As part of ThinkAdvisor’s Special Report, 21 Days of Tax Planning Advice for 2014, throughout the month of March, we are partnering with our Summit Professional Networks sister service, Tax Facts Online, to take a deeper dive into certain tax planning issues in a convenient Q&A format.
What is a longevity annuity?
A longevity annuity – also sometimes called a “deferred income annuity” (DIA) – is an annuity contract that provides no cash value or death benefits during a deferral period, and begins to make annuitized payments for life at the end of that period, if the annuity owner is still alive. For instance, the contract for a 60-year-old might provide that payments will not begin until age 85, but upon reaching that age payments will be made for life; due to the long deferral period and the accumulation of significant mortality credits, the payments that ultimately begin may be very large relative to the original payment amount.
The IRS has issued a private letter ruling explaining the tax treatment of a so-called longevity annuity. According to the IRS, a longevity annuity qualifies for favorable treatment as long as, on the deferral period end date, the contract’s contingent account value becomes the cash value and is accessible by the owner through:
(1) the right to receive annuity payments at guaranteed rates,
(2) the right to surrender the contract for its cash value,
(3) the right to take partial withdrawals of the cash value, and
(4) a death benefit.
The IRS has concluded that a longevity annuity is an annuity contract for purposes of IRC Section 72 because the contract is in accordance with the customary practice of life insurance companies and the contract does not make periodic payments of interest.
In support of its first conclusion, the IRS notes that insurance companies historically have issued deferred annuity contracts that, like longevity annuities, did not have any cash value during the deferral stage and did not provide any death benefit or refund feature should the annuitant die during this time. Thus, in the IRS’s opinion, survival of the annuitant through the deferral period is not an inappropriate contingency for the vesting of cash value and the application of annuity treatment to the proposed contract.
In reaching the second conclusion, the IRS has taken note of the fact that the longevity annuity (1) provides for periodic payments designed to liquidate a fund, (2) contains permanent annuity purchase rate guarantees that allow the contract owner to have the contingent account value applied to provide a stream of annuity payments for life or a fixed term at any time after the deferral period, and (3) provides for payments determined under guaranteed rates.