September 22, 2014

Longevity Insurance and the Minimum Distribution Requirements

Mark J. Warshawsky

Former Senior Research Fellow
Summary

Earlier this summer, Treasury released the final version of its regulation carving out an exception for longevity insurance from the minimum distribution requirements applying to defined contribution accounts and IRAs. Minimum required distributions (MRDs), established by code section 401(a)(9), are a long-standing feature of the retirement regulatory regime. The intent behind MRDs is that tax-favored retirement assets, through timely distributions and thereby taxed as income, will be used for their primary purpose — to support spending in retirement.

Contact us
To speak with a scholar or learn more on this topic, visit our contact page.

Earlier this summer, Treasury released the final version of its regulation carving out an exception for longevity insurance from the minimum distribution requirements applying to defined contribution accounts and IRAs. Minimum required distributions (MRDs), established by code section 401(a)(9), are a long-standing feature of the retirement regulatory regime. The intent behind MRDs is that tax-favored retirement assets, through timely distributions and thereby taxed as income, will be used for their primary purpose — to support spending in retirement. The MRD rules require that an individual’s retirement assets be distributed — and taxed — over a period not extending beyond the life or life expectancy of the individual and his designated beneficiary.

Over the years, Treasury and the IRS have interpreted the code requirements in a fairly specific manner. This interpretation has in some cases inhibited financial and insurance retirement income innovations (products and strategies), in particular those using life income annuities, even if only as part of a more complete strategy. In this new regulation, Treasury has granted an exception to a partial annuitization strategy called longevity insurance or deferred income annuities. Hopefully, this development is a sign that other innovations will be similarly encouraged in the future, either piecemeal or, better, through a more fundamental reform of the regulations.

Minimum Distribution Requirements in General

Under the law, an individual’s entire interest in a qualified retirement plan or IRA must be distributed over his lifetime or expected lifetime or the joint lives of the participant and his beneficiary beginning at age 70ó or, if still a working participant in the plan at that age, when retired. The regulations under section 401(a)(9) provide different sets of rules for determining MRDs depending on whether the interest is in the form of an individual account or an annuity.

For an individual account, the MRD is determined by dividing the value of the account balance as of the end of the previous calendar year by the applicable distribution period specified in the regulations. The length of the distribution period is related to the remaining life expectancies of the individual and a hypothetical beneficiary 10 years younger or an actual spouse more than 10 years younger. As the individual ages, life expectancies and the distribution period shorten and MRDs increase in percentage terms with age — substantially so when the individual reaches his mid-80s.

Under the MRD regulations, the value of deferred annuity contracts1 generally must be included in the overall account balance subject to MRDs. Hence, even though no payments were made from the deferred contracts, but would eventually be if the insured survived, their value was subject to MRDs taken from other account balance assets. Under the new regulations, a deferred annuity is excluded from this treatment if it constitutes a qualifying longevity annuity contract (QLAC).

Continue reading