Life and Death Planning for Retirement Benefits

CHAPTER 10: MINIMUM DISTRIBUTION RULES FOR DEFINED BENEFIT PLANS AND ANNUITIZED IRAS

Chapters 10 and 11 deal with the interaction between life insurance and annuity contracts and retirement plans. Chapter 10 covers the special set of “required minimum distribution rules” for immediate annuities purchased in defined contribution plans. Chapter 11 covers life insurance and all other aspects of annuity contracts.

The required minimum distribution RMD) rules for Defined Contribution (DC) plans, also called individual account plans, were explained in Chapter 1 . This Chapter 10 explains the completely different RMD rules that apply to defined benefit plans and to defined contribution plans that are “annuitized.”

10.1 Terminology You Must Know

Additional definitions of various annuity terms are contained in ¶ 10.2.03 .

Annuity, deferred and immediate

An “annuity” is an arrangement under which one party (the issuer) is obligated to pay another (the annuitant) a stream of payments of a specified amount made at regular intervals (such as monthly, quarterly, or annually) for a specified term such as the life of an individual, the joint lives of two or more individuals, a term of years, or a combination of life or lives and term(s) of years. Unlike with “investment income” (such as interest and dividend payments on securities), there is no capital fund or investment owned by the person who receives the payments; rather the issuer owns whatever capital and investment is involved. The annuitant owns only the issuer’s promise to make the periodic payments. Though the above is the “classic” meaning of “annuity,” in modern terms an “annuity contract” often does not look much like the classic idea of an annuity. The modern annuity contract is often more like a collection of mutual funds inside a “wrapper.” The wrapper contains various guarantees concerning the investment performance of the funds, as well as a series of fees and charges to pay for the administration of the product and the guarantees, and is designed to qualify for the federal income tax treatment applicable to annuities under § 72 (and state insurance- regulators’ definitions of annuities). The contract-wrapper provides that the contract can or must be “annuitized” at some point in the future, but until that happens the contract is considered a “deferred” annuity. Buyers of these annuities may be attracted more by the guaranteed returns and/or the tax-deferred investing aspect (there is no income tax until distributions are taken) than by the prospect of actually turning the contract into an income stream. Some buyers intend from the start to cash out the contract at some future time and never “annuitize” it. Insurance people call a true old-fashioned annuity an “immediate” annuity. But since there is also such a thing as a “deferred immediate annuity” (see ¶ 10.2.03 ), the terminology continues to be confusing. An excellent resource for professionals seeking to understand the investment and tax aspects of modern annuities is The Advisor’s Guide to Annuities by John L. Olsen and Michael E. Kitces (National Underwriter; 4 th ed. 2014). Highly recommended.