By W. Mark Smith and Joanna G. MyersIn PLR 201120011 (Feb. 11, 2011), the Internal Revenue Service (Service) ruled that nonqualified annuity payouts that automatically increase by a fixed percentage are not within the "substantially equal periodic payment" (SEPP) exception to the IRC § 72(q) premature distribution 10% penalty tax. Although the ruling applies by its terms only to nonqualified annuities, its conclusions implicitly extend to the comparable exception under the § 72(t) premature distribution penalty for qualified retirement plans.By way of background, Notice 89-25, Q&A-12 approved three methods for determining SEPPs under the § 72(t) qualified plan rule, including "payments that would be acceptable for purposes of calculating the minimum distribution required under section 401(a)(9)." That guidance was reformulated and modified by Rev. Rul. 2002-62, which restated this "RMD method" in the terms applicable to non-annuitized accounts - i.e., annually dividing the account balance by the applicable factor from certain IRS life expectancy tables. This guidance was extended to the § 72(q) rule for nonqualified annuities in Notice 2004-15.On the facts of the ruling, payouts from a nonqualified fixed annuity could increase by 1%, 2%, 3% or 4% annually, as irrevocably elected at the outset by the contract owner. (Payments that increase in this manner are rare in qualified plans but sometimes are available under annuity contracts.) Annuity payments with these irrevocable, automatic increases would satisfy the RMD rules for annuitized payments. The Service read the RMD method in Rev. Rul. 2002-62 narrowly, however, to adopt only the RMD "account balance" mechanics. Since the increases in these annuity payouts were automatic and not driven by increases in an account balance, the Service concluded they were not SEPPs. The Service also rejected the taxpayer's argument based on the § 72(t) legislative history that SEPPs may increase by cost-of-living adjustments (COLA), on the basis that the increases here were at a fixed rate chosen by the contract owner.
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© 2011 Sutherland Asbill & Brennan LLP. All Rights Reserved.This communication is for general informational purposes only and is not intended to constitute legal advice or a recommended course of action in any given situation. This communication is not intended to be, and should not be, relied upon by the recipient in making decisions of a legal nature with respect to the issues discussed herein. The recipient is encouraged to consult independent counsel before making any decisions or taking any action concerning the matters in this communication. This communication does not create an attorney-client relationship between Sutherland and the recipient.
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