Hybrid annuity receives tax treatment for its fixed and public-fund accounts

Plain-English summary

A life insurance company proposed a nonqualified deferred annuity with a fixed account and a separate account holding publicly available mutual funds. The IRS ruled that the policyholder, not the insurer, would own the public mutual fund shares for federal tax purposes and would report their income, gains, and losses as if the shares were held directly. The contract would otherwise qualify as an annuity under IRC § 72, with only the fixed account treated as its cash value. Specified fixed-account contributions, amounts applied to annuity payments, and contract charges would count as investment in the contract. Lifetime income-benefit and annuity payments would use the § 72(b) exclusion ratio, subject to a special rule for an initial income-benefit payment that does not meet the timing requirements.

Ruling snapshot

• Question: How do the ownership, cash value, investment, withdrawals, charges, and benefit payments of the proposed hybrid deferred annuity receive federal tax treatment?
• Outcome: Approved. The IRS granted all five requested rulings, subject to the stated timing rule for an initial income-benefit payment.
• Key authorities: IRC §§ 61 and 72; Treas. Reg. §§ 1.72-1, 1.72-2, and 1.72-4; Rev. Rul. 81-225

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201519001 Third Party Communication: None
Release Date: 5/8/2015 Date of Communication: Not Applicable
Index Number: 72.00-00, 72.01-00, 72.02-
00, 72.07-00, 72.07-05 Person To Contact:
------------------------, ID No. ------------------
-------------------------- ----------------------------------------------------
-------------------------------------------------- Telephone Number:
------------------------------------------- ----------------------
--------------------------------------------- Refer Reply To:
-------------------------------------- CC:FIP:B04
PLR-116057-14
Date:
October 10, 2014

Taxpayer = -------------------------------------------------------------------
Parent Company ----------------------------------------------------------
X% = ------
Sub-Account A = ------------------------
Y% = -----

Dear ------------------:

This letter is in response to the letter submitted by your authorized representative
requesting several rulings concerning the application of certain provisions of the Internal
Revenue Code (the “Code”) to a deferred annuity contract.

                                                 FACTS

The Taxpayer is a life insurance company within the meaning of § 816(a) of the Code,
joins in filing a consolidated federal income tax return with Parent Company on a
calendar year basis, and reports its income on an accrual method of accounting.

The Taxpayer intends to issue a non-qualified deferred annuity contract (the “Contract”).
The Contract provides the right to receive life contingent payments (“Income Benefit
Payments”) that are similar to guaranteed lifetime withdrawal benefits. The Income
Benefit Payments are triggered upon the depletion of an account value (the “Contractual
Account Value”) by withdrawals taken within prescribed annual limits, poor investment
performance, or the combined effect thereof. The Contractual Account Value is the sum
of (1) the value of a fixed account (the “Fixed Account”) and (2) the value of a separate
account (the “Separate Account”). The Fixed Account value (the “Fixed Account Value”)
is credited with interest and is supported solely by the Taxpayer’s general asset
account. The Separate Account value (the “Separate Account Value”) equals the market
value of certain mutual funds the Taxpayer holds in a separate account.
PLR-116057-14 2

Prior to the triggering of the Income Benefit Payments, the policyholder may apply the
Contractual Account Value (plus any additional premiums) to an annuity payment option
under the Contract. The annuity payment options are life-contingent or period certain
annuity payments (“Annuity Payments”).

Form and Regulatory Treatment

The Contract is an individual flexible premium deferred annuity contract. The Contract
will be treated as a variable annuity contract under the laws of each state in which it is
issued, and will satisfy the nonforfeiture laws applicable to the Contract. The Contract
will not be part of any eligible retirement plan within the meaning of § 402(c)(8)(B).
Pursuant to the Securities Act of 1933, the Taxpayer will register the Contract as a
security with the Securities and Exchange Commission (“SEC”).

Ownership and Contributions

The policyholder will be the sole owner and annuitant of the Contract. All benefits under
the Contract will be paid to the policyholder while he is alive, unless he directs the
Taxpayer otherwise.

The Contract will allow flexible premiums (“Contributions”), subject to specified minimum
and maximum contributions. Contributions may be made in cash or in kind, as
described in more detail below. To facilitate in-kind Contributions to the Contract (and
in-kind withdrawals from the Contract), the Contract will require the policyholder to
maintain a brokerage account with a financial institution that the Taxpayer approves (the
“Policyholder’s Account”).

The Fixed Account

A portion of each Contribution must be allocated to the Fixed Account. The required
allocation will be specified in the Contract as a percentage of each Contribution and will
not change after issuance. This requirement will continue until the Contract terminates,
unless the Contract specifies a date on which the Fixed Account terminates (“Fixed
Account Termination Date”).

The Contract will not permit the policyholder to reallocate (transfer) any Fixed Account
Value to the Separate Account. If, however, the Contract specifies a Fixed Account
Termination Date, on that date all amounts in the Fixed Account Value will be
automatically reallocated to the Separate Account pro rata based on the then-existing
allocations to the Separate Account under the Contract.

Allocations to the Fixed Account will be made in cash only. Thus, if the policyholder
makes a Contribution in kind by transferring mutual fund shares to the Taxpayer, the
Taxpayer will sell or redeem a portion of those shares and credit the Fixed Account
PLR-116057-14 3

Value with an amount equal to the cash proceeds. Likewise, all withdrawals from the
Fixed Account will be made in cash.

The Taxpayer will hold assets supporting the Fixed Account Value in its General
Account. The Taxpayer will credit the Fixed Account Value with interest at a guaranteed
minimum rate or such higher rate as the Taxpayer may declare from time to time.

The Separate Account

To the extent the Contract does not require Contributions to be allocated to the Fixed
Account, they will be allocated among the various Separate Account investment options
pursuant to the terms of the Contract and the policyholder’s instructions. If the
policyholder makes a Contribution in cash, the Issuer will purchase shares of the mutual
fund that correspond to the Separate Account investment options under the Contract, as
described below. If the policyholder already owns shares of a mutual fund that
correspond to a Separate Account investment option under the Contract, the
policyholder may make a Contribution by transferring legal ownership of those shares to
the Taxpayer in lieu of cash.

Each Separate Account investment option under the Contract will correspond to a sub-
account of the Separate Account. Each sub-account will correspond to a mutual fund
that is identified in the prospectus or other materials accompanying the Contract.
Shares of the mutual funds will be available for direct purchase by the general public,
including the policyholder, without having to purchase a Contract (hereinafter, “Public
Mutual Funds”). The Taxpayer will hold legal title to the Public Mutual Funds in each
sub-account of the Separate Account. Any dividends received with respect to the Public
Mutual Funds will be automatically reinvested in the same Public Mutual Funds, and the
value of the Public Mutual Funds will flow through directly to the Separate Account
Value under the Contract. The Separate Account is registered with the SEC as a unit
investment trust under the Investment Company Act of 1940.

The Contract will permit the policyholder to allocate and reallocate the Separate
Account Value among the Public Mutual Funds within the Separate Account, subject to
certain “Investment Guidelines.” The Investment Guidelines are as follows:

                1. Prescribed Menu of Public Mutual Funds. Only the Public Mutual Funds
         that the Taxpayer identifies in the prospectus or similar materials will be
         available as Separate Account investment options under the Contract, and
         the Taxpayer will reserve the right to add, remove, or replace Public
         Mutual Funds as investment options under the Contract.

                2. Asset Class Concentration Limits. The Taxpayer will impose allocation
         limits based on asset classes. For example, the Taxpayer may not allow
         the policyholder to allocate more than X% of policyholder’s Separate
         Account Value to Public Mutual Funds that fall within the international

PLR-116057-14 4

         equity asset class. The Taxpayer also may require that allocations among
         Public Mutual Funds be rebalanced when market value fluctuations cause
         the allocations across asset classes to deviate from the prescribed
         parameters.

                3. Mandatory Allocations to Sub-Account A. As discussed in more detail
         below, the Taxpayer will require that a portion of the Separate Account
         Value be allocated to Sub-Account A in certain circumstances.

Sub-Account A is a sub-account of the Separate Account. Sub-Account A will invest in
shares of a public mutual fund that is identified in the prospectus or other materials
accompanying the Contract. The public mutual fund in which the Sub-Account A invests
will follow a bond, fixed income, or similarly conservative investment strategy.

The Contract will allow the policyholder to allocate Separate Account Values to and
from Sub-Account A in the same manner as other Separate Account investment options
under the Contract, but in some circumstances the Taxpayer may require that a certain
portion of the Separate Account Value be allocated to Sub-Account A. Based on a
formula specified in the Contract, the Taxpayer may require part of the Separate
Account Value to be reallocated to Sub-Account A. Similarly, the formula may require
that Sub-Account A allocations be transferred back to the other Separate Account
investment options the policyholder has chosen.

Withdrawals Prior to Annuitization

Prior to the date that Income Benefit Payments or Annuity Payments commence, the
policyholder will have the right to take withdrawals from the Contractual Account Value.
The policyholder may, but is not required to, withdraw a certain amount per Contract
year. This amount is the “Guaranteed Amount” and is calculated at the time of the first
withdrawal. The initial Guaranteed Amount equals the “Applicable Percentage”
multiplied by the “Covered Contract Value.” The Applicable Percentage is specified in
the Contract and the Taxpayer expects it to be a percentage up to Y%, depending on
the policyholder’s age on the date of the first withdrawal. The Covered Contract Value is
generally the Contractual Account Value on the date of the first withdrawal, subject to
stated maximum values. The Contract also may include a “roll-up” feature under which
the Covered Contract Value will grow by no less than a guaranteed minimum rate if no
withdrawals are taken. In addition to these withdrawals, the policyholder has the option
to take one withdrawal, subject to certain limitations specified in the Contract, prior to
withdrawing the Guaranteed Amount.

Such withdrawals will be taken pro rata from the Fixed Account Value and the Separate
Account Value. All withdrawals from the Fixed Account Value will be made in cash. With
respect to the portion of a withdrawal that is allocable to the Separate Account Value,
the withdrawal will be taken pro rata from the Separate Account investment options,
including Sub-Account A (whether amounts were transferred there voluntarily or
PLR-116057-14 5

formulaically). The policyholder may choose to receive withdrawals from the Separate
Account in kind or in cash. If the withdrawal is in cash, the Taxpayer will liquidate shares
of the relevant public mutual fund(s) and forward the proceeds to the policyholder. If the
withdrawal is in-kind, the Taxpayer (or the Separate Account) will transfer to the
policyholder legal ownership of the shares of the relevant public mutual fund(s).

Income Benefit Payments

If the Contractual Account Value is reduced to zero by withdrawals taken within
prescribed annual limits, poor investment performance, or the combined effect thereof,
the Contract will begin paying Income Benefit Payments equal to the Guaranteed
Amount for the remainder of the policyholder’s life.

The initial Guaranteed Amount is subject to adjustments in the following circumstances:

                1. Withdrawals: Any withdrawal or portion thereof that exceeds the
         Guaranteed Amount in any Contract year (an “Excess Withdrawal”) will
         reduce the Guaranteed Amount available in future years in the same
         proportion that the excess reduces the Contractual Account Value. (The
         Guaranteed Amount is not increased if the policyholder withdraws less
         than the Guaranteed Amount during a Contract year.)

                2. Contributions: Contributions to the Contract after the first withdrawal is
         taken will increase the Guaranteed Amount by the product of the
         Contribution multiplied by the Applicable Percentage on the first
         withdrawal date. No Contributions are permitted after Income Benefit
         Payments begin.

                3. Step-up increases: The Guaranteed Amount may be eligible to be
         increased, on each Contract anniversary after the first withdrawal. The
         increase is equal to the Covered Contract Value multiplied by the
         Applicable Percentage as of that anniversary date to determine the
         Guaranteed Amount for that Contract year.

If the Income Benefit Payments are triggered, the Taxpayer will make fixed periodic
payments (e.g., annually) equal to the Guaranteed Amount for the policyholder’s life.1
In the first year Income Benefit Payments are made, they will equal the excess of the
current Guaranteed Amount over the sum of any withdrawals already taken during that

1
The Contract also allows the policyholder to make an election at issuance pursuant to
which Income Benefit Payments would be payable for the joint lives of the policyholder
and the policyholder’s spouse if the policyholder’s spouse at the time of purchase is
alive and remains married to the policyholder when Income Benefit Payments
commence.
PLR-116057-14 6

year. Thereafter, the Income Benefit Payment will equal the Guaranteed Amount
applicable on the date the Contractual Account Value was reduced to zero. If the
Income Benefit Payments do not exceed a stated minimum, the Taxpayer may
commute them to a lump sum.

Annuity Payments

Prior to Income Benefit Payments commencing, the Contract will permit the policyholder
to apply the Contractual Account Value to one of several payment options to generate a
series of fixed Annuity Payments. In such case, the Taxpayer will liquidate the public
mutual fund shares comprising the Separate Account Value and apply the cash
proceeds, plus any Fixed Account Value, to the selected annuity option. Once the
Annuity Payments begin, the Contractual Account Value will be zero.

The Annuity Payments will commence on the date specified in the Contract, or on an
earlier date the policyholder selects (subject to an initial waiting period). The
policyholder can choose Annuity Payments that will continue at least annually (1) for his
life, (2) for his life with a period certain not exceeding his life expectancy, (3) a period
certain not exceeding his life expectancy, or (4) in accordance with any other Annuity
Payment option the Taxpayer makes available. The policyholder cannot change the
selection after Annuity Payments commence. The Annuity Payments for life are equal to
the Guaranteed Amount under the Income Benefit. The Taxpayer calculates the annuity
payment for life with a guaranteed period based on the policyholder’s age, gender, and
a table of guaranteed permanent annuity purchase rates set forth in the Contract (or
more favorable annuity purchase rates that the Taxpayer makes available).

Policyholder Surrenders and Distributions Upon Policyholder’s Death

If the policyholder surrenders the Contract or dies before the Income Benefits Payments
or Annuity Payments commence, the Contractual Account Value will be disbursed to the
policyholder or the policyholder’s estate.

If Income Benefit Payments have begun prior to the policyholder’s death, no further
payments will be made and the Contract will terminate upon the Issuer’s receipt of due
proof of the policyholder’s death. If Annuity Payments have begun prior to the
policyholder’s death, they will continue to the extent provided in the Annuity Payment
option, e.g., for any remaining period certain. The Contract will include provisions
requiring that all distributions after the policyholder’s death be paid within the
timeframes that § 72(s) prescribes.
PLR-116057-14 7

Contract Fees and Charges

Certain fees and charges (collectively, “Contract Charges”) are payable to the Taxpayer
under the terms of the Contract, as follows:2

                1. Charges that compensate the Taxpayer for its expenses in issuing and
         administering the Contract, including its assumption of the risks that the
         Taxpayer will become obligated to make Income Benefit Payments or
         Annuity Payments for the policyholder’s entire life. These Contract
         Charges are payable on a quarterly or other periodic basis at a rate
         specified in the Contract multiplied by the greater of the Covered Contract
         Value or the Contractual Account Value. The policyholder may elect to pay
         these charges in one of two ways:

            a. The policyholder may elect to pay them directly.

            b. Alternatively, the policyholder may elect to have these charges
               deducted pro rata from the Separate Account investment options to
               which he voluntarily allocated his Separate Account Value. The
               charges will not be deducted from the Fixed Account or from any
               amounts in Sub-Account A that are attributable to mandatory
               formulaic allocations thereto. When Contract Charges are debited
               against the Separate Account Value, the Taxpayer will liquidate
               shares of Public Mutual Funds within the Separate Account and
               transfer the cash proceeds to its General Account.

                2. A surrender charge if the policyholder surrenders the Contract within a
         specified number of years after issuance. The surrender charge is
         calculated as a percentage of the Contractual Account Value. This charge
         will be debited against the Contractual Account Value pro rata based on
         the allocations to the Fixed Account Value and the Separate Account
         Value.

                3. Any premium taxes or similar taxes that are imposed against the
         policyholder and that the Contract permits the Taxpayer to pass through to
         the policyholder. These taxes will be debited against the Contractual
         Account Value pro rata based on the allocations to the Fixed Account
         Value and the Separate Account Value.

2
The Taxpayer represents that no part of the Contract Charges compensate the
Taxpayer for any investment advisory, management, or allocation services with respect
to the investments made in the Separate Account.
PLR-116057-14 8

Termination

The Contract will terminate upon the first of the following events to occur:

                1. The policyholder surrenders the Contract prior to Annuity Payments or
         Income Benefit Payments commencing;

                2. The Taxpayer receives proof of the policyholder’s death prior to Annuity
         Payments or Income Benefit Payments commencing;

                3. The policyholder dies after Income Benefit Payments have commenced;

                4. Annuity Payments cease pursuant to the terms of the selected payment
         option, e.g., the policyholder dies and/or the chosen period certain
         expires;

                5. The policyholder takes an Excess Withdrawal that exhausts his
         Contractual Account Value;

                6. The policyholder fails to pay certain Contract Charges within the required
         timeframe;

                7. The policyholder closes the Policyholder’s Account; or

                8. Annuity Payments or Income Benefit Payments are set to commence but
         would be payable in amounts that are less than minimums stated in the
         Contract, in which case the Taxpayer will commute the payments to a
         single lump sum payment.

                      ADDITIONAL REPRESENTATIONS

The Taxpayer makes the following representations in support of the rulings requested
herein:

                1. The Contract will comply with § 72(s).

                2. The Contract will be treated as an annuity contract under the state
         insurance laws and regulations of any state in which it is issued.

                3. The marketing materials for the Contract will not include any explicit or
         implicit representations that changes in the fair market value of the
         Contractual Account Value, including the Separate Account Value and any
         Public Mutual Funds that comprise that value, are expected to
         approximate, directly or inversely, changes in the fair market value of the
         Contract.

PLR-116057-14 9

            4. The Income Benefit protects primarily against longevity risk rather than
       market risk.

            5. If Annuity Payments commence over a period certain without a life
       contingency, the period certain will be longer than one year.

            6. Based on Rev. Rul. 81-225, 1981-2 C.B. 12, the Taxpayer will be a
       nominee of the policyholder with respect to amounts the Separate Account
       receives from the relevant Public Mutual Funds on the policyholder’s
       behalf. As a nominee, the Taxpayer will have, and intends to comply with,
       obligations to report such amounts to the Service and the policyholder.

                          REQUESTED RULINGS

1. For federal income tax purposes, the policyholder, and not the Taxpayer, will be
 treated as owning the Public Mutual Fund shares that comprise the Separate
 Account Value under the Contract, and as result of this conclusion:

    a. Each year, the policyholder should reflect in his gross income any gains,
       income, or losses with respect to the Public Mutual Fund shares, with the
       amount and tax character of such items being the same as if he held the
       shares directly. For this purpose, any redemption of Public Mutual Fund
       shares to (1) make a cash payment to the policyholder or his designee, (2)
       reallocate the Separate Account Value among the Separate Account
       investment options, (3) pay Contract Charges, or (4) be applied to
       generate Annuity Payments will incur the same tax consequences to the
       policyholder as if he redeemed the Public Mutual Fund shares directly and
       received the resulting cash.

    b. A transfer of legal ownership of Public Mutual Fund shares between the
       Taxpayer (or the Separate Account) and the policyholder, whether as a
       Contribution to or a withdrawal from the Contract, will not be a taxable
       event.

2. For federal income tax purposes, the Contract will constitute an annuity contract
 taxable under § 72, except for the portion of the Contract comprised of the
 Separate Account Value where the policyholder is treated as the owner of the
 Public Mutual Fund shares and taxable under § 61.

3. For purposes of § 72, the Contract’s “cash value” or “cash surrender value” will
 be comprised solely of the Fixed Account Value and not the Separate Account
 Value, and as a result of this conclusion:

    a. Any withdrawal from the Contract that is allocable to the Fixed Account
       Value will be taxable under § 72(e); and

PLR-116057-14 10

      b. Any Contract Charges that are deducted from the Fixed Account Value will
         be treated as internal charges under the Contract that do not give rise to a
         taxable distribution.

    4. Any Contributions that are allocated to the Fixed Account, any Separate Account
  Value that is applied to generate Annuity Payments, and any Contract Charges
  that are paid from the Separate Account Value or that the policyholder pays
  directly from his checking or similar after-tax account will give rise to “investment
  in the contract” within the meaning of §§ 72(c)(1) and 72(e)(6).

    5. The Income Benefit Payments and Annuity Payments will be treated as “amounts
  received as an annuity” using an “exclusion ratio” under § 72(b), except that the
  initial Income Benefit Payment will be treated as an “amount not received as an
  annuity” that is taxable under § 72(e) if such payment is not made within the
  same interval as the succeeding Income Benefit Payments or is not made on or
  after the annuity starting date as defined in § 1.72-4(b).

                             LAW AND ANALYSIS

Requested Ruling #1

In general, the holder of legal title is the owner of the property and is taxed on the
income derived from the property. However, if a person other than the holder of legal
title possesses the “benefits and burdens” of ownership, that person is attributed
ownership of property for tax purposes. See, e.g., Frank Lyon Company v. United
States, 435 U.S. 561 (1978); Helvering v. Clifford, 309 U.S. 331 (1940). The Supreme
Court summarized this principle in Corliss v. Bowers, 381 U.S. 376, 378 (1930), stating
that “taxation is not so much concerned with the refinements of title as it is with actual
command over the property taxed - the actual benefit for which the tax is paid.”

The Service applied these general tax ownership principles in a series of “investor
control” rulings. Rev. Rul. 77-85, 1977-1 C.B. 12, Rev. Rul. 80-274, 1980-2 C.B. 27,
Rev. Rul. 81-225, Rev. Rul. 82-54, 1982-1 C.B. 11, Rev. Rul. 2003-91, 2003-2 C.B.
347, and Rev. Rul. 2003-92, 2003-2 C.B. 350. The rulings stand for the proposition that
contract holders possessing control over the investment of the separate account assets
(in addition to the other benefits and burdens of contract ownership) are the owners of
separate account assets for federal income tax purposes even if the insurance company
retains possession of and legal title to those assets. See also, Christoffersen v. United
States, 749 F.2d 513 (8th Cir. 1984).

In Rev. Rul. 81-225, the Service described four situations in which the contract holder is
considered the owner of mutual fund shares held by insurance companies in connection
with annuity contracts and one situation in which the insurance company is the owner of
the mutual fund shares for federal income tax purposes. In the four situations in which
the contract holder is considered the owner of the mutual fund shares, the shares are
PLR-116057-14 11

available for purchase other than through the purchase of an annuity contract. In those
situations, the Service concluded that the contract holder had investment control over
the mutual fund shares and that the contract holder’s position in each situation was
substantially identical to what it would have been had the mutual fund shares been
purchased directly by the contract holders. Conversely, in the situation in which the
mutual fund shares were only available through the purchase of an annuity contract, the
insurance company was the owner for federal income tax purposes.

In Rev. Rul. 2003-92, the purchasers of variable annuity and variable life insurance
contracts were able to allocate their premiums among ten different sub-accounts. Each
sub-account invested in a partnership. In the factual scenario in which the partnership
interests were available other than through the purchase of a variable annuity or life
insurance contract, the Service concluded that the contract holders were the owners of
the interests in the partnerships. In contrast, if the partnership interests were only
available through the purchase of a variable annuity or life insurance contract, the
Service concluded that the insurance company was the owner of the interests in the
partnerships.

Here, each sub-account corresponds to a Public Mutual Fund that is identified in the
prospectus or other materials accompanying the Contract. The Taxpayer will hold legal
title to the Public Mutual Funds in each sub-account of the Separate Account. However,
shares of the Public Mutual Funds will be available for direct purchase by the general
public, including the policyholder, without having to purchase a Contract. Accordingly,
for federal income tax purposes, the policyholder, and not the Taxpayer, will be treated
as owning the Public Mutual Fund shares that comprise the Separate Account Value
under the Contract. Thus, the Taxpayer should not reflect in the computation of its
taxable income any gains, income, or losses with respect to the Public Mutual Fund
shares.

a. Each year, the policyholder should reflect in his gross income any gains, income,
or losses with respect to the Public Mutual Fund shares, with the amount and tax
character of such items being the same as if he held the shares directly. For this
purpose, any redemption of Public Mutual Fund shares to (1) make a cash
payment to the policyholder or his designee, (2) reallocate the Separate Account
Value among the Separate Account investment options, (3) pay Contract
Charges, or (4) be applied to generate Annuity Payments will incur the same tax
consequences to the policyholder as if he redeemed the Public Mutual Fund
shares directly and received the resulting cash.

As a result of the policyholder being treated as owning the Public Mutual Fund shares,
each year, the policyholder should reflect in his gross income any gains, income, or
losses with respect to the Public Mutual Fund shares, with the amount and tax character
of such items being the same as if he held the shares directly.
PLR-116057-14 12

b. A transfer of legal ownership of Public Mutual Fund shares between the
Taxpayer (or the Separate Account) and the policyholder, whether as a
Contribution to or a withdrawal from the Contract, will not be a taxable event.

Similarly, as a result of the policyholder being treated as owning the Public Mutual Fund
shares, a transfer of legal ownership of Public Mutual Fund shares between the
Taxpayer (or the Separate Account) and the policyholder, whether as a Contribution to
or a withdrawal from the Contract, will not be a taxable event.

Requested Ruling #2

Section 72(a) provides that, except as otherwise provided, gross income includes any
amount received as an annuity (whether for a period certain or during one or more lives)
under an annuity, endowment, or life insurance contract. The Code does not otherwise
define an annuity contract or “any amount received as an annuity.”

Section 1.72-2(a)(1) of the Income Tax Regulations provides that the contracts under
which amounts paid will be subject to the provisions of § 72 include contracts which are
considered to be life insurance, endowment, and annuity contracts in accordance with
the customary practice of life insurance companies. Under §§ 1.72-1(b) and (c), as a
general matter “amounts received as an annuity” 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 so payable or the period for
which they are to be paid can be determined as of that date, a proportionate part of
which is considered to represent a return of premiums or other consideration paid.

Under § 1.72-2(b), amounts are considered as “amounts received as an annuity” only if
all of the following tests are met: (1) the amounts are received on or after the annuity
starting date, (2) the amounts are payable in periodic installments at regular intervals
over a period of more than one full year from the annuity starting date, and (3) the
amounts payable must be determinable either directly from the terms of the contract or
indirectly from the use of either mortality tables or compound interest computations, or
both (if the contract is a variable contract, § 1.72-2(b)(3) provides an alternative
formulation of this requirement). Under § 1.72-4(b)(1), the annuity starting date is the
first day of the first period for which an amount is received as an annuity; the first day of
the first period for which an amount is received as an annuity shall be the later of (1) the
date upon which the obligations under the contract became fixed or (2) the first day of
the period which ends on the date of the first annuity payment.

Explaining imposition of an “income-out-first” rule under §72(e) for withdrawals prior to
the annuity starting date, the Senate report described a commercial annuity as

          a promise by a life insurance company to pay the beneficiary
          a given sum for a specified period, which period may
          terminate at death. Annuity contracts permit the systematic

PLR-116057-14 13

          liquidation of an amount consisting of principal (the
          policyholder’s investment in the contract) and income…. An
          individual may purchase an annuity by payment of a single
          premium or by making periodic payments. A deferred
          annuity contract may, at the election of the individual, be
          surrendered before annuity payments begin, in exchange for
          the cash value of the contract…. The committee believes
          that the use of deferred annuity contracts to meet long-term
          investment goals, such as income security, is still a worthy
          ideal.

S. Rep. No. 97-494 at 349-50 (1982)(footnote omitted).

In Life & Health Insurance, Black and Skipper state that “[i]n the broadest sense, an
annuity is simply a series of periodic payments” and while “[l]ife insurance has as its
principal mission the creation of a fund [, t]he annuity, on the contrary, has as its basic
function the systematic liquidation of a fund.” Kenneth Black, Jr. and Harold D. Skipper,
Jr., Life & Health Insurance, 161-62 (13th ed. 2000).

Elsewhere an annuity has been described as “a right to receive fixed, periodic
payments, for a specified period of time” and an annuity contract as

          a contract under which, in exchange for the payment of a
          premium or premiums, the recipient thereof is bound to
          make future payments, typically at regular intervals, in
          amounts, to payees, and conditions specified in the parties’
          agreement. The determining characteristic of an annuity is
          that the annuitant has an interest only in the periodic
          payments and not in any principal fund or source from which
          they may be derived. Although an individual who purchases
          an annuity remains the technical owner of the asset, he or
          she does not retain total control over that asset and does not
          have unfettered access to the full amount of his or her own
          “property.”

4 Am. Jur. 2d Annuities, § 1 (2008). Moreover, “[t]he purchaser of an annuity surrenders
all rights to the money paid, and therefore installment payments of a debt, or payments
of interest on a debt, do not constitute an annuity.” Id. at § 2.

Here, except for the portion of the Contract comprised of the Separate Account Value
where the policyholder is treated as the owner of the Public Mutual Fund shares and
taxable under § 61, the Contract possesses the essential attributes of an annuity. The
Contract and the Income Benefits Payments meet the requirements of §§ 1.72-1(b) and
(c), 1.72-2(a)(1) and (b)(3), and 1.72-4(b)(1) as annuity contracts and annuity payments,
respectively. Additionally, the Contract is purchased “by making periodic payments” of
PLR-116057-14 14

premium for “a promise by a life insurance company to pay the beneficiary a given sum
for a specified period, which period may terminate at death,” and is “used to provide
long-term income security.” S. Rep. No. 97-464 at 349. Moreover, it has “the
determining characteristic … that the annuitant has an interest only in the periodic
payments and not in any principal fund or source from which they may be derived.” 4
Am. Jur. 2d Annuities, §1. The policyholder will have “surrender[ed] all rights to the
money paid,” thereby distinguishing the Contract from “installment payments of a debt,
or payments of interest on a debt,” which are not annuities. Id.

Accordingly, the Contract will constitute an annuity contract taxable under § 72, except
for the portion of the Contract comprised of the Separate Account Value where the
policyholder is treated as the owner of the Public Mutual Fund shares and taxable under
§ 61.

Requested Ruling #3

Section 72(e) governs the federal income tax treatment of amounts received under
annuity, endowment, or life insurance contract that are not received as an annuity. In
general under § 72(e)(2), a non-annuity amount that is received on or after the annuity
starting date is included in gross income. If a non-annuity amount is received before the
annuity starting date, it is included in gross income to the extent allocable to income on
the contract, but not to the extent allocable to investment in the contract.

Section 72(e)(3)(A) specifies that any amount to which this subsection applies is treated
as allocable to income on the contract to the extent that such amount does not exceed
the excess (if any) of the cash value of the contract (determined without regard to any
surrender charge) immediately before the amount is received, over the investment in
the contract at such time.

Section 72 does not define the terms “cash value” or “cash surrender value” with regard
to an annuity contract. The common definition of “cash surrender value” is “the amount
made available, contractually, to a withdrawing policyowner who is terminating his or
her protection.” Black, supra, at 46 (13th ed. 2000); see also John H. Magee, Life
Insurance 599 (3d ed. 1958) (“The cash value represents the amount available to the
policyholder upon the surrender of the life insurance contract.”).

Rev. Rul. 77-85, 1977-1 C.B. 12, addressed an arrangement involving an investment
annuity policy. In the ruling,

         [t]he policyholder may not receive any amount directly from
         the account and may not receive a distribution of assets in
         kind. At any time prior to the annuity starting date, however,
         the policyholder may make a full or partial surrender of the
         policy to the insurance company. If such a surrender is
         made, the custodian is directed by the agreement to sell all

PLR-116057-14 15

         or part of the assets as appropriate and to pay over the
         necessary proceeds to the insurance company. The
         insurance company in turn will make the full or partial cash
         surrender payment to the policyholder in an amount equal to
         the proceeds received by the insurance company from the
         account, less any cash surrender charges.

The ruling does not address whether the underlying account created any “cash value” or
“cash surrender value” for the investment annuity policy. Nonetheless, the ruling
illustrates the connection between an account owned by the policyholder (here, the
Separate Account) and the annuity contract (here, the Contract). The policyholder is the
owner of the Separate Account assets for federal income tax purposes. Accordingly,
those shares cannot also comprise part of the Contract’s “cash value” or “cash
surrender value” for purposes of § 72.

On the other hand, the Fixed Account Value is part of the Contract for federal income
tax purposes. Accordingly, it is proper to treat the Fixed Account Value as comprising
the Contract’s “cash value” or “cash surrender value” for purposes of § 72.

      a. Any withdrawal from the Contract that is allocable to the Fixed Account
         Value will be taxable under § 72(e).

Based on the conclusion that the Fixed Account Value comprises the Contract’s “cash
value” or “cash surrender value,” any withdrawals from the Contract, to the extent they
are allocable to the Fixed Account Value under the terms of the Contract, will be taxable
to the policyholder under § 72(e).

      b. Any Contract Charges that are deducted from the Fixed Account Value will
         be treated as internal charges under the Contract that do not give rise to a
         taxable distribution.

Also based on the conclusion that the Fixed Account Value comprises the Contract’s
“cash value” or “cash surrender value,” the Contract Charges that are deducted from the
Fixed Account Value will be treated as internal charges against the Contract’s cash
value for purposes of § 72 that do not give rise to a taxable distribution.

Requested Ruling #4

Section 72(c)(1) provides that, for purposes of the exclusion ratio under § 72(b), the
“investment in the contract” as of the annuity starting date is the aggregate amount of
premiums or other consideration paid for the contract, minus the aggregate amount
received under the contract before such date, to the extent that such amount was
excludable from gross income. Under § 72(c)(2), this amount is then reduced by the
value of the refund feature, if any.
PLR-116057-14 16

Section 72(e)(6) provides that for purposes of § 72(e), the “investment in the contract”
as of any date is the aggregate amount of premiums or other consideration paid for the
contract before such date, minus the aggregate amount received under the contract
before such date, to the extent that such amount was excludable from gross income.

As mentioned, Rev. Rul. 77-85 addressed an investment annuity contract. That ruling
held that the issuer should include in its premium income only the premiums and
charges paid each year.

Accordingly, any Contributions that are allocated to the Fixed Account, any Separate
Account Value that is applied to generate Annuity Payments, and any Contract Charges
that are paid from the Separate Account Value or that the Individual pays directly from
his checking or similar after-tax account will give rise to “investment in the contract”
within the meaning of §§ 72(c)(1) and 72(e)(6).3

Requested Ruling #5

Section 72(a) provides that gross income includes any amount received as an annuity
(whether for a period certain or during one or more lives) under an annuity, endowment,
or life insurance contract.

Section 72(b)(1) provides that gross income does not include that part of any amount
received as an annuity under an annuity, endowment, or life insurance contract which
bears the same ratio to such amount as the investment in the contract (as of the annuity
starting date) bears to the expected return under the contract (as of such date).

Section 72(c)(4) defines “annuity starting date” as the first day of the first period for
which an amount is received as an annuity under the contract.

Section 1.72-2(b)(2) defines “amounts received as an annuity” as only those amounts
that meet all of the following tests:

   a. they must be received on or after the ‘annuity starting date’ as that term is
      defined in § 1.72-4(b);

   b. 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

3
As explained at note 2, Taxpayer represents that no part of the Contract Charges
compensate the Taxpayer for any investment advisory, management, or allocation
services with respect to the investments made in the Separate Account.
PLR-116057-14 17

     c. except as indicated in § 1.72-2(b)(3), the total of the amounts payable must
        be determinable at the annuity starting date either directly from the terms of
        the contract or indirectly by use of either mortality tables or compound interest
        computations, or both, in conjunction with such terms and in accordance with
        sound actuarial theory.

Section 1.72-4(b) defines “annuity starting date” as the first day of the first period for
which an amount is received as an annuity; 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:

     a. the date upon which the obligations under the contract became fixed, or

     b. 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.

Here, once the Contractual Account Value is reduced to zero and Income Benefit
Payments become payable, (1) the annuity starting date is reached; (2) the Income
Benefit Payments will be payable at periodic intervals over a period of more than one
full year from the annuity starting date; and (3) the total amount payable is determinable
at the annuity starting date using mortality tables and sound actuarial theory. Hence, the
Income Benefit Payments will be amounts received as an annuity, except that the initial
Income Benefit Payment will be treated as an “amount not received as an annuity” that
is taxable under § 72(e) if such payment is not made within the same interval as the
succeeding Income Benefit Payments or is not made on or after the annuity starting
date as defined in § 1.72-4(b).

With respect to the Annuity Payment, if the policyholder exercises the annuity option,
the obligations under the Contract become fixed once the Annuity Payments begin.
Specifically, the amount of the Annuity Payments will not change. The Annuity
Payments will be (1) received on or after the annuity starting date; (2) will be payable at
regular intervals over a period of more than one full year from the annuity starting date;
and (3) the total amount payable is determinable at the annuity starting date using
mortality tables and sound actuarial theory. Accordingly, the Annuity Payment will be
“an amount received as an annuity.”

Either the Income Benefit Payment or the Annuity Payment4 will be taxable under
§ 72(a) as an amount received as an annuity, subject to the exclusion of the amount
allocable to the investment in the contract determined under § 72(b).

4
The Taxpayer cannot receive both.
PLR-116057-14 18

                                    RULINGS

Based on the foregoing,

    1. For federal income tax purposes, the policyholder, and not the Taxpayer, will be
  treated as owning the Public Mutual Fund shares that comprise the Separate
  Account Value under the Contract, and as result of this conclusion:

      a. Each year, the policyholder should reflect in his gross income any gains,
         income, or losses with respect to the Public Mutual Fund shares, with the
         amount and tax character of such items being the same as if he held the
         shares directly. For this purpose, any redemption of Public Mutual Fund
         shares to (1) make a cash payment to the policyholder or his designee, (2)
         reallocate the Separate Account Value among the Separate Account
         investment options, (3) pay Contract Charges, or (4) be applied to
         generate Annuity Payments will incur the same tax consequences to the
         policyholder as if he redeemed the Public Mutual Fund shares directly and
         received the resulting cash.

      b. A transfer of legal ownership of Public Mutual Fund shares between the
         Taxpayer (or the Separate Account) and the policyholder, whether as a
         Contribution to or a withdrawal from the Contract, will not be a taxable
         event.

    2. For federal income tax purposes, the Contract will constitute an annuity contract
  taxable under § 72, except for the portion of the Contract comprised of the
  Separate Account Value where the policyholder is treated as the owner of the
  Public Mutual Fund shares and taxable under § 61.

    3. For purposes of § 72, the Contract’s “cash value” or “cash surrender value” will
  be comprised solely of the Fixed Account Value and not the Separate Account
  Value, and as a result of this conclusion:

      a. Any withdrawal from the Contract that is allocable to the Fixed Account
         Value will be taxable under § 72(e); and

      b. Any Contract Charges that are deducted from the Fixed Account Value will
         be treated as internal charges under the Contract that do not give rise to a
         taxable distribution.

    4. Any Contributions that are allocated to the Fixed Account, any Separate Account
  Value that is applied to generate Annuity Payments, and any Contract Charges
  that are paid from the Separate Account Value or that the policyholder pays
  directly from his checking or similar after-tax account will give rise to “investment
  in the contract” within the meaning of §§ 72(c)(1) and 72(e)(6).

PLR-116057-14 19

    5. The Income Benefit Payments and Annuity Payments will be treated as “amounts
  received as an annuity” using an “exclusion ratio” under § 72(b), except that the
  initial Income Benefit Payment will be treated as an “amount not received as an
  annuity” that is taxable under § 72(e) if such payment is not made within the
  same interval as the succeeding Income Benefit Payments or is not made on or
  after the annuity starting date as defined in § 1.72-4(b).

                                     CAVEATS

The rulings contained in this letter are based upon information and representations
submitted by the Taxpayer and accompanied by a penalty of perjury statement
executed by an appropriate party. This office has not verified any of the material
submitted in support of the request for rulings and it is subject to verification upon
examination.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter, including but not limited to issues under Subchapter D (§ 401-436), the
computation of the exclusion ratio under § 72(b), or the application of part 1 of
subchapter L (§§ 801-818).

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides that
it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                   Sincerely,


                                   John E. Glover
                                   John E. Glover
                                   Senior Counsel, Branch 4
                                   (Financial Institutions & Products)