By Timothy C. Pfeifer and Susan J. Sell

A new Internal Revenue Service regulation will impact calculations of required minimum distributions (RMDs) from variable annuity contracts starting Jan. 1, 2006.

Heres why. The IRS adopted revisions to Treasury Regulations 1.401(a)(9)-6 related to RMDs under deferred annuity contracts, effective June 15, 2004. This effective date was extended to Dec. 31, 2005, to provide time for adjustments needed to comply with the regulations. Many carriers just now are addressing the calculation changes that are necessary for compliance with the new regulation.

The primary change in the revised IRS regulation that impacts VA carriers involves the definition of “entire interest under an annuity contract.” Historically, the entire interest equaled the account value determined on Dec. 31 of the relevant valuation calendar year. The revised regulation now defines the entire interest in the contract as the account value plus the actuarial value of any additional benefits (in excess of the account value) provided under the contract. For VAs, this is interpreted to mean that the actuarial value of any guaranteed minimum death benefits (GMDBs) or any guaranteed living benefits (GLBs) must be considered when calculating RMDs.

Specific exclusions were cited under the new regulations regarding additional benefits. If the only additional benefit provided under the contract is a return of premium death benefit, its value may be disregarded in determining the entire interest in the contract. The regulation also allows carriers to ignore the actuarial present value of any additional benefit if the value of the benefit does not exceed 20% of the VA account value, and the VA only includes the following additional benefits:

Additional benefits that are reduced at least proportionately for withdrawals, and

An additional benefit that provides a return of premium upon death.

The IRS provided 2 examples that illustrate application of the revised regulation, but the examples unfortunately did not clarify many of the questions that have arisen about implementing the new regulations. The IRS has provided no additional substantive guidance in interpreting the new requirements for determining the entire interest in a VA contract. (Note: The regulation could impact fixed annuities, as well.)

Many carriers are struggling with the appropriate approach to determining the actuarial present value of GMDBs and GLBs. Is it appropriate to establish a value equal to the future charges collected for the additional benefit? Should a reserve-type approach be used? Can a 1-year term approach be assumed? The range of possibilities is extensive. In the past, carriers have determined actuarial present values for other circumstances and would likely want to be consistent with those approaches.

VA insurers that have been addressing this challenge appear to be focusing more on GMDBs than GLBs currently. Much of the death benefit focus is on benefits with dollar-for-dollar partial withdrawal treatment. In general, many questions have arisen with few answers. (See the accompanying box for some questions that must be resolved.)

The examples the IRS provided to illustrate the calculation of the actuarial present value of additional benefits included assumptions for discount rates, mortality rates and account value growth rates. Is use of these assumptions in actual calculations a safe harbor? Annuity insurers will need to evaluate the reasonableness of these assumptions as they relate to the insurers own blocks of business.

Some carriers, hoping for further guidance from the IRS, have been reluctant to expend large efforts to program administrative systems to handle the new RMD regulations. Compliance with this regulation may end up evolving over time.

Other carriers are developing language that would be inserted into the prospectus to address the RMD requirements. Most are keeping the language generic and at this time, with explanations of the implications of the revised rules in broader terms.

However, VA carriers and their sales representatives must be prepared to explain the increased RMD amounts that policyholders with enhanced benefits on their VA contracts must take.

Given the numerous outstanding questions in the annuity industry regarding this regulation, a Society of Actuaries tax committee has been formed to look into the RMD requirements as they relate to actuarial calculations. It is anticipated that this committee will provide guidance to annuity carriers regarding compliance with the new RMD rules.

The annuity industry must move forward with its best efforts to ensure that RMD procedures are in place by the end of 2005. It will be interesting to observe how this regulation will be enforced and to see how this dilemma is solved.

Timothy C. Pfeifer, FSA, MAAA, a principal in the Chicago office of the Milliman actuarial consulting firm, can be reached at tim.pfeifer@milliman.com. Susan Sell, FSA, MAAA, a consulting actuary with Milliman in the same office, can be reached at sue.sell@milliman.com.


Reproduced from National Underwriter Edition, April 1, 2005. Copyright 2005 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.