Life and Death Planning for Retirement Benefits

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CHAPTER 10: MINIMUM DISTRIBUTION RULES FOR
DEFINED BENEFIT PLANS AND ANNUITIZED IRAS
Chapters 10 and 11 deal with the interaction between life insurance
and annuity contracts and retirement plans. Chapter 10 covers the
special set of “required minimum distribution rules” for immediate
annuities purchased in defined contribution plans. Chapter 11
covers life insurance and all other aspects of annuity contracts.
The required minimum distribution RMD) rules for Defined Contribution (DC) plans, also
called individual account plans, were explained in This Chapter 10 explains the
completely different RMD rules that apply to defined benefit plans and to defined contribution
plans that are “annuitized.”
10.1 Terminology You Must Know
Additional definitions of various annuity terms are contained in
10.1.01 Annuity, deferred and immediate
An “annuity” is an arrangement under which one party (the issuer) is obligated to pay
another (the annuitant) a stream of payments of a specified amount made at regular intervals (such
as monthly, quarterly, or annually) for a specified term such as the life of an individual, the joint
lives of two or more individuals, a term of years, or a combination of life or lives and term(s) of
years. Unlike with “investment income” (such as interest and dividend payments on securities),
there is no capital fund or investment owned by the person who receives the payments; rather the
issuer owns whatever capital and investment is involved. The annuitant owns only the issuer’s
promise to make the periodic payments.
Though the above is the “classic” meaning of “annuity,” in modern terms an “annuity
contract” often does not look much like the classic idea of an annuity. The modern annuity contract
is often more like a collection of mutual funds inside a “wrapper.” The wrapper contains various
guarantees concerning the investment performance of the funds, as well as a series of fees and
charges to pay for the administration of the product and the guarantees, and is designed to qualify
for the federal income tax treatment applicable to annuities under (and state insurance-
regulators’ definitions of annuities). The contract-wrapper provides that the contract can or must
be “annuitized” at some point in the future, but until that happens the contract is considered a
“deferred” annuity. Buyers of these annuities may be attracted more by the guaranteed returns
and/or the tax-deferred investing aspect (there is no income tax until distributions are taken) than
by the prospect of actually turning the contract into an income stream. Some buyers intend from
the start to cash out the contract at some future time and never “annuitize” it.
Insurance people call a true old-fashioned annuity an “immediate” annuity. But since there
is also such a thing as a “deferred immediate annuity” (see , the terminology continues
to be confusing.
An excellent resource for professionals seeking to understand the investment and tax
aspects of modern annuities is The Advisor’s Guide to Annuities by John L. Olsen and Michael E.
Kitces (National Underwriter; 4th ed. 2014). Highly recommended.