than to the entire optional form of benefit. Thus, if a plan offers a bifurcated annuity and lump-sum payment, the plan would have to apply the Section 417(e)(3) actuarial assumptions only to the lump-sum portion, and would be able to use its usual annuity equivalence factors for the annuity portion of the benefit. This calculation method is administratively simpler and produces a more intuitive result, according to Treasury and the IRS. 6

There are several ways to structure benefit options eligible for simplified treatment under the Proposed Regulations. Generally, a qualifying bifurcated accrued benefit is defined in Prop. Regs. 1.417(e)-1(d)(7)(iii) through (v) as a form of benefit that provides for:

  1. Two separate portions of the accrued benefit that are determined without regard to any election of optional form of benefit, whereby a participant may choose different forms of benefit with respect to each of those portions of the accrued benefit ("separately determined benefits"),
  2. A participant to apply different distribution elections to different portions of the accrued benefit so that the amount of the distribution, with respect to the distribution election applied to its respective portion of the accrued benefit, is the pro rata portion of the amount of the distribution that would be determined if that distribution election had been applied to the entire accrued benefit ("separate election for proportionate benefits"), or
  3. A single-sum distribution option with respect to only a portion of the benefit and a separate benefit election for the remainder of the distribution ("single sum with separate election for remainder").

In order to offer these qualifying bifurcated accrued benefits, a plan would have to provide explicitly that if a participant selects two different distribution options with respect to separate portions of the bifurcated accrued benefit, the two different distribution options are treated as two separate optional forms of benefit for purposes of applying the requirements of Section 417(e)(3). Therefore, a plan sponsor generally would have to amend its plan to provide for the use of plan factors instead of Section 417(e)(3) factors in qualifying circumstances. 7


Prop. Regs. 1.401(a)(9)-5 and 1.401(a)(9)-6 modify the RMD rules to facilitate the purchase of annuities that begin at an advanced age by participants in qualified defined contribution, Section 403(b) and eligible governmental Section 457 plans, as well as Section 408 individual retirement accounts and annuities. The Proposed Regulations generally would exclude the value of such "qualifying longevity annuity contracts" from the account balance used to determine a participant's RMDs. Treasury and the IRS hope that, by providing relief from the minimum distribution requirements, the Proposed Regulations will encourage the purchase of annuities that will ensure lifetime income as life expectancies continue to grow. 8

In response to a joint request for information issued in 2010 by Treasury and the Labor Department, commentators identified RMD rules as an impediment to the purchase of deferred lifetime income options by defined contribution plan participants. 9 Under existing RMD rules, prior to annuity commencement, the value of an annuity contract held under a defined contribution plan is included in the account balance used to determine RMDs from a participant's account. Because RMDs are calculated by dividing the participant's entire account balance by the participant's (or the participant's and beneficiary's) life expectancy, participants may have difficulty meeting a higher RMD amount due to inclusion of the annuity value in their account balance. 10 In some instances, if the remainder of the account already has been depleted, participants may be forced, under the current RMD rules, to draw from the annuity before reaching the designated start date. This uncertainty may discourage participants from purchasing longevity annuities, as evidenced by the rarity of such offerings by Section 401(k) plans and IRAs. 11

The Proposed Regulations exclude the value of any "qualifying longevity annuity contract" from the account balance used to calculate RMDs. 12 Since the value of qualifying annuities would no longer be a factor in RMD calculations, participants will no longer be required to receive early distributions from the annuity contract to satisfy RMD rules, and consequently these annuities would be able to provide a fixed start date without accelerated commencement. 13

This special treatment under the RMD rules is reserved for "qualified longevity annuity contracts," or QLACs. A QLAC is defined as an annuity contract offered under a qualified plan that meets all of the following conditions:

  1. The amount of premiums paid does not exceed $100,000 or 25% of participant's account balance. 14
  2. The annuity payments start no later than age 85.
  3. The contract does not make available any commutation benefit, cash surrender right, or similar feature.
  4. No benefits are payable after a participant's death except certain life annuity benefits payable to a designated beneficiary.
  5. The contract states that it is intended to be a QLAC. 15

Issuers of QLACs must also satisfy certain reporting and disclosure requirements. 16

The IRS wants to encourage the purchase of QLACs as a method of hedging the risks of outliving retirement assets. Significant income can be provided by a longevity annuity, even with the $100,000 or 25%-of-account-balance caps. For example, an annuity commencing at age 85, purchased at age 70 for $100,000, could provide expected annual income between $26,000 and $42,000 (assuming a 3% interest rate, no pre-commencement death benefit, use of the Annuity 2000 Mortality Table, and no indexation for inflation or load for expenses). 17 With a guaranteed income stream starting at age 85, participants can better manage their retirement assets through a predetermined date, while also guaranteeing that they won't outlive their nest eggs.


In Rev. Rul. 2012-3, the IRS addressed the application of the QJSA and QPSA rules when a deferred annuity contract is purchased under a profit sharing plan. The guidance in Rev. Rul. 2012-3 identifies plan and annuity terms that will protect spousal rights automatically without requiring spousal consent before the annuity starting date. 18 Because QPSA and QJSA spousal protection rules can be administratively burdensome, the IRS hopes that the addition of certainty to the application of those rules will encourage plans to offer deferred annuity options, such as longevity annuities.

Generally, defined benefit and money purchase plans are required to provide spousal death benefits in the form of a QJSA 19 and QPSA. 20 QJSA and QPSA requirements also apply to profit sharing and stock bonus plans, unless:

  1. The plan provides that any account balance not paid before a participant's death is payable to the participant's surviving spouse (or designated beneficiary, if there is no surviving spouse).
  2. The participant does not elect payment of benefits in the form of a life annuity.
  3. With respect to the particular participant, the plan is not a direct or indirect transferee of a defined benefit or money purchase plan. 21

If a profit sharing plan separately accounts for a life annuity, only the portion of a participant's account balance covered by the life annuity election will be subject to QJSA and QPSA requirements. 22 If a participant's account is subject to the QJSA and QPSA requirements, the applicable rules are multifold, and include various waiver, spousal consent, written explanation, and availability requirements. 23

Rev. Rul. 2012-3 establishes conditions under which a profit sharing or stock bonus plan may offer an annuity option and remain exempt from the QJSA and QPSA requirements. Absent this guidance, it was unclear whether election of a deferred annuity would be treated as election of a life annuity option to which QJSA and QPSA requirements would attach. Under the Revenue Ruling, however, even though a life annuity may be the default payment under a deferred annuity contract, if a participant has the option to elect another form of payment before the annuity starting date (such as a lump sum or a transfer of the account to another investment option), so long as a participant does not make an affirmative election of a life annuity during 180 days prior to the annuity starting date, that participant is considered not to have elected a life annuity until his annuity starting date.

Therefore, if a plan is not otherwise subject to the QJSA and QPSA requirements and satisfies the other conditions for exemption from those requirements, a deferred annuity option will not subject the plan to QJSA and QPSA requirements so long as the participant does not irrevocably elect the life annuity payment option prior to the annuity starting date. On the annuity starting date, unless the participant has elected a different distribution form, the participant is deemed to have elected a life annuity form of payment, and the plan would then be subject to QJSA requirements with regard to the deferred annuity. 24 As long as the plan also separately accounts for the deferred annuity contract, the remainder of the plan and the participant's account, if any, are not subject to QJSA and QPSA requirements by virtue of Rev. Rul. 2012-3.

The Ruling also addresses several design nuances for compliance with QJSA and QPSA requirements by a plan offering a deferred annuity option. In particular, Rev. Rul. 2012-3 points out that a deferred annuity is exempt from the QJSA and QPSA requirements only if there is a choice presented to the participant to elect another form of payment. If a participant is not allowed to transfer out of the annuity contract, or to take the annuity amount as a single-sum payment, then the participant is effectively "locked in" to the annuity form of benefit. In that event, a participant will have elected a life annuity by electing the deferred annuity contract, and his account will be subject to QJSA and QPSA requirements (with regard to that annuity contract) as of the date he first invests in the deferred annuity contract. Nevertheless, so long as the plan also separately accounts for the deferred annuity contract, the remainder of the plan and the participant's account, if any, are not subject to QJSA and QPSA requirements.


In Rev. Rul. 2012-4, the IRS provides guidance for how a rollover of a lump-sum distribution from an employer's defined contribution plan to that same employer's defined benefit plan can be used to purchase an annuity under the defined benefit plan. By clarifying the applicable valuation rules, the IRS hopes to encourage employers that sponsor both types of plans to offer an annuity purchase option under their defined benefit plans. 25 The Ruling applies to rollovers after 1/1/13.

Certain defined benefit plans may provide, among various optional forms of benefit, for a supplemental annuity based on the actuarially equivalent value of an amount rolled over from the profit sharing or other defined contribution plan (such as a Section 401(k) plan). Because a rollover is treated as a distribution to the participant that is subsequently contributed by the participant to the defined benefit plan, the amount rolled over is treated as an employee contribution for the purposes of the nonforfeitability provisions and contribution limits of Sections 411 and 415, respectively. The Revenue Ruling sets the following valuation guidelines for converting a rollover from a Section 401(k) or other defined contribution plan into an immediate straight life or other form of annuity:

  1. The defined benefit plan does not violate Section 411 or Section 415 if the defined benefit plan converts the rollover amount using the actuarial assumptions set forth in Section 417(e).
  2. An annuity that is determined using less favorable actuarial assumptions fails to satisfy the nonforfeitability requirement of Section 411(a)(1) . This is because the value of the incremental additional annuity the participant receives would be deemed to be less than the full actuarially equivalent value of his rollover contribution.
  3. If an annuity is determined using more favorable assumptions (so that the annuity value would be greater than the deemed actuarially equivalent value of the participant's rollover contribution), the excess over the value calculated using the Section 417(e) assumptions will be treated as attributable to employer contributions and be subject to Section 411's nonforfeitability rules for such benefits and Section 415 's annual limits. In addition, any excess value would not be treated as part of the rollover and would instead be taken into account for purposes of the nondiscriminatory amount requirement of Section 401(a)(4).

If the annuity starting date is after the time of the direct rollover (e.g., the purchased annuity is not an immediate annuity), Rev. Rul. 2012-4 provides that the plan must credit interest to the rollover amount at 120% of the federal mid-term rate until the annuity starting date. The value of any credited interest is included in the total amount of the annuity calculated using Section 417(e) actuarial assumptions.

The Ruling also provides guidance for the death benefits payable under the defined benefit plan if the participant dies after the rollover but before the annuity starting date. If a participant dies before the annuity commences, a benefit equal (or actuarially equivalent) to the amount rolled over (plus interest, if applicable) must be paid to the participant's beneficiary, in addition to any death benefits that the beneficiary would have received without the rollover. If the participant is married and has not waived the QPSA form of death benefit, the spousal beneficiary will receive a life annuity actuarially equivalent to the amount rolled over (plus interest, if applicable), in addition to any death benefits that the surviving spouse otherwise would have received without the rollover.


This initial guidance does not address all of the issues that have been raised by commentators concerning the paucity of lifetime income options. Instead, it is a first step in clearing the way for increased accessibility to a broader selection of retirement income options. 26 By addressing specific regulatory hurdles surrounding annuitization, the guidance seeks to pave the way for investment in deferred lifetime annuity options.

It remains uncertain, however, whether this will indeed trigger the increased plan sponsor and retiree interest in annuity investments that the IRS intends. Plan sponsors may remain unwilling to assume additional fiduciary responsibilities attendant to the selection of annuity products to offer under their retirement plans. Relief from the Department of Labor would be most welcome on this front. And retirees will still need to overcome their reluctance to trade, even in part, a more liquid form of benefit for an irrevocable, more complex option that may well be priced above market. 27

As published in the May 2012 edition of the Journal of Taxation

1. Executive Office of the President, Council of Economic Advisers, Supporting Retirement for American Families (2/2/12) ("CEA Report").

2. Id. The IRS also voiced concerns regarding longevity planning among retirees in its recent (3/6/12) "401(k) Questionnaire Interim Report IRS Phone Forum," citing the fact that the most common form of benefit among surveyed Section 401(k) plans was the lumpsum payment. See www.irs.gov/retirement/article/0,,id=218995,00.html.

3. CEA Report, supra note 1. The CEA Report also presents statistics suggesting that private access to annuities is limited, and that the percentage of defined contribution plans offering such investment options has decreased over time.

4. Treasury Fact Sheet: Helping American Families Achieve Retirement Security by Expanding Lifetime Income Choices (2/2/12).

5. Id.

6. See the Preamble to REG-110980-10, 2/2/12.

7. If the plan previously provided for a split benefit, and the plan is amended to treat that benefit as a bifurcated accrued benefit pursuant to the Proposed Regulations, the plan must ensure that the resultant benefit is at least the amount of the benefit under the previous method in order to comply with the anti-cutback rules of Section 411(d)(6) .

8. See the Preamble to REG-115809-11, 2/2/12.

9. See the Treasury Fact Sheet, supra note 4.

10. Inclusion of the annuity in the value of the account also raises certain valuation problems, such as an overvaluation based on the ability to accelerate annuity payments, regardless of whether the participant actually elects to do so. See note 8, supra.

11. Id.

12. Prop. Reg. 1.401(a)(9)-5, A-3(d).

13. See note 8, supra.

14. The $100,000 limit is cumulative among all plans in which a participant participates. See Prop. Reg. 1.401(a)(9)-6 , A-17(b)(2)(ii).

15. Prop. Reg. 1.401(a)(9)-6, A-17(a).

16. Prop. Reg. 1.6047-2 sets forth the information disclosure requirements for QLAC providers. Providers generally will have to issue an initial disclosure to purchasers of QLACs, along with annual reports to be furnished to the IRS and purchasers.

17. See note 8, supra.

18. See the Treasury Fact Sheet, supra note 4.

19. A QJSA is defined in Section 417(b) as an annuity for the life of the participant with a survivor annuity for the life of the spouse which is neither less than 50% nor more than the amount of the annuity payable during the joint lives of the participant and the spouse, which is the actuarial equivalent of a single annuity for the life of the participant.

20. A QPSA is defined in Section 417(c)(2) , for defined contribution plans, as an annuity for the life of the surviving spouse the actuarial equivalent of which is not less than 50% of the portion of the account balance of the participant (as of the date of death) to which the participant had a nonforfeitable right.

21. Section 401(a)(11)(B)(iii).

22. Reg. 1.401(a)-20, A-4.

23. Section 417(a).

24. With the exception of the spousal consent rules, for which the insurance company issuing the annuity contract would be responsible for assuring compliance. See the Treasury Fact Sheet, supra note 4.

25. See the Treasury Fact Sheet, supra note 4.

26. See the Treasury Fact Sheet, supra note 4.

27. Economists have proposed various "annuitization barriers," as described in the CEA Report, supra note 1, to explain the lack of popularity of immediate or longevity annuities among retirees. These annuitization barriers include: concerns over the irrevocability of the choice to purchase an annuity; the desire to retain liquid assets in case of emergency or bequest; the complexity of annuities, lack of transparency, or concerns over the long-term financial soundness of annuity providers; a lack of understanding of longevity risk; and lack of familiarity with annuity products.