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IRS Gives Owners More Flexibility

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By Steven Brostoff


Life insurers are praising a new Internal Revenue Service notice that provides owners of nonqualified annuities with more flexibility in taking distributions.

The notice, 2004-15, in effect applies the same guidance to distributions from nonqualified annuities as applies to qualified annuities. This means that by following the proper procedures, owners of nonqualified annuities will be able to receive distributions before age 59 without incurring a 10% penalty tax.

The IRS provided this guidance for qualified annuities in 2002 (Revenue Ruling 2002-62). Laurie Lewis, an attorney with the American Council of Life Insurers, says ACLI then asked IRS for guidance on whether the treatment should also apply to nonqualified annuities.

The key to the new guidance, Lewis says, is that owners of nonqualified annuities will have greater flexibility.

Under the law, early distributions from annuities generally are subject to a 10% penalty tax. However, the penalty tax is waived if the distribution satisfies one of the exceptions set out in the Code.

Specifically, the distribution will not be subject to a penalty tax if it is part of a series of substantially equal periodic payments (not less frequently than annually).

There are 3 methods for determining whether distributions satisfy the requirement for substantially equal periodic payments. These are the required minimum distribution method, the fixed amortization method and the fixed annuitization method.

If the payments are subsequently modified, the penalty tax plus interest are imposed on the annuity owner, with one exception. An individual who begins receiving distributions in a year using either the fixed amortization method or fixed annuitization method may switch to the minimum distribution method and the change will not be treated as a modification triggering the penalty tax.

Any subsequent change, however, will be treated as a modification.

Prior to the new notice, this methodology and the one-time switch applied specifically to qualified annuities. The new notice applies the methodology and the one-time switch to nonqualified annuities as well.

Reproduced from National Underwriter Life & Health/Financial Services Edition, March 5, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.


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