SECURE 2.0 Includes Several Changes Intended to Encourage the Use of Retirement Annuities

SECURE 2.0, which was included as part of the Consolidated Appropriations Act of 2023, was signed into law in late December 2022. The statute contains 92 substantive sections making reforms to a broad array of retirement-related provisions in ERISA, the Internal Revenue Code (the Code) and certain other laws. Of these 92 sections, four make changes to various aspects of the required minimum distribution (RMD) rules set forth under the Code that apply to annuities in various situations. Below is a brief summary of these new provisions.

Removing RMD Barriers to Life Annuities. Generally, the Code’s RMD rules are intended to limit long tax deferrals, and one way they purport to do this is by prohibiting annuity contracts from providing distributions that begin small and grow excessively over time. Unfortunately though, real-world application of the rules sometimes prevents even modest benefit increases. To help remedy this, Section 201 of the Act provides that commercial annuities purchased under 401(k) and other defined contribution plans, as well as IRAs, may provide for:

• Certain payment increases of up to 5% per year.
• Certain lump sums which commute future distribution payments.
• Acceleration of up to 12 months of payments.
• Reasonable dividend payments.
• Death benefits which are equal to the cost of the annuity, reduced by prior payments.

QLACs. The RMD rules have been a significant impediment to the use of longevity annuities in particular, since they generally compel payments to commence at an earlier age, such as 70 ½, 72 or otherwise (depending on when the retiree was born). While the RMD rules were previously changed to exempt “qualifying longevity annuity contracts” (QLACs) meeting certain premium limit and other requirements from the rules until distributions actually begin, a number of challenges remained. Section 202 of the Act requires the Treasury Department to further amend the RMD rules to:

• Repeal the 25% QLAC premium limit.
• Increase the premium limit from $125,000 to $200,000, subject to further indexing.
• Provide that QLAC benefits purchased with joint and survivor (spousal) benefits will not become non-compliant due to a subsequent divorce.
• Permit “free look” recission of QLACs to be permitted for up to 90 days following purchase.

Eliminating Partial Annuitization “Penalties.” Under prior law, where tax-advantaged retirement accounts held annuities and non-annuity assets alike, they were treated separately for calculating RMDs, resulting in higher RMDs for the annuity portion than non-annuity assets of equal value. Section 204 of the Act requires the Treasury Department to further amend the RMD rules such that individuals can elect to have their RMDs calculated upon the total account value with respect to defined contribution plans and IRAs.

Clarification of the Substantially Equal Periodic Payment Rule. Where a “substantially equal periodic payment” stream (paid over a retiree’s life, or joint life with a spouse) that is not subject to the 10% additional penalty tax on early retirement distributions is subsequently modified, the penalty tax relief may be lost. Section 323 of the Act clarifies that, for purposes of the penalty tax relief, transfers and rollovers between tax-advantaged plans, 1035 exchanges and payments from annuities that otherwise satisfy the RMD rules will not be treated as “modifications” to the payment stream, thus preserving the relief.

Readers should recognize that, while some of these above changes are effective already, others have future effective dates, while still others are subject to a “good faith” interpretation standard pending the issuance of formal regulatory guidance.

Historically, the RMD rules have presented significant impediments to the use of retirement annuities, including for the reasons described above. While some technical guidance is still needed, these changes from SECURE 2.0 clearly reflect congressional intent to dissolve these technical barriers where possible, and therefore encourage the use of annuities in defined contribution plans and IRAs as a means of enhancing retirement security for millions of Americans.