PLR 200117045: Flexible retirement plan withdrawals are treated as pre-annuity distributions

Plain-English summary

A plan sponsor proposed letting participants choose when and how much to withdraw from a merged retirement plan, subject to required minimum distributions. The IRS ruled that payments under this flexible option would not be amounts received as an annuity because their payment period and total could not be determined when withdrawals began. The payments would therefore be treated as made before an annuity starting date under section 72(e). Participants with qualifying pre-1987 after-tax contributions to the former profit sharing plan could recover those contributions tax free before the rest of their profit sharing distributions became taxable. The IRS assumed the merged plan was qualified under section 401(a) and its trust was exempt under section 501(a).

Ruling snapshot

• Question: How are distributions under the plan's proposed flexible withdrawal option taxed, including withdrawals attributable to pre-1987 after-tax contributions?
• Outcome: Approved the requested treatment, subject to the plan qualification and trust exemption assumptions.
• Key authorities: IRC §§ 72(e)(2)(B), 72(e)(8)(D), 401(a), 402(a); Treas. Reg. §§ 1.72-1(b), 1.72-2(b)(2), 1.72-4(b).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Washington, DC 20224

Significant Index No.: 72.00-00
Contact Person:
Telephone Number:
In Reference to:
Date: T:EP:RA:T2
JAN 31 2001
LEGEND:
Taxpayer A -
Plan B -
Plan C -
Plan D -
Dear
:
This is in response to a letter dated , as
amended by letters dated
, and

, submitted on your behalf by your authorized representative, in which a private letter ruling was requested

under section 72 of the Internal Revenue Code ("Code"). Your authorized representative submitted the following facts and representations:

Taxpayer A sponsors Plan B. Plan B was most recently restated to be effective as of , by an amendment executed on . Plan B is the result of the merger of Plan C and Plan D, which were merged effective January 1, 1995. Plan B has received a favorable determination letter from the Internal Revenue Service dated

Under the terms of Plan C, but not Plan D, a participant could make voluntary contributions. Under section 12.2 of Plan C, participants could withdraw these contributions prior to termination of service with Taxpayer A. This provision was in

Page 2 200117045

effect as of May 5, 1986.

Each Plan B participant’s account is maintained with several separate subaccounts. Each participant’s account is allocated among a “Profit Sharing Plan Account” and a “Pension Plan Account,” and if necessary, a “Deferral Contributions Account,” “Participant’s Contribution Account,” and a “Rollover Contribution Account.” Upon the Merger of Plan C and Plan D, a participant’s balance in Plan C (referred to as the “Profit Sharing Plan” in Plan B) was considered a “Rollover Contribution” for purposes of the participant’s separate accounts. As such, it is allocated to the “Rollover Contribution Account,” except that to the extent it is attributable to the participant’s after-tax contributions, in which case it is allocated to the “Participant’s Contribution Account.”

Each participant can select among a number of investment options for the investment of his account. The options that are offered are selected by Taxpayer A and can include registered investment companies, collective investment funds for employee plans, the trustee of which is a company in the same affiliated group as Taxpayer A, loans to participants, and other investment media. Each participant elects in writing or electronically among the options for the investment of his account, and as a practical matter can change his investment options at his demand.

A participant can elect the form of distribution of retirement benefits from his “Profit Sharing Plan Account,” which for these purposes includes any amounts allocated to a participant’s “Deferral Contributions Account,” “Participant’s Contributions Account,” or “Rollover Contribution Account”. Under section 12.2(a) of Plan B a participant can elect to withdraw his “Profit Sharing Plan Account” in the form of (1) a lump sum distribution, (2) substantially equal installments over a period certain (though no longer than the participant’s life expectancy or the joint and survivor life expectancy of the participant and his spouse), or (3) any reasonable combination of the first two options or any other reasonable time or manner of distribution, provided only that payments shall not in any event be made or guaranteed for the life of any person (“Option Three”). Any option selected must conform to the requirements of section 401(a)(9) of the Code and sections 1.401(a) (9)-1 and 1.401(a)(9)-2 of the Proposed Income Tax Regulations.

Under section 12.3(a) of Plan B, a participant can also elect the form of distribution of retirement benefits from his “Pension Plan Account.” With spousal consent, if married, a

Page 3 200117045

participant can elect to withdraw his “Pension Plan Account” in the form of (1) a lump sum distribution, (2) substantially equal installments over a period certain (though no longer than the participant's life expectancy or the joint and survivor life expectancy of a participant and his spouse), or (3) any reasonable combination of the first two options or any other reasonable manner of distribution (“Option Three”). Any option

selected must conform to the requirements of section 401 (a) (9) and sections 1.401(a)(9)-1 and 1.401(a)(9)-2 of the Proposed Regulations. In default of an election, the participant is to receive as a distribution a fixed or variable annuity contract

payable over his own life. If he is married, the annuity contract must cover the lives of the participant and his spouse, unless both elect otherwise. Plan B is in no event ever to

become liable to pay benefits for the life of any person.

If a participant elects to withdraw distributions in installments over a period certain in accordance with Plan B, the amounts of the installments are determined by dividing the balance of the participant’s account at the beginning of the year in which the installment is to be paid by the number of years remaining in the period certain chosen by the participant.

In a letter dated , Taxpayer A represented that it will amend Plan B, section 12.2(a) which relates to the available distribution options for participants’ Profit Sharing Plan Accounts, and section 12.3 (a) which relates to distributions of the Pension Plan Account as follows:

Option Three under both of the sections will be revised and renumbered to become “Option Four” and will be replaced with a “New Option Three”. New Option Three will provide that a participant may elect to receive his distribution “in such amounts and at such times as a Participant or Former Participant may request, but not less than the minimum amounts that must be distributed by the applicable distribution date necessary to comply with Section 401 (a) (9) of the Code and any proposed, temporary or final regulations promulgated thereunder”. Option Four will provide that distributions may be made in “any reasonable combination of the foregoing (i.e. any of the other available options) or any other reasonable manner of distribution”.

Taxpayer A anticipates that most of Plan B participants who will in coming years be required to receive minimum required distributions from Plan B and whose accounts include after-tax contributions to Plan C prior to 1987 (“Future Distributees”) will elect to fulfill the requirements of section 401 (a) (9) of

Page 4 200117045

the Code by choosing the New Option Three.

Based on the above, you request the following letter rulings:

1. None of the distributions from Plan B
   received by future distributees who make a distribution election pursuant to the New Option Three as provided in the proposed amendment to sections 12.2(a) or 12.3(a) of Plan B, is an amount received as an annuity under Section 72 of the Code.

2. Because none of the distributions from Plan
   B to Future Distributees who make a
   distribution election pursuant to the New Option Three as provided in the proposed amendment to sections 12.2(a) or 12.3(a) of Plan B, is an amount received as an annuity, (a) there is no “annuity” as defined under Section 72 of the Code, (b) there is no “annuity starting date” as defined under section 72(c) (4) and section 1.72-4(b) of the Income Tax Regulations, (c) all of the distributions have been and will be considered made before the “annuity starting date” and (d) all of the distributions will be subject to section 72 (e) (2) (B) of the Code.

3. Because (a) all of the distributions from a
   Future Distributee’s Profit Sharing account balance in Plan B who make a distribution election pursuant to the New Option Three as provided in the proposed amendment to sections 12.2(a)of Plan B, have been and will be considered made before the annuity starting date, and (b) as of May 5, 1986, Plan C allowed participants to withdraw after-tax contributions before separation from service, Section 72(e)(8)(D) will apply to allow a Future Distributee to recover without income tax the entire amount of his or her after-tax contributions made in years before 1987 before any portion of his or her distributions from his or her Profit Sharing account will be subject to income tax.

Page 5 200117045
Section 402(a) of the Code provides, in general, that the

amounts actually distributed to any distributee by an employee's

trust described in section 401(a) shall be taxable to him in the

year in which such amounts are distributed, under section 72 of the Code.

Section 72(a) of the Code provides the rules for amounts “received as an annuity” and section 72(e) of the Code provides the rules relating to “amounts not received as an annuity”. Section 72(e) of the Code further distinguishes “amounts not received as an annuity” by designating them as either amounts “received on or after the annuity starting date” or as amounts “received before the annuity starting date.”

Pursuant to section 72(e) (2) (A), an amount that is “not received as an annuity” and that is “received on or after the annuity starting date” is included entirely in the distributee’s gross income when received, without an offset for the distributee’s investment in the contract (as that term is defined in section 72(e) (6)). However, pursuant to section 72(e) (2) (B)of the Code an amount that is “not received as an annuity” and that is “received before the annuity starting date” is included in the distributee’s gross income to the extent allocable to income on the contract, and not included in gross income to the extent allocable to the distributee’s investment in the contract.

Section 72(e) (2) (8) (A) of the Code provides the rules for distributions from qualified plans that are “amounts not received as an annuity” and that are “received before the

annuity starting date”. Section 72(e) (2) (8) (A) of the Code provides that Section 72(e)(2)(B) of the Code applies to such amounts. Therefore, those distribution are included in gross

income to the extent allocable to income on the contract, and not included in gross income to the extent allocable to the distributee’s investment in the contract.

Section 72(e)(8)(D) of the Code provides a special grandfather provision to 72(e) (2) (8) (A) for distributions from qualified plans (that are “amounts not received as an annuity” and that are “received before the annuity starting date”) that on May 5, 1986 permitted withdrawal of employee contributions before separation from service. In general, distributions from such plans are not included in the distributee’s income until all of his after-tax contributions (i.e. his investment in the contract) that were made in years prior to 1987 are recovered tax-free.

Q&A-13 of Internal Revenue Service Notice 87-13, 1987-1 C.B. 432 describes the grandfather provision outlined in Section

Page 6 200117045
72(e) (8) (D) of the Code. It provides that if a plan (for example, Plan C) that, on May 5, 1986, permitted in-service distributions of employee contributions is merged after May 5, 1986 with a plan (for example, Plan D) that, on May 5, 1986, did not permit such in-service distributions, investment in the contract on December 31, 1986 under Plan C (or the portion of

the merged plan that comprises Plan C) will continue to qualify for the special grandfather provision under section 72 (e) (8) (D)of the Code. Investment in the contract on December 31, 1986 under Plan D (or the portion of the merged plan that comprises Plan D) will not qualify for the grandfather and thus is to be treated under the merged plan, for purposes of section 72(e), as though it is not part of the investment in the contract on December 31, 1986.

Section 1.72-1(b) of the Income Tax Regulations defines the term “amounts received as an annuity” and provides that they are amounts which are payable at regular intervals over a period of more than one full year from the date on which they are deemed to begin, provided the total of the amounts which are so payable or the period for which they are to be paid can be determined as of that date. Any other amounts to which the provisions of section 72 apply are considered to be “amounts not received as an annuity”.

Section 1.72-2(b) (2) of the Income Tax Regulations provides that amounts are considered “amounts received as an annuity” only if all of the following tests are met:

(i) they must be received on or after the “annuity starting date” as that term is defined in section 1.72-4 of the Income Tax Regulations;

(ii) they must be payable in periodic installments at regular intervals (whether annually, semiannually, quarterly, monthly, weekly, or otherwise) over a period of more than one full year from the annuity starting date; and

(iii) the total of the amounts payable must be determinable at the annuity starting date either from the terms of the contract or indirectly by the use of either mortality tables or compound interest computations, or both, in conjunction with such terms and in accordance with sound actuarial theory.

Section 1.72-2(b) (3) of the regulations goes on to state, in part, that if amounts are to be received for a definite or determinable time under a contract which provides that the amounts of the periodic payments may vary in accordance with investment experience (as in certain profit-sharing plans), costs of living indices, or similar fluctuating criteria, each

Page 7 200117045
such payment received shall be considered, to the extent enumerated therein, as an amount received as an annuity.

Section 1.72-4(b) of the Regulations, in general, defines an annuity starting date as the first day of the first period for which an amount is received an an annuity, except that if such date was before January 1, 1954, then the annuity starting date is January 1, 1954. The first day of the first period for which an amount is received as an annuity shall be whichever of the following is the later:

(i) the date upon which the obligations under the contract became fixed, or

(ii) the first day of the period (year, half-year, quarter, month, or otherwise, depending on whether payments are to be made annually, semiannually, quarterly, monthly, or otherwise) which ends on the date of the first annuity payment.

Whether the distributions received by a Future Distributee constitute “amounts not received as an annuity”, we must determine whether these payment satisfy the definition of “amounts received as an annuity” found in sections 1.72-1(b) and 1.72-2(b) (2) of the Regulations. If they do not, then these amounts conversely satisfy the definition of “amounts not received as an annuity”.

Future Distributees who make a distribution election pursuant to the New Option Three as provided in the proposed amendment to section 12.2(a) or 12.3(a) of Plan B may request distributions in such amount and at such time as they may desire. The period for which payments will be made will not be ascertainable and the total amount of distributions that future distributees are to receive cannot be determined as of the commencement of distributions because they will have the option to withdraw more than the minimum amount earlier than is otherwise required. The New Option Three distribution method is too flexible to satisfy the definition of an annuity as defined in section 1.72-2(b) (2) of the Regulations.

Therefore, with respect to ruling request number one, we conclude that none of the distributions from Plan B received by Future Distributees who make a distribution election pursuant to the New Option Three as provided in the proposed amendment, is an amount received as an annuity under section 72 of the Code.

The distributions to Future Distributees who make a distribution election pursuant to the New Option Three are “amounts not received as an annuity”. Because these amounts are not received as an annuity, there is no annuity per se, and

Page 8 200117045
thus, the distributions can not be made “after” an annuity starting date. Therefore, these payments are treated under section 72(e) of the Code as “amounts received before the annuity starting date.”

Accordingly, with respect to your second ruling request, we conclude that because none of the distributions from Plan B to Future Distributee who make a distribution election pursuant to the New Option Three as provided in the proposed amendment to sections 12.2(a) or 12.3(a) of Plan B, is an amount received as an annuity, (a) there is no “annuity” as defined under section 72 of the Code, (b) there is no “annuity starting date” as defined under section 72(c) (4) and section 1.72-4(b) of the Income Tax Regulations, (c) all of the distributions have been and will be considered made before the “annuity starting date” and (d) all of the distributions will be subject to section 72 (e) (2) (B) of the Code.

You represented that as of May 5, 1986, Plan C permitted participants to withdraw their voluntary contributions. You also represented that Future Distributees made after-tax contributions in years before 1987 to Plan C. Therefore, the grandfather provision of Section 72(e)(8)(D) will apply to distributions made pursuant to §12.2(a) of Plan B to Future Distributees who elect the New Option Three under the proposed amendment to Plan B and who made after-tax contributions in years before 1987. Pursuant to Q&A-13 of IRS Notice 87-13, the grandfather provision will apply even though Plan C merged with Plan D to become Plan B.

Accordingly, with respect to your third ruling request, we conclude, that because (a) all of the distributions from a Future Distributee’s Profit Sharing account balance in Plan B to a Future Distributee who makes a distribution election pursuant to the New Option Three as provided in the proposed amendment to section 12.2(a) of Plan B, have been and will be considered made before the annuity starting date, and (b) as of May 5, 1986, Plan B allowed participants to withdraw after-tax contributions before separation form service, Section 72(e) (8) (D) will apply to a Future Distributee who made after- tax contributions in years before 1987, to recover without income tax the entire amount of his or her after-tax contributions made in years before 1987 before any portion of his or her distributions from his or her Profit Sharing account balance will be subject to income tax.

This ruling is based on the assumption that Plan B is qualified under Code section 401(a), and its related trust tax- exempt under Code Section 501(a) at all times relevant to this

ruling.

Page 9 200117045

This ruling is directed only to the taxpayer who requested it. Section 6110(k) (3) of the Internal Revenue Code provides that it may not be used or cited by others as precedent.

Pursuant to a power of attorney on file in this office, a copy of this letter ruling is being sent to your authorized

representative.

Sincerely yours,

(signed) JOYCE E. FLOYD

Joyce E. Floyd, Manager

Employee Plans Technical Group 2.

Tax Exempt and Government Entities Division Enclosures:

Deleted copy of letter ruling
Form 437