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.