What Is a Fully Paid Individual Insurance Annuity Contract?

Q: In an Ask the Experts column on 403(b) plan termination, the Experts mentioned that “delivery of a fully paid individual insurance annuity contract is treated as a distribution” for plan termination purposes. Can you clarify what is meant by this language, including what exactly is a “fully paid individual insurance annuity contract”?

Kimberly Boberg, Taylor Costanzo, Kelly Geloneck and David Levine, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:

A: Certainly! Some annuity contract providers have restrictions that would prevent the type of lump-sum distribution normally required by the IRS for a plan termination. In a plan termination, the goal is to ensure that all assets can be distributed from the plan as soon as administratively practical. For plans with annuity contracts to terminate, the 403(b) regulations provide relief by allowing plans to provide participants with a fully paid individual insurance annuity contract, in lieu of an actual distribution.

Basically this means that, instead of the contract existing inside of the plan, it exists outside of the plan, with the plan, in effect, having transferred its liability for the contract to the annuity provider. All of the same annuity contract restrictions that existed prior to the plan termination still exist, but now the annuity provider is solely responsible for providing the benefit under the annuity contract to the participant. The contract still exists as it has before, but the plan sponsor no longer has any responsibility for the contract.

The reference to “fully paid” only means that the participant’s account balance was used to fully fund this contract, and no future payments are necessary to receive benefits; annuity contracts would normally require regular payments into the account.

NOTE: This feature is to provide general information only, does not constitute legal advice and cannot be used or substituted for legal or tax advice.

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