SEPP distributions from non-qualified plans
L1: SEPP distributions from non-qualified plans
My wife and I are nearly 54 years old and jointly purchased a NON-qualified Variable Annuity in the 1990s that we now take SEPP distributions from. Should the SEPP distributions be allocated between earnings and cost or should the entire amount be allocated first to earnings until exhaused and then to cost?Pub 575 indicates that treatment for NON-qualified plans partly depends on whether the payments are “Periodic Payments” or “Nonperiodic Payments”. One might think that a SEPP is a stream of “Periodic Payments” given its IRS name – Substantially Equal “Periodic Payments” and payments should be allocated between earnings and cost.
HOWEVER, Pub 575 also indicates that Periodic Payments “are also known as amounts received as an ANNUITY” and “An annuity is a series of payments under a CONTRACT …. You can BUY the CONTRACT …” So to allocate a SEPP payment from a NON-qualified plan between earnings and cost, a SEPP would have to meet the definition of annuity which is unclear to me. The SEPP payments are FROM a Variable Annuity “Contract” and calculated like an annuity, but the SEPP itself isn’t a “contract”, it is a self determined payment stream using the guidelines of 72(q)(2)(D). So is the SEPP an annuity “UNDER” a “CONTRACT”?Thanks much for your help and a great site!!
2010-03-02 16:29, By: JW, IP: [188.8.131.52]
L2: SEPP distributions from non-qualified plansNot good news… Unless you actually anuitize the annuity contract (example life income) then you will not meet the definition of a “Periodic Payment” and distributions would be deemed a simple withdrawal which is subject to the Last-In-First-Out rules… gain first and then a return of cost.2010-03-02 16:37, By: Gfw, IP: [184.108.40.206]
L3: SEPP distributions from non-qualified plans
Thanks! Not good or bad news, I just want to make sure that I am treating it right for tax purposes as the amounts are significant. I could argue treatment both ways from what I read, and the tax compliance officer at the large company that issued the contract thought tax treatment wasn’t clear for a SEPP under a non-qualified plan, so please allow me to play devil’s advocate. 1) Why would the IRS term a SEPP a SEPP (ie a SE Periodic Payment) if it wasn’t a Periodic Payment?2)A SEPP is calculated using annuity concepts and IRS life tables but SEPPs aren’t annuities or periodic payments? Periodic payments don’t need to be for life per Pub 575 page 10, they just need to be for “greater than one year (such as for 15 years or for life)”.3)What IRS rulings or IRS feedbacksupport your position?Thanks again for your expertise!
2010-03-02 17:29, By: JW, IP: [220.127.116.11]
L4: SEPP distributions from non-qualified plansThe following is based on previous experience, I’ll let you find the cites and code sections.
A SEPP plan under 72(q) is similar to, but nor identical to a SEPP plan under 72(t). Initially there was some question as to whether a non-qualified annuity was eligible to be identified as a SEPP after 2002-62, what assumptions were to be used and then came PLR 200313016 which said that an non-qualified annuity would use the same rules (age, interest, mortality, etc) for as 72(t) for a SEPP.
One of the places where they differ is in the tax treatment of distributions – using an IRA, it is always a pro-rata distribution made up of part gain and part basis. If no basis, then all gain. For this purpose, all IRAs are treated as a single IRA.
Since about 1986, non-qualified annuities have never really used that rule. Even today, an annuitized contract is treated as part gain and part basis only until basis is recovered – then it is all gain.
The term “annuity” as used for determining the tax treatment under a non-qualified annuity is defined as periodic payments resulting from the systematic liquidation of the principal sum.
You also have to look in IRC section 72 for the definition of an “annuity starting date” which is defined as the date on which the annuitant begins receiving payments from an annuity. A SEPP plan does not change your status under the terms of the contract from owner to annuitant unless you actually convert the deferred annuity to an real annuity providing you an income.
BTW… before retirement I also worked for an insurance company where I determined what was a SEPP and how we would code a 1099. We always treated any distribution that wasn’t deemed an annuity – for example SEPP distributions from non-qualified annuities – as withdrawals. All withdrawals from an annuity are treated as gain first, then basis. If you are going to argue the case with the IRS, you will have to prove that the distributions aren’t merely withdrawals that you are an annuitant as defined by IRC Section 72 and that the ability change, increase or decrease, your payments at any time still qualifies your distributions as an annuity.2010-03-02 19:44, By: Gfw, IP: [18.104.22.168]
L5: SEPP distributions from non-qualified plansLet me take a shot at this since I use Variable Annuities quite a lot in my practice. The confusion comes in the definition … rather mis-definition … of how an annuity is used. Here are two self-definitions that may help.Annuity: Stream of income lasting for the life of the annuitant, or some other time period. In this situation a sum of money is “irrevocably given” to the insurance company in exchange for the promise to pay the annuitant the stream of income. The term “annuitized annuity” is used for this situation and will receive the prorated tax treatment between investment gain and cost basis.Deferred Annuity: A variable or fixed annuity used to fund an IRA or other tax-favored plan, or a non-qualified or non tax-favored investment. Until a deferred annuity is “annuitized” it remains just an investment vehicle used to fund something; IRA, etc. Any withdrawals from a deferred annuity will be taxed 100% on the investment gain first. Once all gain is removed then “return of principle” occurs and it is tax free for non tax-favored accounts. Of course if fuding an IRA and the cost basis is zero, then all distributions are taxable as ordinary income.Hope this helps.Jim2010-03-05 18:40, By: Jim, IP: [22.214.171.124]