How New IRS Annuity Rules Could Cause Confusion

Federal law requires most savers who have reached a certain age to take some money out of their pretax retirement savings accounts.

The IRS wants to let savers who annuitize some assets cut their required minimum distributions.

The Committee of Annuity Insurers does not like how the IRS is handling that.

The annuity issuer group may be protecting retirement savers from a world of future hurt. Or it could be giving you an early warning about what will hurt, and why.

The group has provided a long, detailed plan for change, or work of prophecy, in a comment it sent to the Internal Revenue Service to respond to a recently posted batch of proposed and final regulations affecting how retirement savers take required minimum distributions.

The American Council of Life Insurers gave the comment a glowing review. “That letter provides an in-depth review of issues and concerns of life insurers with the proposal and on certain aspects of the final regulations that warrant further clarification.”

What it means: The Committee of Annuity Insurers’ comment could lead to major changes in IRS regulations that will be important to retirement savers.

For any concerns that the IRS fails to address, the comment may be a guide an agent or advisor can use to prepare for future client problems.

RMD basics: The government tries to squeeze income tax revenue out of traditional individual retirement accounts, traditional individual retirement annuities, traditional 401(k) plan accounts and other retirement arrangements that qualify for special contribution tax breaks by requiring the owners to take out a minimum amount of cash once they turn 73.

The proposed and final regulations affect how the RMDs work and how they intersect with the new retirement savings laws and regulations.

The Committee of Annuity Insurers cares deeply about the provisions that could affect annuities and annuity owners, because it represents all of the big annuity issuers, ranging from Allianz Life to USAA Life, with all of the household-name issuers in between.

Bryan Keene and Mark Griffin, partners at Davis Harman, helped them submit a concise but detailed look at 25 issues of concern.

The gift-tax method for valuing annuities: One of the issues the authors of the comment address is how savers should calculate the value of annuities when they’re annuitizing part of their retirement assets.

Section 204 of the Secure 2.0 Act lets savers use annuitization moves to offset part of their RMDs.

They can “reduce their RMD for the remaining non-annuitized account balance by any excess of their annuity payments over what their RMD would have been if they had not annuitized,” according to the comment. “For this purpose, the excess amount is determined by comparing the annuity payments to the RMD that would be determined using the ‘value of the annuity contract.”

Secure 2.0 states that savers can use “reasonable, good faith interpretations” until the IRS changes the RMD regulations.

The new batch of regulations established guidelines for RMDs and partial annuitizations in an “Optional Aggregation Rule.”

In the final regulations, the IRS has called for taxpayers involved with partial annuitizations to value the annuities by applying the “gift tax method.”

The gift tax method bases the fair market value of an annuity on the value of comparable annuities sold by the same issuer.

The Committee of Annuity Issuers wants the IRS to replace that requirement with a flexible, principles-based approach, “under which the ‘value’ would be equal to the present value of the future annuity payments determined using reasonable actuarial methods and assumptions, determined in good faith,” and to “confirm that the gift tax method is merely one method that can be used to satisfy the principle-based rule.”

One reason is that this is the only part of the RMD regulations that requires the use of a particular valuation method.

Another is that many annuity issuers already have different systems in place for determining annuities’ fair market value for other purposes.

“Those systems may not follow the gift tax method and may produce slightly different values than the gift tax method,” the committee warns.

That could lead to customer confusion and, possibly, IRS misreporting penalties, the committee says.

Changing all systems to the new method would not be practical, the committee adds.

It suggests that valuation systems based on “actuarial present value” are much more common than those based on fair market value.

“To use the gift tax method on the wider scale that the proposed regulations contemplate, annuity insurers likely would need to create entirely new systems that are separate from their existing valuation systems,” the committee says. “In essence, those systems would need to run policy illustrations on every payout annuity every year. This would require a massive programming and administrative effort that companies simply cannot undertake.

The IRS could solve the problem by letting individuals determine the fair market value of their own annuities on their own using online calculators, the committee suggests.