The IRS has provided guidance with respect to the recovery of investment in the contract from payments received from a qualified defined benefit plan by an employee during phased retirement. Notice 2016-39 provides that if certain conditions are met, these payments are not treated as received from an annuity. Rev. Proc. 2016-39 provides that these rules apply only to annuities under a qualified plan, and do not apply to nonqualified contracts. Notice 87-13, 1987-1 CB 432, is modified by Notice 2016-39.
The annuity rules under Code Sec. 72 distinguish between amounts received as an annuity and amounts not received as an annuity for purposes of determining the portion of the amount that is treated as a nontaxable return of investment. Reg. §1.72-2(b)(2) provides that amounts subject to Code Sec. 72 are considered “amounts received as an annuity” only if (i) the amounts are received on or after the annuity starting date, (ii) the amounts are payable in periodic installments at regular intervals over a period of more than one full year from the annuity starting date, and (iii) subject to certain exceptions, the total of the amounts payable are determinable at the annuity starting date either directly from the terms of the contract or indirectly by the use of either mortality tables or compound interest computations, or both, in conjunction with the terms of the contract and in accordance with sound actuarial theory. Reg. §1.72-4(b)(1) provides that the term “annuity starting date” is generally the first day of the first period for which the first periodic payment is made under an annuity contract, provided that obligations under the contract have been fixed as of that date.
The IRS in Notice 2016-39 points out that depending on a qualified plan’s terms, the plan’s obligations to an employee receiving phased retirement payments might not be fixed within the meaning of Reg. §1.72-4(b)(1) during the employee’s continued part-time employment. For example, if the terms of the phased retirement program do not fix the employee’s date of full retirement, the plan will not, during the period of part-time employment, be able to determine its total retirement obligations to the employee. An employee’s date of full retirement is not fixed if the date can change, for example, due to a unilateral decision of the employee to commence full retirement sooner or pursuant to an agreement between the employer and employee to change the full retirement date. Also, an employee might accrue additional plan benefits during the period of phased retirement that affect the amounts payable to the employee at full retirement. Further, the plan might allow an employee to elect a distribution option at the time of full retirement that could also alter the plan’s obligations to the employee. Lastly, a qualified retirement plan might be amended to modify the benefit formula with respect to benefits that are not yet accrued during the period of part-time employment.
Notice 2016-39 provides that periodic phased retirement benefits under a qualified defined benefit plan do not qualify as “amounts received as an annuity” for these purposes if: (1) the employee begins to receive a portion of his or her retirement benefits entering phased retirement and begins part-time employment, and will not begin receiving his or her entire plan benefits until ceasing employment and commencing full retirement at an indeterminate future time; (2) the plan’s obligations to the employee are based in part on the employee’s continued part-time employment; and (3) under the plan terms, the employee does not have an election as to the form of the phased retirement benefit to be paid during phased retirement, but elects a distribution option at full retirement that applies to the employee’s entire retirement benefit, including the portion that commenced as phased retirement benefits.
Rev. Proc. 2016-36 provides that the IRS will not apply Notice 2016-39 to amounts received from a nonqualified contract. Accordingly, in applying Reg. §§1.72-2(b)(2) and 1.72-4(b)(1) to a nonqualified contract, the possibility of further contributions to the contract or a subsequent election under the contract to receive the benefit payable under the contract in a different manner generally will not affect the determination of whether payments are amounts received as an annuity.
Notice 2016-39, 2016FED ¶46,344
Rev-Proc 2016-36, 2016FED ¶46,345
Code Sec. 72
CCH Reference – 2016FED ¶6140.62
CCH Reference – 2016FED ¶6140.775
Tax Research Consultant
CCH Reference – TRC INDIV: 30,054
CCH Reference – TRC RETIRE 42,354.10