United States: Applying The Qualified Joint And Survivor Annuity Requirements To GMWBs

Last Updated: February 7 2013
Article by Bruce L. Ashton

A vexing question for providers of guaranteed minimum withdrawal benefit (GMWB) features is whether (and how) the qualified joint and survivor annuity (QJSA) rules of the Internal Revenue Code apply to these products. By GMWB, we mean an insurance company guarantee attached as a rider to an investment (such as a target date fund inside a group variable annuity), under which the insurance company guarantees lifetime benefits to a retiree. The guarantee applies if a participant’s defined contribution or IRA account runs out of money before the retiree dies, so long as the retiree observed certain withdrawal restrictions from his account. (This article focuses only on GMWB features offered in qualified retirement plans, principally 401(k) plans.)

The requirement that distributions from certain qualified plans be made in the form of a QJSA, unless the participant’s spouse consents to a different form, was added to the Internal Revenue Code in 1984, long before GMWBs were conceived. Code section 401(a) (11) applies to distributions from defined benefit pension plans and money purchase pension plans at the “annuity starting date” (generally, the date of retirement). Section 401(a)(11) also applies to participants in defined contribution plans who elect to take a distribution in the form of a life annuity. In this sense, the QJSA requirement does not apply to the entire 401(k) plan, only to specific, affected participants.

The central question, then, for GMWB providers is whether the GMWB constitutes a life annuity.

In a traditional life annuity, an individual pays a premium to the provider that in part represents the principal amount to be paid when annuity payments start. The annuitant retains no control over the funds; and if he dies before the funds run out, there is no residue left for his beneficiaries. Of course, if he outlives his life expectancy, he continues to be paid.

In contrast, in the case of a GMWB, when a participant purchases a GMWB guarantee, he pays a smaller premium, retains control over the funds in his account and, when he retires, withdraws his own funds from his account. There are restrictions on how the funds must be invested and how much the retiree may withdraw each year. If the retiree dies before the funds run out, the balance goes to his beneficiaries, and the insurance company pays nothing. In this sense, the GMWB guarantee is more akin to disability insurance. That is, under disability insurance, payments are made by the insurance company only upon the happening of the covered event – which is also the case under the GMWB guarantee.

So how does this impact the QJSA analysis? To the extent the IRS has looked at the issue, it has done so in private letter rulings (PLRs). PLRs may be relied on only by the individual taxpayer to whom they are issued and do not constitute legally binding precedent for other taxpayers. That said, PLRs often reflect the thinking of the IRS on key issues but cannot be considered authoritative guidance.

In the case of GMWBs, the IRS has said in one PLR that the “annuity starting date” is the date when a participant begins to take systematic withdrawals. If those withdrawals begin while the participant’s benefit remains in the plan, then – according to the IRS position in this PLR – the participant must take distributions under the joint and survivor requirements of the GMWB feature unless his spouse consents to a different form of distribution. Consider, for example, a GMWB that permits distributions at 5 percent of the benefit base on a life only basis and 4.5 percent on a joint and survivor basis. If the IRS position in this PLR were to be applied, the practical impact would appear to be that the participant must take distributions at 4.5 percent absent spousal consent. This requirement would only apply to the affected participant and not to the entire plan.

Suppose, however, that the participant rolls his entire account balance, including the GMWB guarantee, to an IRA before beginning systematic withdrawals. The IRS position suggests that the QJSA rules do not apply to IRAs. Thus, in the case of a rollover, there is no “annuity starting date” so there is no requirement for the spouse to consent to the lump sum distribution to the IRA. And thereafter, the retiree is able to withdraw funds without requiring spousal consent.

The analysis of the QJSA rules in the GMWB context is conceptually difficult. To the extent there is an annuity element to the guarantee, it would seem to apply only when the insurance company becomes obligated to make payments. Prior to that time, the retiree is withdrawing his own funds, so even at the point when systematic withdrawals begin, it is difficult to say that the arrangement constitutes an annuity. We are not suggesting that the interests of non-participant spouses should be ignored, but we are concerned about the application of rules designed for significantly different situations to products that did not exist when the rules were enacted.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Bruce L. Ashton
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