DC Plan Withdrawal Guarantees and QJSA Rules

Bruce L. Ashton, partner at Drinker Biddle & Reath, explained to PLANADVISER that in a typical annuity situation, the individual who buys it makes a significant premium payment to the provider—in effect, a present value of what the annuity will be later on, as well as a payment to the insurance company for assuming the risk of making payments. The insurance company takes the money and invests it, and those funds, along with investment earnings and other money the insurance company may have to come up with, are used to make payments to the annuitant. Once the premium payment is made, the annuitant cannot get the money back.  

By contrast, with a GMWB, a qualified plan participant contributes money to an account in the plan which gets invested in a specified investment—typically a target-date fund (TDF)—and offers the guarantee that if in the future the participant starts taking distributions or rolls over assets in his account and runs out of money later, the insurance company will make payments to the participant of a specified amount as long as certain conditions are satisfied. When the participant first takes a distribution, he is taking his own money. In addition, the participant maintains control of the account and can drop the guarantee and still have his assets.   

QJSA rules say that distributions from certain qualified plans must be made in QJSA form, unless the participant’s spouse consents to a different form. The rules were added to the Internal Revenue Code in 1984, long before GMWBs were conceived. Code Section 401(a)(11) applies to distributions from defined benefit (DB) pension plans and money purchase pension plans at the “annuity starting date” (generally, the date of retirement). Section 401(a)(11) also applies to participants in defined contribution (DC) plans who elect to take a distribution in the form of a life annuity.  

Ashton said that in his view, the account with a GMWB is not a life annuity. However, the Internal Revenue Service (IRS) has said in one private-letter ruling (PLR) that the “annuity starting date” is the date when a participant begins to take systematic withdrawals. If those withdrawals begin while the participant’s benefit remains in the plan, then—according to the IRS position in the PLR—the participant must take distributions under the joint and survivor requirements of the GMWB feature unless his spouse consents to a different form of distribution. Ashton pointed out that PLRs may be relied on only by the individual taxpayer to whom they are issued and do not constitute legally binding precedent for other taxpayers.

“The IRS is wrestling with the issue. It seems to want to treat an account with a GMWB as an annuity, subject to QJSA rules, because at some point, the insurance company may have an obligation to put up money to pay the retiree,” Ashton said. He explained that how a retiree withdraws money when he still has account will impact how the insurance company will have to pay later on. For example, if a GMWB permits distributions at 5% of the benefit base on a life-only basis and 4.5% on a joint and survivor basis, and the retiree decides to take 5%, the insurance company will continue to pay if the retiree runs out of money, but when the retiree dies, the insurance company’s obligation is over and the spouse will not get paid. However, if the retiree takes the 4.5% joint and survivor-based payment, the insurance company will have to continue paying the spouse when the retiree dies. Ashton said he understands the IRS's desire to protect the interest of spouses.  

He added that the QJSA rules were not created to deal with GMWBs, so from a technical perspective, it looks like IRS rules would not apply. “I think there will be two ways this issue will get dealt with,” Ashton commented. “The IRS and Treasury will come out with more guidance, or providers will address the issue regardless of whether there is authoritative guidance. Until guidance comes out, some in the industry will take it upon themselves to apply rules similar to a QJSA and impose a spousal consent requirement at the point participants start to take withdrawals.”  

In plan design, defined contribution plan sponsors could impose a spousal consent requirement on any distribution, if they wanted to, Ashton said. He noted that if a provider imposed a spousal consent requirement as a part of a GMWB contract, it is unclear whether the plan document would also have to include a provision in order for the provider to impose this requirement. On the other hand, Ashton does not think a plan document can have a provision that would override a provision in the GMWB contract. These are still unanswered questions.   

“I think this is an important emerging issue, so it is important for providers and plan sponsors to begin to address what happens when participants start taking their money out,” Ashton stated. “It’s not a legal obligation at this point, but is perhaps a best practice for plan sponsors to look at alternatives for how to address the issue. Should plan sponsors offer annuity options or options with GMWBs in their plans, or are there other options they can use to address retirement risk?” He added that more plan sponsors are looking at GMWBs, so it is incumbent upon the IRS, Treasury and the Department of Labor (DOL) to focus on legal issues and how to address them.