Insurer's contingent deferred annuity qualified under section 72

Plain-English summary

A life insurance company planned to issue a contingent deferred annuity linked to an individual's separately owned taxable investment account. The individual would retain control of the account, while the contract would begin lifetime protected-income payments if the account was depleted or fell below a threshold, or provide optional fixed annuity payments if the account was liquidated and transferred to the insurer. The IRS ruled that the contract qualified as an annuity under section 72 and explained the tax treatment of fixed, fluctuating, and optional annuity payments. The separate account would not create cash value in the contract or become part of it for federal tax purposes. The individual's investment in the contract would include periodic contract charges and any account proceeds transferred to the insurer when protected-income or annuity payments began.

Ruling snapshot

• Question: Would the insurer's contingent deferred annuity qualify under section 72, and how would its payments, separate account, and investment in the contract be treated?
• Outcome: approved (all four requested rulings granted)
• Key authorities: IRC § 72; Treas. Reg. §§ 1.72-1 through 1.72-14; Rev. Rul. 77-85

Full text (IRS public release)

 Internal Revenue Service                                      Department of the Treasury
                                                               Washington, DC 20224

 Number: 202250012                                             Third Party Communication: None
 Release Date: 12/16/2022                                      Date of Communication: Not Applicable
 Index Number: 72.00-00
                                                               Person To Contact:
 -------------------------                                     --------------------, ID No. -----------------
 ---------------------------------------------------           Telephone Number:
 --------------------------------------------                  --------------------
 ------------------------------                                Refer Reply To:
 ----------------------------                                  CC:FIP:B04
                                                               PLR-114089-21
                                                               Date:
                                                               January 03, 2022




Legend:

 Taxpayer       =   -------------------------------------------------------------------------------------
 Individual     =   -------------------------
 X              =   ---
 Y              =   ---
 Z              =   ---



Dear ----------------:

Taxpayer has requested several rulings regarding whether and how § 72 of the Internal
Revenue Code applies to a contingent deferred annuity contract (“the Contract”)
Individual plans to purchase from Taxpayer. This letter ruling is being issued
electronically in accordance with section 6 of Rev. Proc. 2020-29, 2020-21 I.R.B. 859. A
paper copy will not be mailed.

FACTS:

Taxpayer represents that:

Taxpayer is a life insurance company within the meaning of § 816(a).

Individual will own assets in a taxable investment account (“Account”). Taxpayer will
have no legal or equitable interest in any assets owned by Individual in the Account,
and Taxpayer will not treat the Account or any of the assets in the Account as
Taxpayer’s assets for any purpose. Individual will be free to liquidate all or any portion
of the assets in the Account at any time without Taxpayer’s consent.
PLR-114089-21                                 2

Taxpayer intends to issue the Contract to Individual. The Contract will provide certain
benefits in the event the value of the Account is depleted before Individual’s death.
Specifically, if the Account’s value reaches zero or some other minimum threshold
amount for reasons other than withdrawals in excess of the prescribed limit, Taxpayer
will begin making annual payments to Individual under the contract on either a fixed
(“Fixed Method”) or a fluctuating (“Fluctuating Method”) basis (collectively, “Protected
Income Payments”). The payments will continue for Individual’s life or for the joint lives
of Individual and Individual’s spouse. Alternatively, prior to the point at which annual
payments begin under the Contract, Individual can elect to liquidate the Account and
transfer the proceeds to Taxpayer in exchange for fixed payments at minimum purchase
rates guaranteed in the Contract (“Annuity Payments”).

Individual can make withdrawals from the Account. Once Individual begins making
“Protected Income Withdrawals” from the Account, the maximum amount Individual may
withdraw from the Account is set each year by reference to the performance of the
assets in the Account. “Excess Withdrawals” in excess of the maximum amount reduce
maximum withdrawal amounts going forward. Too many Excess Withdrawals can also
result in termination of the Contract. The Contract may include a feature whereby
unused withdrawal amounts for a given year are carried forward to subsequent years to
increase the maximum withdrawal amounts in those years.

Though Taxpayer’s exposure to investment risk is limited due to the fluctuating limit
placed on maximum withdrawals from the Account, Taxpayer also may, but does not
currently plan to, restrict permissible asset holdings in the Account. For instance, certain
kinds of “exotic” investments may be restricted. Exotic investments may include private
securities, investments that are not priced daily, and investments that are not registered
with the Securities and Exchange Commission.

Unless Individual liquidates the Account and transfers the proceeds to Taxpayer in
exchange for Annuity Payments, annual payments will begin under the Contract once
the Account’s value reaches zero or otherwise falls below a minimum threshold amount.
Individual can select either fixed payments under the Fixed Method or fluctuating
payments under the Fluctuating Method.

Each payment option differs in the following respects. If Individual selects the Fixed
Method (which is the default option), the Contract’s annual payments will commence
when the Account’s value is reduced to zero (for reasons other than Excess
Withdrawals) and will be equal to the maximum withdrawal amount in effect as of that
time. If Individual selects the Fluctuating Option before the Account falls below a
minimum threshold amount (for reasons other than Excess Withdrawals), then
payments will commence once the Account’s value falls below a minimum threshold
amount and the Contract’s annual payments will initially be equal to the maximum
withdrawal amount in effect as of the time that Contract payments commence but will
thereafter fluctuate with investment performance.
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If Individual selects the Fluctuating Option, then once the value of the Account reaches
a minimum threshold amount, the remaining assets in the Account must be liquidated
and the proceeds transferred to Taxpayer before payments commence. Individual may
then allocate those transferred proceeds among one or more separate sub-accounts.
The investment performance of the sub-account(s) that Individual selects is used solely
to generate a rate of return. That rate of return is then applied to adjust the annual
payouts under the Contract.

Individual will not be able to access the amounts in the sub-account(s) in any way, and
the amounts will not give rise to any cash value. Any amounts allocated to the sub-
account(s) are, as indicated above, used solely to generate a rate of return to use in
determining annual payments under the Contract under the Fluctuating Method.

The Contract may be issued with a feature guaranteeing a payment to Individual at the
age of 95 in certain circumstances (“Cumulative Income Minimum”). Specifically, if
Individual reaches the age of 95 and has not had the opportunity, either through
permissible withdrawals from the Account or through payments under the Contract, to
recover Individual’s net deposits into the Account at the time of the first Protected
Income Withdrawal (proportionally reduced by any Excess Withdrawals taken after the
first Protected Income Withdrawal), Taxpayer will make a one-time payment to
Individual making up the difference.

Individual will periodically pay consideration for the Contract either out of the Account
(on an after-tax basis) or out of other sources of after-tax funds. Additionally, as
indicated above, Individual may transfer a final amount of cash proceeds to Taxpayer
once the Account reaches a minimum threshold amount, which Taxpayer will treat as
additional consideration for the Contract.

Amounts Individual pays for the Contract will not give rise to any cash value, and the
Contract will not otherwise have any cash value accessible by Individual. The Contract
is not assignable or transferable by Individual. The Contract will not serve as collateral
for any loan from Taxpayer or Taxpayer’s affiliates.

Individual is X years old. It is anticipated that Individual will be X years old at the time
Taxpayer issues the Contract to Individual. In general, Taxpayer anticipates that
Individual’s age will be typical of other customers. Taxpayer intends to restrict the
availability of the Cumulative Income Minimum feature to customers who are Y-Z years
old at the time of Contract issuance.

The Contract will terminate if Individual dies prior to the commencement of Annuity
Payments or Protected Income Payments, unless continued by Individual’s spouse
pursuant to § 72(s).

The Contract will be treated as an annuity contract for state law purposes and will be
registered as a security with the Securities and Exchange Commission. Taxpayer will
PLR-114089-21                                4

maintain reserves for its liabilities under the Contract. Taxpayer will treat the
consideration Individual pays for the Contract (whether the periodic fees or any transfer
of proceeds from the Account after liquidation of the Account’s assets) as premiums for
state premium tax purposes and will account for the consideration as annuity premiums
both on its National Association of Insurance Commissioners annual statement and for
federal income tax purposes.

REQUESTED RULINGS

Taxpayer requests the following rulings:

1. The Contract will constitute an annuity contract for purposes of § 72.

2. The Protected Income Payments that are made using the Fixed Method and the
Annuity Payments will be taxable as “amounts received as an annuity” under § 72(b). In
addition, a portion of each Protected Income Payment that is made using the
Fluctuating Method will be treated as an “amount received as an annuity,” as follows:

        (a) The portion of each such Protected Income Payment that will be treated as an
amount received as an annuity will be excludable from gross income pursuant to
§ 72(b)(1) and §§ 1.72-2(b)(3) and 1.72-3 of the Income Tax Regulations, subject to the
limitation imposed by § 72(b)(2); and

        (b) The excess (if any) of each such Protected Income Payment over the portion
determined in (a) above will be treated as an amount not received as an annuity on or
after the annuity starting date and will be includible in gross income as provided in
§ 72(e)(2)(A) and §§ 1.72-1(d), 1.72-4(a)(3), (d)(3), and 1.72-11(b)(2).

3. The Account will not cause the Contract to have a “cash value” or “cash surrender
value” for purposes of § 72, and will not otherwise be part of the Contract for federal
income tax purposes.

4. For purposes of § 72(c)(1) and § 72(e)(6) (each defining “investment in the contract”),
the “aggregate amount of premiums or other consideration paid” for the Contract will
equal the sum of all charges Individual paid under the Contract plus any proceeds
Individual paid to Taxpayer upon liquidation of the Account as consideration for
Protected Income Payments or Annuity Payments.

LAW AND ANALYSIS

Requested Ruling # 1

Section 72(a) provides that, except as otherwise provided, gross income includes any
amount received as an annuity (whether for a period certain or during one or more lives)
under an annuity, endowment, or life insurance contract.
PLR-114089-21                                  5


Section 72(b)(1) provides that gross income does not include that part of any amount
received as an annuity under an annuity, endowment, or life insurance contract which
bears the same ratio to such amount as the investment in the contract (as of the annuity
starting date) bears to the expected return under the contract (as of such date).

Section 72(b)(2) provides that the portion of any amount received as an annuity which is
excluded from gross income under section 72(b)(1) shall not exceed the unrecovered
investment in the contract immediately before the receipt of such amount.

Section 1.72-2(a)(1) provides that the contracts under which amounts paid will be
subject to the provisions of § 72 include contracts which are considered to be life
insurance, endowment, and annuity contracts in accordance with the customary
practice of life insurance companies. Under §§ 1.72-1(b) and (c), as a general matter
“amounts received as an annuity” are amounts which are payable at regular intervals
over a period of more than one full year from the date on which they are deemed to
begin, provided the total of the amounts so payable or the period for which they are to
be paid can be determined as of that date, a proportionate part of which is considered to
represent a return of premiums or other consideration paid.

Under § 1.72-2(b), amounts are considered as “amounts received as an annuity” only if
all of the following tests are met: 1) the amounts must be received on or after the
annuity starting date; 2) the amounts must be payable in periodic installments at regular
intervals over a period of more than one full year from the annuity starting date; and 3)
the amounts payable must be determinable either directly from the terms of the contract
or indirectly from the use of either mortality tables or compound interest computations,
or both (if the contract is a variable contract, § 1.72-2(b)(3) provides an alternative
formulation of this requirement).

Under § 1.72-4(b)(1), the annuity starting date is the first day of the first period for which
an amount is received as an annuity. The first day of the first period for which an
amount is received as an annuity shall be the later of 1) the date upon which the
obligations under the contract became fixed or 2) the first day of the period which ends
on the date of the first annuity payment.

Explaining imposition of an “income-out-first” rule under § 72(e) for withdrawals prior to
the annuity starting date, the Senate report described a commercial annuity as

       [A] promise by a life insurance company to pay the beneficiary a given sum
       for a specified period, which period may terminate at death. Annuity
       contracts permit the systematic liquidation of an amount consisting of
       principal (the policyholder's investment in the contract) and income . . . . An
       individual may purchase an annuity by payment of a single premium or by
       making periodic payments. A deferred annuity contract may, at the election
       of the individual, be surrendered before annuity payments begin, in
PLR-114089-21                                   6

       exchange for the cash value of the contract . . . . The committee believes
       that the use of deferred annuity contracts to meet long-term investment
       goals, such as income security, is still a worthy ideal.

S. Rep. No. 97-494 at 349-50 (1982) (footnote omitted). The report also explains § 72's
utilization of an exclusion ratio regime: “[a] portion of each amount paid to a policyholder
as an annuity generally is taxed as ordinary income under an ‘exclusion ratio’ (§ 72(b))
computed to reflect the projected nontaxable return of investment in the contract and
the taxable growth on the investment.” Id. As described in Samuel v. Commissioner,
306 F.2d 682, 687 (1st Cir. 1962), aff’g Archibishop Samuel Trust v. Commissioner, 36
T.C. 641 (1961), acq., 1964-2 C.B. 3:

       Inherent in the concept of an annuity is a transfer of cash or property from
       one party to another in return for a promise to pay a specific periodic sum
       for a stipulated time interval . . . . Again, in the normal annuity situation, once
       the annuitant has transferred the cash or property to the obligor and has
       received his contractual right to periodic payments, he is unconcerned with
       the ultimate disposition of the property transferred once it is in the obligor's
       hands.

In Life Insurance, Black and Skipper state that “[i]n general financial terms, an annuity is
simply a series of periodic payments” and while “[l]ife insurance has as its principal
mission the creation of a fund[, t]he annuity, on the contrary, has as its basic function
the systematic liquidation of a fund.” Kenneth Black, Jr., Harold D. Skipper, and
Kenneth D. Black, III, Life Insurance, 144-45 (15th ed. 2015). Accordingly, “[e]ach
payment under a life annuity is a combination of principal and interest income and a
survivorship element. Although not completely accurate, one can view the operation of
an annuity as follows: If a person dies precisely at his or her life expectancy, he or she
would have neither gained nor lost through utilizing a life annuity.” Life Insurance at 46.
Elsewhere an annuity has been described as “a right to receive fixed, periodic
payments, for a specified period of time” and an annuity contract as a contract under
which, in exchange for the payment of a premium or premiums, the recipient thereof is
bound to make future payments, typically at regular intervals, in amounts, to payees,
and conditions specified in the parties' agreement. The determining characteristic of an
annuity is that the annuitant has an interest only in the periodic payments and not in any
principal fund or source from which they may be derived. Although an individual who
purchases an annuity remains the technical owner of the asset, he or she does not
retain total control over that asset and does not have unfettered access to the full
amount of his or her own “property.” 4 Am. Jur. 2d Annuities, § 1 (2021). Moreover,
“[t]he purchaser of an annuity surrenders all rights to the money paid, and therefore
installment payments of a debt, or payments of interest on a debt, do not constitute an
annuity.” Id., § 2.
PLR-114089-21                                    7

Whether an annuity contract allows the owner to access the value of the contract
through other than periodic (“annuity”) payments is a product of the terms of the
contract. 8 New Appleman on Insurance Law Library Edition § 91.02[6][b] (2009).

Here, on balance the Contract possesses the essential attributes of an annuity. It is true
that the Contract may not, “at the election of [Individual], be surrendered before annuity
payments begin, in exchange for the cash value of the contract,” S. Rep. No. 97-464 at

349. It is also true that because the annuity starting date for the Fixed Method and
Fluctuating Method is contingent upon the value of the Account being exhausted or
reduced to a minimum threshold amount while Individual is alive, it is not the case that
“if [Individual] exactly lives out his or her life expectancy, he or she would have neither
gained nor lost through utilizing the annuity contract,” Life Insurance at 46. However,
these conditions are not dispositive.

The Contract and the amounts paid (other than any one-time Cumulative Income
Minimum payment)1 under the Contract meet the requirements of §§ 1.72-1(b) and (c),
1.72-2(a)(1) and (b)(3), and 1.72-4(b)(1) as an annuity contract and annuity payments.
Additionally, the Contract is purchased “by making periodic payments” of premium for “a
promise by a life insurance company to pay the beneficiary a given sum for a specified
period, which period may terminate at death,” and is “used to provide long-term income
security.” S. Rep. No. 97-464 at 349. Moreover, it has “the determining characteristic . .
. that the annuitant has an interest only in the periodic payments and not in any principal
fund or source from which they may be derived.” 4 Am. Jur. 2d Annuities, § 1 (2021).
Individual will have “surrender[ed] all rights to the money paid,” thereby distinguishing
the Contract from “installment payments of a debt, or payments of interest on a debt,”
which are not annuities. Id.

The Contract is not a contract to pay interest. See § 1.72-14(a).

Accordingly, the Contract will constitute an annuity contract for purposes of § 72.

Requested Ruling # 2

Section 72(a) provides that, except as otherwise provided, gross income includes any
amount received as an annuity (whether for a period certain or during one or more lives)
under an annuity, endowment, or life insurance contract.

Section 72(b)(1) provides that gross income does not include that part of any amount
received as an annuity under an annuity, endowment, or life insurance contract which
bears the same ratio to such amount as the investment in the contract (as of the annuity
starting date) bears to the expected return under the contract (as of such date).



1 The payment of the Cumulative Income Minimum would be an amount not received as an annuity under

§ 72(e).
PLR-114089-21                                  8

Section 72(b)(2) provides that the portion of any amount received as an annuity which is
excluded from gross income under section 72(b)(1) shall not exceed the unrecovered
investment in the contract immediately before the receipt of such amount.

Section 72(c)(4) defines “annuity starting date” as the first day of the first period for
which an amount is received as an annuity under the contract.

Section 1.72-2(b)(2) defines “amounts received as an annuity” as only those amounts
that meet all of the following tests:

       (i) They must be received on or after the “annuity starting date” as that term is
       defined in § 1.72-4(b);

       (ii) They must be payable in periodic installments at regular intervals (whether
       annually, semiannually, quarterly, monthly, weekly, or otherwise) over a period of
       more than one full year from the annuity starting date; and

       (iii) Except as indicated in § 1.72-2(b)(3), the total of the amounts payable must
       be determinable at the annuity starting date either directly from the terms of the
       contract or indirectly by use of either mortality tables or compound interest
       computations, or both, in conjunction with such terms and in accordance with
       sound actuarial theory.

Section 1.72-2(b)(3) provides in pertinent part that notwithstanding the determinability
requirement stated immediately above, if amounts are to be received for a definite or
determinable time (whether for a period certain or for a life or lives) under a contract
which provides that the amount of the periodic payments may vary in accordance with
investment experience (as in certain profit-sharing plans), cost of living indices, or
similar fluctuating criteria, each such payment received shall be considered as an
amount received as an annuity only to the extent that it does not exceed the amount
computed by dividing the investment in the contract, as adjusted for any refund feature,
by the number of periodic payments anticipated during the time that the periodic
payments are to be made. If payments are to be made more frequently than annually,
the amount so computed shall be multiplied by the number of periodic payments to be
made during the taxable year for the purpose of determining the total amount which
may be considered received as an annuity during such year. To this extent, the
payments received shall be considered to represent a return of premium or other
consideration paid and shall be excludable from gross income in the taxable year in
which received. To the extent that the payments received under the contract during the
taxable year exceed the total amount thus considered to be received as an annuity
during such year, they shall be considered to be amounts not received as an annuity
and shall be included in the gross income of the recipient.

Section 1.72-3 provides that, in general, amounts received under contracts described in
paragraph (a)(1) of § 1.72-2 are not to be included in the income of the recipient to the
PLR-114089-21                                 9

extent that such amounts are excludable from gross income as the result of the
application of section 72 and the regulations thereunder.

Section 1.72-4(b) defines “annuity starting date” as the first day of the first period for
which an amount is received as an annuity; the first day of the first period for which an
amount is received as an annuity shall be whichever of the following is the later:

       (i) The date upon which the obligations under the contract became fixed, or

       (ii) The first day of the period (year, half-year, quarter, month, or otherwise,
       depending on whether payments are to be made annually, semiannually,
       quarterly, monthly, or otherwise) which ends on the date of the first annuity
       payment.

Section 72(e)(2)(A) provides the general rule for amounts not received as an annuity. If
an amount is an amount not received as an annuity and is an amount to which § 72(e)
applies as provided by the rule in § 72(e)(1), then, if received on or after the annuity
starting date, the amount shall be included in gross income. If the amount is received
before the annuity starting date, the amount shall be included in gross income to the
extent provided by the rule in § 72(e)(2)(B).

Section 1.72-1(d) provides in pertinent part that in the case of amounts not received as
an annuity, if such amounts are received after an annuity has begun and during its
continuance, amounts so received are generally includible in the gross income of the
recipient.

Section 1.72-4(a)(3) provides in pertinent part that the exclusion ratio shall be applied
only to amounts received as an annuity within the meaning of that term under paragraph
(b)(2) and (3) of § 1.72-2. Where the periodic payments increase in amount after the
annuity starting date in a manner not provided by the terms of the contract at such date,
the portion of such payments representing the increase is not an amount received as an
annuity.

Section 1.72-4(d)(3) provides in pertinent part that if a contract provides for payments to
be made to a taxpayer in the manner described in paragraph (b)(3) of § 1.72-2, the
investment in the contract shall be considered to be equal to the expected return under
such contract and the resulting exclusion ratio (100%) shall be applied to all amounts
received as an annuity under such contract. For any taxable year, payments received
under such a contract shall be considered to be amounts received as an annuity only to
the extent that they do not exceed the portion of the investment in the contract which is
properly allocable to that year and hence excludable from gross income as a return of
premiums or other consideration paid for the contract. The portion of the investment in
the contract which is properly allocable to any taxable year shall be determined by
dividing the investment in the contract (adjusted for any refund feature in the manner
described in paragraph (d) of § 1.72-7) by the applicable multiple (whether for a term
PLR-114089-21                                10

certain, life, or lives) which would otherwise be used in determining the expected return
for such a contract under § 1.72-5. The multiple shall be adjusted in accordance with
the provisions of the table in paragraph (a)(2) of § 1.72-5, if any adjustment is
necessary, before making the above computation. If payments are to be made more
frequently than annually and the number of payments to be made in the taxable year in
which the annuity begins are less than the number of payments to be made each year
thereafter, the amounts considered received as an annuity (as otherwise determined
under this subdivision) shall not exceed, for such taxable year (including a short taxable
year), an amount which bears the same ratio to the portion of the investment in the
contract considered allocable to each taxable year as the number of payments to be
made in the first year bears to the number of payments to be made in each succeeding
year.

Section 1.72-11(b)(2) provides in pertinent part that if dividends or payments in the
nature of dividends are paid under a contract to which section 72 applies and such
payments are received on or after the annuity starting date, such payments shall be fully
includible in the gross income of the recipient. Section 1.72-11(b)(2) shall apply to
amounts received under a contract described in paragraph (b)(3)(i) of § 1.72-2 to the
extent that the amounts received exceed the portion of the investment in the contract
allocable to each taxable year in accordance with paragraph (d)(3) of § 1.72-4. Hence,
such excess is fully includible in the gross income of the recipient.

Here, with respect to the Protected Income Payments, when the Protected Income
Payments become payable the obligations under the Contract become fixed: no
additional Contract charges are due and Taxpayer is obligated to pay the Protected
Income Payments until Individual’s death (or the death of Individual’s spouse). Hence,
the Protected Income Payments will be received on or after the annuity starting date.

Second, the Protected Income Payments will be paid periodically at regular intervals
over a period of more than one full year from the annuity starting date (unless death
occurs).

Third, under the Fixed Method, the total amount payable is determinable from the
Contract using mortality tables and sound actuarial theory. Accordingly, the Protected
Income Payments under the Fixed Method will be “amounts received as an annuity.”

Fourth, under the Fluctuating Method, the total amount payable is not determinable at
the annuity starting date but will fluctuate with investment experience. Accordingly, the
Protected Income Payments under the Fluctuating Method will be “amounts received as
an annuity” only to the extent provided by §§ 1.72-2(b)(3) and 1.72-4(d) and will be
“amounts not received as an annuity” to the extent the payments are not “amounts
received as an annuity.”

With respect to Annuity Payments, if Individual exercises that option the obligations
under the Contract become fixed: no additional Contract charges are due and Taxpayer
PLR-114089-21                                       11

is obligated to pay the annuity settlement option consistent with the rate guarantee.
Hence, the Annuity Payments will be received on or after the annuity starting date.

Second, the Annuity Payments will be paid periodically at regular intervals over a period
of more than one full year from the annuity starting date, consistent with the annuity
settlement option.

Third, the total amount payable is determinable from the Contract’s rate guarantee
using mortality tables and sound actuarial theory.

Accordingly, the Annuity Payments will be “amounts received as an annuity.”

Either the Protected Income Payments payable under the Fixed Method or the Annuity
Payments2 will be taxable under § 72(a) as amounts received as an annuity, subject to
the exclusion of the amount of each payment allocable to the investment in the contract
determined under § 72(b).

As for Protected Income Payments payable under the Fluctuating Method, the portion of
each Protected Income Payment under the Fluctuating Method treated as an “amount
received as an annuity” will be excludable from gross income pursuant to § 72(b)(1) and
§§ 1.72-2(b)(3), 1.72-3, and 1.72-4(d), subject to the limitation imposed by § 72(b)(2).
The portion of each Protected Income Payment under the Fluctuating Method treated as
an “amount not received as an annuity” will be treated as an amount not received as an
annuity on or after the annuity starting date and will be includible in gross income. See
§ 72(e)(2)(A) and §§ 1.72-1(d), 1.72-4(a)(3), (d)(3), and 1.72-11(b)(2).

Requested Ruling # 3

Section 72 does not define the terms “cash value” or “cash surrender value” with regard
to an annuity contract. With regard to a life insurance contract, § 7702(f)(2)(A) defines
“cash surrender value” as “cash value determined without regard to any surrender
charge, policy loan, or reasonable termination dividend.” Section 1.7702-2(h)(2) of the
Proposed Income Tax Regulations defines “cash surrender value” of a life insurance
contract as generally equaling its “cash value,” which in turn is defined by proposed
§ 1.7702-2(b)(1) as the greater of “(i) [t]he maximum amount payable under the contract
(determined without regard to any surrender charge or policy loan); or (ii) [t]he
maximum amount that the policyholder can borrow under the contract.”3 See also H.R.
Rep. No. 98-432 at 1444.

The term “cash value” commonly connotes the amount available to a policyholder for
withdrawal or upon surrender of the contract. See, e.g., Life Insurance, at 41-42; see

2 Individual must elect either Protected Income Payments (whether on the Fixed Method or Fluctuating

Method) or Annuity Payments; Individual cannot elect both.
3 Cf. proposed § 1.7702-2(b)(2), which provides certain exclusions from cash value, none of which are

relevant to this discussion.
PLR-114089-21                                 12

also John H. Magee, Life Insurance 599 (3d ed. 1958) (“The cash value represents the
amount available to the policyholder upon the surrender of the life insurance contract.”)

Rev. Rul. 77-85, 1977-1 C.B. 12, addressed an arrangement involving an ”investment
annuity policy” that has some features similar to Taxpayer’s proposed arrangement. In
the ruling, the policyholder could not receive any amount directly from the account and
could not receive a distribution of assets in kind. At any time prior to the annuity starting
date, however, the policyholder could make a full or partial surrender of the policy to the
insurance company. If such a surrender were made, the custodian was directed by the
agreement to sell all or part of the assets as appropriate and to pay over the necessary
proceeds to the insurance company. The insurance company in turn would make the full
or partial cash surrender payment to the policyholder in an amount equal to the
proceeds received by the insurance company from the account, less any cash
surrender charges.

The ruling does not address whether the underlying account created any “cash value” or
“cash surrender value” for the investment annuity policy. Nonetheless, the contrast in
the mechanics illustrates the loose connection between the Account and
the Contract. The Contract cannot be monetized at the discretion of Individual other
than through receipt of Protected Income Payments or exercise of the option to receive
Annuity Payments. It cannot be assigned, cannot be surrendered in whole or part in
exchange for cash, and cannot be used as collateral against a loan from Taxpayer. The
connection to the Account is unlike that in the ruling - the Account’s value is used only
to pay the Contract charges or to purchase the Annuity Payments if that option is
exercised. Individual can access the Account’s value without operation of the Contract,
though with consequences if, for example, such access produces a withdrawal that
exceeds the maximum withdrawal amount (an Excess Withdrawal) or if the assets
selected by Individual are outside any limits that Taxpayer might set on permissible
assets.

Although the Contract (1) has utility only in conjunction with an eligible Account,
(2) controls, to some extent, Individual’s activities with regard to that Account, and
(3) cannot be alienated or otherwise monetized, the Account is not so intertwined with
the Contract as to be effectively part of the Contract. Cf. Rev. Rul. 77-85; Rev. Rul.
2003-97, 2003-2 C.B. 380.

Accordingly, the Account will not cause the Contract to have a “cash value” or “cash
surrender value” for purposes of § 72, and will not otherwise be part of the Contract for
federal income tax purposes.

Requested Ruling # 4

Section 72(c)(1) provides that, for purposes of the exclusion ratio under § 72(b), the
“investment in the contract” as of the annuity starting date is the aggregate amount of
premiums or other consideration paid for the contract, minus the aggregate amount
PLR-114089-21                                13

received under the contract before such date, to the extent that such amount was
excludable from gross income. Under § 72(c)(2), this amount is then reduced by the
value of the refund feature, if any.

Section 72(e)(6) provides that for purposes of § 72(e), the “investment in the contract”
as of any date is the aggregate amount of premiums or other consideration paid for the
contract before such date, minus the aggregate amount received under the contract
before such date, to the extent that such amount was excludable from gross income.

As mentioned, Rev. Rul. 77-85 addressed an arrangement with some similar features.
That ruling held that the issuer should include in its premium income only the premiums
and charges paid each year.

Accordingly, with regard to Protected Income Payments, the Contract charges
(including any final proceeds paid upon final liquidation of the Account should the
Account’s value fall below the minimum threshold amount) should be taken into account
in the determination of Individual’s “investment in the contract” for the Contract under
§ 72; with regard to Annuity Payments, both the Contract charges and the amount
remitted to Taxpayer upon exercise of the option to receive Annuity Payments should
be taken into account in the determination of Individual’s “investment in the contract” for
the Contract under § 72.

RULINGS

1. The Contract will constitute an annuity contract for purposes of § 72.

2. The Protected Income Payments that are made using the Fixed Method and the
Annuity Payments will be taxable as “amounts received as an annuity” under § 72(b). In
addition, a portion of each Protected Income Payment that is made using the
Fluctuating Method will be treated as an “amount received as an annuity,” as follows:

      (a) The portion of each such Protected Income Payment that will be treated as an
amount received as an annuity will be excludable from gross income pursuant to
§ 72(b)(1) and §§ 1.72-2(b)(3) and 1.72-3, subject to the limitation imposed by
§ 72(b)(2); and

        (b) The excess (if any) of each such Protected Income Payment over the portion
determined in (a) above will be treated as an amount not received as an annuity on or
after the annuity starting date and will be includible in gross income as provided in
§ 72(e)(2)(A) and §§ 1.72-1(d), 1.72-4(a)(3), (d)(3), and 1.72-11(b)(2).

3. The Account will not cause the Contract to have a “cash value” or “cash surrender
value” for purposes of § 72, and will not otherwise be part of the Contract for federal
income tax purposes.
PLR-114089-21                                  14

4. For purposes of § 72(c)(1) and § 72(e)(6) (each defining “investment in the contract”),
the “aggregate amount of premiums or other consideration paid” for the Contract will
equal the sum of all charges Individual paid under the Contract plus any proceeds
Individual paid to Taxpayer upon liquidation of the Account as consideration for
Protected Income Payments or Annuity Payments.

CAVEATS

The rulings contained in this letter are based upon information and representations
submitted by Taxpayer and accompanied by penalty of perjury statements executed by
appropriate parties. While this office has not verified any of the material submitted in
support of the request for rulings, it is subject to verification on examination.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter, including but not limited to issues under Subchapter D (§ 401 et seq.), the
computation of the exclusion ratio under § 72(b), the characterization of the reserve
under § 816(b), or the computation of the amount of any reserve.

This ruling letter is directed only to the taxpayer who requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent.

Taxpayer must attach a copy of this letter ruling to any tax return to which it is relevant.

In accordance with a power of attorney on file in this office, a copy of this ruling is being
furnished to your authorized representatives.




                                                    Sincerely,



                                                    John E. Glover
                                                    Senior Counsel, Branch 4
                                                    Associate Chief Counsel
                                                    (Financial Institutions and Products)




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