Advanced Underwriting Consultants

Ask the Experts – June 17, 2015

Question: If my client activates the income rider on my annuity, does that qualify for the substantially equal periodic payments exception to the early distribution penalty?

Answer:  Not necessarily.

The IRS gives us three methods under Code Section 72(t) to determine substantially equal periodic payments in order to avoid the 10% additional tax on distributions taken from qualified accounts before age 59 ½. The methods can be found in Revenue Ruing 2002-62, they are:

  • Required minimum distribution method
  • Amortization method
  • Annuitization method

Each of these methods requires its own calculation based upon the account value and the life expectancy of the account owner. Simply receiving a set amount each year from an income rider does not necessarily meet these calculation requirements.

The payments from the income rider would have to exactly equal to the Section 72(t) substantially equal periodic payments determined by one of these methods to qualify as an exception to the additional tax on early distributions.

There is a free calculator for Section 72(t) distributions at http://72t.net/72t/Sepp/Calculators.

Ask the Experts – August 11, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client participates in a defined benefit plan that provides a joint and survivor annuity after retirement. If my client and his wife divorce, what happens to the potential spousal benefit?

Answer: If divorce occurs before the annuity payments begin, the qualified joint survivor annuity is usually cancelled, but it’s best to check with the plan administrator. That doesn’t mean the ex-wife will get nothing though. She may still be able to get a qualified domestic relations order (QDRO) that allows her to access a portion of the plan.

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Ask the Experts – May 30

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client’s mother passed away on July 10, 2009. My client inherited her mother’s nonqualified annuity but has failed to take any distributions from it since she inherited it. Is it too late to make a stretch election, or must she fully distribute the annuity within 5 years? What are the penalties if she fails to fully liquidate the annuity within 5 years?

Answer: There are multiple issues, but we’ll start with the basic rule. Under Code Section 72(s), an inherited annuity must either be stretched based on the life of the beneficiary or fully distributed within 5 years.

First, it’s not clear when the 5-year period starts. The language in the tax code indicates that the beneficiary must withdraw all the funds by fifth anniversary of the original owner’s death, which would be July 10, 2014 for your client. However, some carriers might interpret this rule to mean 5 years from the end of the year in which the person died—December 31, 2014, for your client. Therefore, your client should has until July 10, 2014, to fully distribute the annuity, but she should check with the carrier first.

Assuming the carrier interprets the 5-year rule to be from the date of death, your client will have no choice but to liquidate the annuity by July 10, 2014, because that’s written in the annuity contract. That is, the life insurance company will distribute the funds from the nonqualified annuity by July 10 whether your client wants the money or not.

Finally, your client must have elected to stretch within one year from her mother’s death, which was on July 10, 2010, if she wanted to stretch out the nonqualified annuity payments based on her life expectancy. Unlike with IRAs, there are no exceptions.

The tax code is not clear as to the timing of distributions when a beneficiary elects to stretch. Section 72(s) only requires that the annuity be distributed “over the life of such designated beneficiary,” so it’s best to check with the carrier to figure out how it handles these types of elections.

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Ask the Experts – May 22

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: Can severance pay be contributed toward a 403(b) tax-sheltered annuity?

Answer: Although a participant in a 403(b) plan contribute up to a $17,500 of her salary to the plan in 2014, the participant cannot contribute more to a 403(b) plan than she earns as compensation for the year. Whether severance pay constitutes “compensation” depends on when the participant receives it.

The general rule is that compensation does not include severance pay if it is paid after severance from employment. Treas. Reg. § 1.415(c)-2(e)(3)(iv). For example, if your client was fired early in 2014, but will receive 6 months of severance pay in 2014, then she cannot contribute to the 403(b) plan.

If the severance pay is actually payment for unused sick, vacation, or other leave, or if the payment is received as part of a nonqualified unfunded deferred compensation plan, then the payments are considered “compensation” and therefore may be deferred to the 403(b) plan.

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Ask the Experts – April 30

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: My client is the executor of an estate, and the estate itself is the beneficiary of an IRA and a deferred annuity. How does an executor decide when and to whom to make distributions from these retirement accounts?

Answer: Since the estate is the beneficiary of the deferred annuity, the deferred annuity must be liquidated within 5 years from the original owner’s death. The same rule applies to the IRA if the deceased was younger than 70 ½ at her death. If older, the estate has the option to stretch distributions over the life expectancy of the deceased based on her age at her death using the single life table published by the IRS.

The executor should make sure these distribution rules are met to ensure that these two accounts aren’t hit with RMD penalties. Additionally, the estate is liable for income taxes on these distributions, and estates are typically taxed at higher rates than individuals.

The next step is getting the annuity and IRA funds from the estate to the estate’s beneficiaries. The executor must work with the probate court to figure out who receives what portion of these distributions. Once it’s determined, the executor can make the proper distributions.

On a related note, estates often incur various bills. The executor can seek permission from the probate court to apply estate funds to such bills.

This may seem troublesome and potentially costly, but it could have been avoided by not naming the estate as beneficiary of the deceased’s IRA and annuity. Keep in mind that this choice was made when the deceased named her estate as the beneficiary to her retirement accounts.

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Ask the Experts – March 13

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: I have a client with two separate IRAs. If he purchases an immediate annuity with one, and it pays more than his RMDs for that specific IRA, could the excess annuity payments be carried over to satisfy a portion of the other IRA’s RMDs?

Answer: We’re not entirely positive since the IRS hasn’t addressed this specific scenario. The conservative answer is that no, your client cannot use an immediate annuity to satisfy her other IRA. However, the logical answer is that she should be able.

While RMDs must be calculated separately for each IRA, the separately calculated amounts may then be aggregated, and the total distribution can be taken from any one or more of the individual’s IRAs.

On the other hand, Regulation Section 1.401(a)(9)-6 states that distributions are required over the life expectancy of the account holder, or over a shorter period. The IRS might argue that where an account holder annuitizes an IRA, she is choosing a shorter period than her own life expectancy.

If your client takes the conservative route, she should not credit the immediate annuity payments towards her other IRA.

If she does decide to credit any excess annuity payments to her other IRA, it seems reasonable to calculate the value of the annuitized IRA by using a present value calculation of all the payments due. Once she has the value determined, she can figure out how much she theoretically must distribute to meet the RMD rules. Any excess could then be used against her other IRA.

We’re not advocating one way or the other, but clients should understand the risks associated with their positions.

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Ask the Experts – March 12

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: I have a client who participates in both his employer-sponsored 403(b) annuity and a simplified employee pension (SEP) for his own side-business. Can he make the full contribution limits for both, or are there restrictions?

Answer: His SEP contribution limit could be reduced by the amount he contributes to his 403(b) account.

In 2014, the limit on elective deferrals is $17,500 for 403(b) annuities. This limitation is per individual—not per plan. The contribution limit for any pension or profit-sharing plan maintained by the same employer is $52,000. SEP plans are slightly different, where the contribution limit is the lesser of $52,000 or 25 percent of the individual’s income.

An employee can generally contribute the full $17,500 in elective deferrals to one employer’s plan, and also make the maximum $52,000 contribution to another employer’s pension or profit-sharing plan. However, Section 415(k)(4) provides for a special rule between 403(b) annuities and SEP plans that essentially treats both plans as maintained by the same employer for purposes of the contribution limits.

Therefore, the $52,000 SEP limit would be reduced by the amount the participant contributes to his 403(b) annuity. If he contributes the maximum $17,500 elective deferrals to the 403(b) annuity, the $52,000 limit decreases to $34,500. In other words, he can now only contribute the lesser of $34,500 or 25 percent of his income.

This reduction from $52,000 to $34,500 will only affect an individual who earns more than $138,000 in his self-employed business because if his self-employment income is $138,000 or less, such contributions would be limited to 25 percent of his income (i.e. $34,500 is 25 percent of $138,000)—in other words, the $34,500 limit is irrelevant for such individuals. If he earns more than $138,000, he’s limited to $34,500 instead of $52,000.

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