Partial Annuitization Legislation and Other Recent Tax Developments Affecting Insurance Companies and Products

Transcription

1 Partial Annuitization Legislation and Other Recent Tax Developments Affecting Insurance Companies and Products Insurance Companies Committee Section of Taxation 2011 Midyear Meeting Friday, January 21, 2011 Moderator: Panelists: Kathleen H. Schluter Northwestern Mutual Life Insurance Company Mark S. Smith Department of the Treasury Mark E. Griffin Davis & Harman LLP 1 Topics Partial exchanges and partial annuitizations Long-term care combination products New prototype IRA procedures Priority Guidance Plan items Reporting of Life Settlements Definition of Cash Value under IRC

2 Partial exchanges and partial annuitizations Background Partial annuitization under new IRC 72(a) Change made by Small Business Jobs Act of 2010 Permits partial annuitization of annuity, endowment, or life insurance contract Treated as a separate contract Pro rata allocation of investment in the contract Separate annuity starting date Effective: Amounts received after Partial exchanges and partial annuitizations Partial annuitization (cont.) Qualified v. non-qualified contracts Modification of existing contracts necessary? Commutation of payments Other issues 4

3 Partial exchanges and partial annuitizations Partial exchanges under Rev. Proc General rule: Respected as tax-free if no distribution or surrender within 12 months following the exchange Exceptions: Certain IRC 72(q) exceptions Including age 59½, death, disability (excludes SEPP and immediate annuity exceptions) Occurred between requirement (See PLR ) Any similar life event (e.g., divorce, loss of employment) Priority Guidance Plan item Interaction of partial annuitization and partial exchange rules 5 Long-term care combination products Background HIPAA (Health Insurance Portability and Accountability Act of 1996) Defined qualified long-term care insurance (stand-alone products); A&H insurance tax treatment applies Addressed Life Insurance-Qualified LTC combination products (Life-QLTCI) Effective for contracts issued after 1996; prior contracts generally grandfathered PPA (Pension Protection Act of 2006) Addressed Annuity-Qualified LTC combination products (Annuity-QLTCI) Effective January 1, 2010, for contracts issued after December 31,

4 Long-term care combination products Insurance requirement A QLTCIC is defined in section 7702B(b) as an insurance contract that meets certain requirements, including the requirement that the only insurance protection provided under the contract is coverage of qualified LTC services It is unclear from section 7702B the extent to which the LTC benefits may be paid out of the annuity contract and still be considered as providing insurance protection for this purpose How much risk shifting and risk distribution is necessary? What standards apply? There are a number of potential designs that could satisfy this requirement (see PLR ) 7 Long-term care combination products Investment in the contract In PLR , IRS ruled that the section 72(e)(6) investment in the contract for the annuity contract is to be reduced by the tax-free LTC benefit payments under a rider to the contract. How is this ruling reconciled with the separate contract treatment provided for LTC riders in section 7702B(e)(1)? Is investment in the contract reduced even if the portion of the LTC benefit payment is not made from the annuity contract s cash value? Also an issue for life insurance-ltc combination products 8

5 Long-term care combination products Consumer protection rules (IRC 7702B(g)) Inflation protection Exception for life insurance contracts and riders What inflation protection is required otherwise? What must be inflated? Premium/cash value increase requirements? Inflation charge structure? Guaranteed renewability and charge structures Standard to apply with respect to events that reduce coverage and the party with control over the change (e.g., surrender of the annuity contract, annuitization) Interaction with Code Section 72(s) rules where the deceased holder is not the LTC insured. Use of spousal exception? Joint coverage situations? DOMA considerations? Trust owned coverage? Other rules In-kind nonforfeiture benefits Rules to prevent unintentional lapse Others 9 Long-term care combination products Funding the LTC benefits LTC coverage can be provided as part of a life insurance or annuity contract (typically as a rider to the contract), or as a separate, stand-alone contract Under IRS 72(e)(11), a charge against the cash value of a life insurance or annuity contract to pay for coverage under a QLTCIC which is part of or a rider on the contract (1) reduces the investment in the contract, and (2) is not includible in gross income IRC 1035 provides for the tax-free exchange of a life insurance, endowment, or annuity contract for a QLTCIC Application of same obligee and same insured requirements in regulations? Allocation of investment in the contract in a partial exchange for a QLTCIC? (See Rev. Rul , providing pro rata approach) Circumstances in which tax-free treatment under IRC 1035 applies to systematic exchanges from a deferred annuity contract, or to the exchange of an immediate annuity or payout annuity contract, to fund the periodic premiums required under a QLTCIC? Priority Guidance Plan item 10

6 New Prototype IRA Procedures Background Only limited model forms available Prototype approval covered only forms reviewed Needed separate approval for different forms and re-approval for modifications (for law changes and unrelated changes) Must include disclosure statement, application, Costly and time consuming to obtain and maintain prototype approval Appeal for friendlier procedures 11 New Prototype IRA Procedures Updated LRMs New Procedures (Rev. Proc ) Changes in the law since prototype approval Permissive amendment for statutory changes since 2002 Amendment not required Amendment with continued reliance on existing approval Amendment with request for new approval Future changes? Favorable opinion letters Must address all applicable issues in LRMs May not incorporate by reference 12

7 New Prototype IRA Procedures Annuity contracts Can request prototype approval of IRA endorsement that applies when issued with one or more contracts IRA endorsement must include all qualification rules IRA endorsement must supersede conflicting terms in contract Make sure that IRA endorsement applies as intended Appears from revised Form 5306 that no longer need to include disclosure statement, application, Available for applications submitted after December 13, 2010 Pending applications? IRA endorsements covered by existing approval? Much more cost effective to obtain prototype approval Any reason to request approval covering specific contract, rider, and endorsement forms? 13 New Prototype IRA Procedures Dual-purpose IRAs Model forms Amendment of existing model forms recommended, but not required Updated model forms soon (e.g., Form 5305-RB) New model forms for traditional and SIMPLE IRA annuity contracts 14

8 Priority Guidance Plan items Insurance Companies and Products Final regulations under IRC 72 (and under section 453, relating to the installment method of accounting) on the exchange of property for an annuity contract Guidance on annuity contracts with a long-term care insurance feature under IRC 72 and 7702B Guidance on the tax-free exchange of life insurance contracts subject to IRC 264(f) Guidance clarifying whether deficiency reserves should be taken into account in computing the amount of statutory reserves under IRC 807(d)(6) Guidance on the determination of the company s share and policyholders share of the net investment income of a life insurance company under IRC 812 Guidance under IRC 1035 on the tax treatment of a partial exchange of an annuity contract Guidance under IRC 7702 defining cash surrender value Priority Guidance Plan items Employee Benefits Guidance on IRC 403(b) plan terminations Guidance on prototype program for IRC 403(b) plans Guidance on issues related to lifetime income from retirement plans Guidance on group trusts under Rev. Rul and Rev. Rul Guidance updating EPCRS 16

9 Reporting on Life Settlements President s FY 2010 Proposed Budget recommendation Require reporting of death proceeds paid to investor in life settlements Modify transfer for value rules to tax death proceeds under life settlements Life Insurance Industry Response to JCT and SFC Developed amendment to IRC 101(a) to tax death proceeds from life insurance sold as an investment Developed requirements to report: Acquisition of life insurance as investment sales proceeds and basis Payment of death proceeds under acquired policy death proceeds and estimated basis 17 Reporting on Life Settlements Life Insurance Industry Response to JCT and SFC Conditioned reporting obligation on: Receipt of notification from purchaser of sale and sales price Purchase price of $600 or more Raised issue of proper calculation of basis in sale Restart dialogue with IRS and Treasury on basis issue 18

10 Definition of Cash Value under IRC 7702 Finalization of Proposed Reg definition of cash value Maximum amount payable under contract, or Maximum amount that can be borrowed Impact on Return of Premium Riders Front load enhancement benefit included in cash value during term of benefit. PLRs , Premium refund on term insurance treated as guaranteed cash surrender value with implicit interest rate Question regarding determination of interest rate 19 QUESTIONS? IRS CIRCULAR 230 NOTICE: As required by the IRS, we inform you that any tax advice contained in this communication (or in any attachment) was not intended or written to be used or referred to, and cannot be used or referred to (i) for the purpose of avoiding penalties under the Internal Revenue Code, or (ii) in promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment). 20