IRS Rules that Annuity Payouts with Automatic Increases Are Not “Substantially Equal Periodic Payments”


In PLR 201120011 (Feb. 11, 2011), the Internal Revenue Service (Service) ruled that nonqualified annuity payouts that automatically increase by a fixed percentage are not within the “substantially equal periodic payment” (SEPP) exception to the IRC § 72(q) premature distribution 10% penalty tax. Although the ruling applies by its terms only to nonqualified annuities, its conclusions implicitly extend to the comparable exception under the § 72(t) premature distribution penalty for qualified retirement plans.

By way of background, Notice 89-25, Q&A-12 approved three methods for determining SEPPs under the § 72(t) qualified plan rule, including “payments that would be acceptable for purposes of calculating the minimum distribution required under section 401(a)(9).” That guidance was reformulated and modified by Rev. Rul. 2002-62, which restated this “RMD method” in the terms applicable to non-annuitized accounts – i.e., annually dividing the account balance by the applicable factor from certain IRS life expectancy tables. This guidance was extended to the § 72(q) rule for nonqualified annuities in Notice 2004-15.

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