Rev. Rul. 73-239

Advice has been requested whether the provisions described below prevent a contract from being treated as an annuity contract for purposes of section 403(b) of the Internal Revenue Code of 1954.

In 1972 an organization that is exempt from Federal income taxes under section 501(c)(3) of the Code purchased an individual contract from an insurance company for one of its employees. The employee's rights under the contract are nonforfeitable. It provides for equal monthly payments over the employee's lifetime, commencing at age 65. The contract further provides that, in lieu of the payments otherwise provided thereunder, the employee may elect, before he reaches age 65, to have the distribution of his interest made under any one of the following options: (1) Payments will commence when the employee attains age 65 and will be paid to him for life and thereafter to his spouse for as long as his spouse shall survive, provided however that each periodic payment to the spouse will be no greater than each payment to the employee during his lifetime, or (2) equal monthly installments, commencing at age 65, will be paid for a period of thirty years, first to the employee and then to his designated beneficiary if the employee dies before the end of the thirty-year period.

Section 403(b) of the Code provides that, if the conditions set forth therein are met, amounts contributed by an employer that is exempt from Federal income taxes under section 501(c)(3), to purchase an annuity for an employee, shall be excluded from the employee's gross income to the extent that such amounts do not exceed his applicable exclusion allowance.

Section 1.403(b)-1(c)(3) of the Income Tax Regulations provides that an individual contract purchased after December 31, 1962, which provides incidental life insurance protection, may be purchased as an annuity contract to which the tax treatment of section 403(b) of the Code applies.

Revenue Ruling 72-241, 1972-1 C.B. 108, discusses the requirement of section 1.401-1(b)(1)(i) of the regulations that benefits payable to the beneficiary of an employee under a pension plan be incidental to the primary purpose of distributing the accumulated funds to the employee. That Revenue Ruling holds that any settlement option will meet that incidental requirement if it contains provisions whereby the present value of the payments to be made to the participant is more than 50 percent of the present value of the total payments to be made to the participant and his beneficiaries. Furthermore, Revenue Ruling 72-241 illustrates the incidental requirement with four situations, situation 3 of which contains a settlement option basically identical to the second option in this case.

Revenue Ruling 72-240, 1972-1 C.B. 108, holds that a pension plan provision, permitting payment of an annuity to a retired employee for life and thereafter to his designated beneficiary for as long as the employee's spouse lives, meets the requirement that payments to persons other than employee participants be incidental, where each periodic payment to the beneficiary will be no greater than each payment to the participant during his lifetime.

Although Revenue Rulings 72-240 and 72-241 involve the qualification of plans under section 401(a) of the Code, the principles set forth therein, relating to whether payments to those other than employees are incidental, are equally applicable in determining whether payments to others are incidental for purposes of section 1.403(b)-1(c)(3) of the regulations. Since the provisions in the contract described in this case are basically identical to those found acceptable in Revenue Ruling 72-240 and situation 3 of Revenue Ruling 72-241, these provisions meet the requirements of section 1.403(b)-1(c)(3) of the regulations.

Accordingly, it is held that these provisions do not prevent the contract from being treated as an annuity contract for purposes of section 403(b) of the Code.