Rev. Rul. 68-488

Rev. Rul. 68-488

Advice has been requested whether an employer's payments to a bank custodian under the circumstances described below are contributions to purchase an annuity contract within the meaning of section 403(b)(1)(A) of the Internal Revenue Code of 1954.

An organization exempt from Federal income tax under section 501(c)(3) of the Code entered into an agreement with an insurance company under which a group annuity contract was issued to the employer corporation obligating the insurance company to provide monthly annuity benefits after the retirement of the employees enrolled under the contract. The employer also entered into a custodial agreement with a bank authorizing the bank to transfer funds to the insurer, set up individual custodial accounts for covered employees, and to make prescribed investments. The group contract and the custodial agreement are irrevocable as far as the employees are concerned.

Upon enrollment a nontransferable certificate containing a summary of the guaranteed annuity benefit rates and other features of the group contract was issued to each employee, and the employer commenced payment of the required contributions to the custodian pursuant to salary reduction agreements executed by the employees. Each employee's rights under the annuity contract are nonforfeitable at the time the employer contributions are made. The custodian paid an initial premium to the insurance company and credited further contributions to each employee's account together with all dividends and distributions on the investments. These investments are required to be made within prescribed limitations set forth in the custodial agreement.

Monthly payments under the contract are to begin when an employee terminates his employment with the employer or when he becomes 65 years old, whichever is earlier. Under the arrangement, the employer contributions retained by the insurance company and all amounts held in the custodial accounts are considered to be the property of the insurance company, a party to the custodial agreement. The custodial agreement may not be amended or modified without the consent of the insurer.

The insurance company is obligated to make annuity payments under the contract even though it does not receive the premium payments because of the custodian's breach of its obligation under the custodial agreement or because of a loss in the employee's account, other than from a loss from a depreciation in investment value. The amount of the payments for the first year following the retirement date is determined by applying the guaranteed annuity rate to the market value of an employee's account at the time of retirement.

An employee may cancel the salary reduction agreement and request that contributions in his behalf cease. However, the employee may not recover employer contributions standing to his credit prior to the time he terminates his employment or attains age 65.

Section 403(b) of the Code provides a limited exclusion from the employee's gross income for amounts contributed to purchase an annuity contract by an employer exempt from Federal income tax under section 501(c)(3) of the Code.

Revenue Ruling 68-116, C.B. 1968-1, 177, holds that a variable annuity contract is an annuity contract for purposes of section 403(b) of the Code.

This case is distinguishable from that described in Revenue Ruling 68-487, page 187, this Bulletin. In that Revenue Ruling the insurance company was not obligated to provide annuity benefits unless and until the custodian made the premium payments. In this case the amounts held under the custodial account are the property of the insurance company and the contract immediately obligates the insurer to provide the employee with periodic payments, determined by reference to recognized mortality tables, and to provide death benefits which do not exceed the larger of the reserve or the total premiums paid for the annuity benefits. The insurance company is not relieved of this obligation even if the premium is not received because of a breach of the custodian's obligation under the custodial agreement or because of a loss in the annuitant's account, other than a loss from the depreciation in the investment value.

Accordingly, payments made to the bank under the instant arrangement are contributions to purchase an annuity contract, within the meaning of section 403(b)(1)(A) of the Code, if all the other requirements of section 403(b) are met.

The result in this case would have been the same if, instead of making payments to a bank custodian, the employer had made the payments directly to the insurance company and the company had placed the payments in a separate account used for investments generally.