How New IRS Annuity Rules Could Cause Confusion

They can “reduce their RMD for the remaining non-annuitized account balance by any excess of their annuity payments over what their RMD would have been if they had not annuitized,” according to the comment. “For this purpose, the excess amount is determined by comparing the annuity payments to the RMD that would be determined using the ‘value of the annuity contract.”

Secure 2.0 states that savers can use “reasonable, good faith interpretations” until the IRS changes the RMD regulations.

The new batch of regulations established guidelines for RMDs and partial annuitizations in an “Optional Aggregation Rule.”

In the final regulations, the IRS has called for taxpayers involved with partial annuitizations to value the annuities by applying the “gift tax method.”

The gift tax method bases the fair market value of an annuity on the value of comparable annuities sold by the same issuer.

The Committee of Annuity Issuers wants the IRS to replace that requirement with a flexible, principles-based approach, “under which the ‘value’ would be equal to the present value of the future annuity payments determined using reasonable actuarial methods and assumptions, determined in good faith,” and to “confirm that the gift tax method is merely one method that can be used to satisfy the principle-based rule.”

One reason is that this is the only part of the RMD regulations that requires the use of a particular valuation method.

Another is that many annuity issuers already have different systems in place for determining annuities’ fair market value for other purposes.

“Those systems may not follow the gift tax method and may produce slightly different values than the gift tax method,” the committee warns.

That could lead to customer confusion and, possibly, IRS misreporting penalties, the committee says.

Changing all systems to the new method would not be practical, the committee adds.

It suggests that valuation systems based on “actuarial present value” are much more common than those based on fair market value.

“To use the gift tax method on the wider scale that the proposed regulations contemplate, annuity insurers likely would need to create entirely new systems that are separate from their existing valuation systems,” the committee says. “In essence, those systems would need to run policy illustrations on every payout annuity every year. This would require a massive programming and administrative effort that companies simply cannot undertake.

The IRS could solve the problem by letting individuals determine the fair market value of their own annuities on their own using online calculators, the committee suggests.