Tax News

CCH (cch.taxgroup.com) reports:

  The IRS has released final regulations regarding the conversion of annuity contracts from non-Roth individual retirement accounts (IRAs) to Roth IRAs under Code Sec. 408A. The final regulations generally follow temporary and proposed regulations released in 2005, but with minor amendments made in response to comments received regarding the regulation.

  The major difference between a traditional, or non-Roth, IRA and a Roth IRA is that a traditional IRA allows for a deduction from income of the contributed amount, allowing for a pre-tax contribution, whereas a Roth IRA allows only after-tax contributions. Consequently, distributions from traditional IRAs are taxed while distributions from Roth IRAs are tax-free. The original final regulations released in 1999 provided guidance, in question-and-answer format, on the conversion of a traditional IRA to a Roth IRA, which requires the inclusion in income of the amount converted because the original contribution to the traditional IRA was a pre-tax contribution.

  Temporary and proposed amendments to Reg. §1.408A-4 released in 2005 provided additional guidance relating to the valuation of traditional individual retirement annuity contracts for purposes of conversion to a Roth IRA. In response to these temporary and proposed amendments, several comments were submitted regarding the proper valuation of the annuities and the methodology used in determining the valuation, and the IRS issued interim guidance in Rev. Proc. 2006-13, 2006-1 CB 315, in response. The commentators' suggestions and the interim guidance from Rev. Proc. 2006-13 have been incorporated into these final regulations.

  The final regulations provide guidance for circumstances in which a conversion is effected by the complete surrender of the annuity, without the transfer or retention of rights, in exchange for its cash value. In those circumstances, the surrendered cash value, which is made up of the proceeds to be contributed to the Roth IRA, is the amount of taxable income, not the fair market value of the annuity as provided under the temporary and proposed regulations.

  The other amendment provided in the final regulations relates to the methodology used to determine the fair market value of the annuity. Under the temporary and proposed regulations, the method of determining the fair market value of an annuity was similar to that found in gift tax regulations and was based upon comparable contracts issued by the same company at or around the same time. However, commentators suggested that the terms used in this guidance were unclear. In response, the final regulations provide for three different methods of determining the fair market value of the annuities. The first is the gift tax method based upon comparable contracts. The second applies where there is no comparable contract, and establishes fair market value through an approximation based upon the interpolated terminal reserve at the date of conversion, plus the proportionate part of the premium paid before conversion covering a period after the date of conversion. A third method is provided and is based on guidance in
Rev. Proc. 2006-13, and establishes the fair market value through a method that uses the accumulation of premiums, similar to a valuation method provided for qualified pension plans under Reg. §1.401(a)(9)-6.

  The final regulations apply to any Roth IRA conversion where an annuity contract is distributed or treated as distributed from a traditional IRA on or after August 19, 2005. However, the valuation methods in the temporary regulations or in Rev. Proc. 2006-13 can be used for annuity contracts distributed or treated as distributed from a traditional IRA on or before December 31, 2008.

T.D. 9418, 2008FED ¶47,054

Other References:

 
Code Sec. 408A

  CCH Reference - 2008FED ¶18,927B

  Tax Research Consultant