Advanced Underwriting Consultants

Non-qualified annuity beneficiary options

Recently, a caller asked about non-qualified annuity beneficiary options. 

There is a tension between Code Sections 72 (h) and 72 (s) over when the stretch election for non-qualified annuity beneficiaries must be made.  I’ve  excerpted Code Sections 72(h) and 72(s).  It seems clear to us based on context that 72(s) should be the provision that applies to non-qualified stretches.

Code Section 72 (s) says the beneficiary must make the stretch choice within one year after death.  Some companies may make it a practice to allow stretch until the end of the calendar year after death, but 72 (s) doesn’t expressly permit it.

We’re not sure that Section 1035 rules allow a tax-free exchange of a beneficiary’s account.  You’re going to be at the mercy of both the existing and new carriers if you try to transfer the beneficiary account to a new company.  The critical tax issues is whether the old carrier will report the transfer as a non-taxable event.  You’ll definitely want to check in advance.

Code Section Excerpts:

    (h) Option to receive annuity in lieu of lump sum
      If -
        (1) a contract provides for payment of a lump sum in full
      discharge of an obligation under the contract, subject to an
      option to receive an annuity in lieu of such lump sum;
        (2) the option is exercised within 60 days after the day on
      which such lump sum first became payable; and
        (3) part or all of such lump sum would (but for this
      subsection) be includible in gross income by reason of subsection
      (e)(1),
    then, for purposes of this subtitle, no part of such lump sum shall
    be considered as includible in gross income at the time such lump
    sum first became payable.

 

    (s) Required distributions where holder dies before entire interest
        is distributed
      (1) In general
        A contract shall not be treated as an annuity contract for
      purposes of this title unless it provides that -
          (A) if any holder of such contract dies on or after the
        annuity starting date and before the entire interest in such
        contract has been distributed, the remaining portion of such
        interest will be distributed at least as rapidly as under the
        method of distributions being used as of the date of his death,
        and
          (B) if any holder of such contract dies before the annuity
        starting date, the entire interest in such contract will be
        distributed within 5 years after the death of such holder.
      (2) Exception for certain amounts payable over life of
          beneficiary
        If -
          (A) any portion of the holder's interest is payable to (or
        for the benefit of) a designated beneficiary,
          (B) such portion will be distributed (in accordance with
        regulations) over the life of such designated beneficiary (or
        over a period not extending beyond the life expectancy of such
        beneficiary), and
          (C) such distributions begin not later than 1 year after the
        date of the holder's death or such later date as the Secretary
        may by regulations prescribe,
      then for purposes of paragraph (1), the portion referred to in
      subparagraph (A) shall be treated as distributed on the day on
      which such distributions begin.

Linas Sudzius