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

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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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