[Federal Register Volume 73, Number 146 (Tuesday, July 29, 2008)]
[Rules and Regulations]
[Pages 43860-43863]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-17271]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9418]
RIN 1545-BE65


Converting an IRA Annuity to a Roth IRA

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations under section 408A of 
the Internal Revenue Code (Code). These final regulations provide 
guidance concerning the tax consequences of converting a non-Roth IRA 
annuity to a Roth IRA. These final regulations affect individuals 
establishing Roth IRAs, beneficiaries under Roth IRAs, and trustees, 
custodians and issuers of Roth IRAs.

DATES: Effective date: These final regulations are effective July 29, 
2008.
    Applicability date: These regulations are applicable to any Roth 
IRA

[[Page 43861]]

conversion where an annuity contract is distributed or treated as 
distributed from a traditional IRA on or after August 19, 2005.

FOR FURTHER INFORMATION CONTACT: William D. Gibbs at 202-622-6060 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

Roth IRAs and Conversions

    This document contains final regulations that amend the Income Tax 
Regulations (26 CFR Part 1) under section 408A of the Code relating to 
Roth IRAs. Section 408A of the Code, which was added by section 302 of 
the Taxpayer Relief Act of 1997, Public Law 105-34 (111 Stat. 788), 
establishes the Roth IRA as a type of individual retirement plan, 
effective for taxable years beginning on or after January 1, 1998.
    The identifying characteristic of Roth IRAs is that all 
contributions to Roth IRAs are after-tax contributions (that is, an IRA 
owner cannot take a deduction for a contribution made to a Roth IRA) 
but qualified distributions are tax-free. A qualified distribution from 
a Roth IRA is a distribution that is made: (1) at least 5 years after 
the account owner (or the account owner's spouse) made a Roth IRA 
contribution, and (2) after age 59\1/2\, after death, on account of 
disability, or for a first-time home purchase.
    A taxpayer whose modified adjusted gross income for a year does not 
exceed $100,000 (and who, if married, files jointly) \1\ may convert an 
amount held in a non-Roth IRA (that is, a traditional IRA or SIMPLE 
IRA) to an amount held in a Roth IRA. If a taxpayer converts an amount 
held in a non-Roth IRA to a Roth IRA, the taxpayer must include the 
value of the non-Roth IRA being converted in gross income (to the 
extent the conversion is not a conversion of basis in the non-Roth 
IRA).
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    \1\ These limitations are removed for taxable years beginning 
after December 31, 2009.
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    A conversion may be accomplished by means of a rollover, trustee-
to-trustee transfer, or account redesignation. Regardless of the means 
used to convert, any amount converted from a non-Roth IRA to a Roth IRA 
is treated as distributed from the non-Roth IRA and rolled over to the 
Roth IRA. In the case of a conversion involving property, the 
conversion amount generally is the fair market value of the property on 
the date of distribution or the date the property is treated as 
distributed from the traditional IRA.
    Final regulations regarding Roth IRAs were published in the Federal 
Register on February 4, 1999 (64 FR 5597). On August 19, 2005, the IRS 
issued temporary regulations under section 408A (70 FR 48868) relating 
to conversions involving annuities. These temporary regulations were 
also issued in identical form as proposed regulations (70 FR 48924).
    Rev. Proc. 2006-13 (2006-1 CB 315), which was issued on January 17, 
2006, in response to several comments received on the temporary and 
proposed regulations, provided interim guidance with respect to the 
temporary regulations. See Sec.  601.601(d)(2)(ii)(b). After 
consideration of all comments received on the proposed regulations, 
these final regulations adopt the provisions of the proposed 
regulations with certain modifications described in the Explanation of 
Provisions.

Explanation of Provisions

    Like the proposed regulations, these final regulations clarify that 
when a non-Roth individual retirement annuity is converted to a Roth 
IRA, the amount that is treated as distributed is the fair market value 
of the annuity contract on the date the annuity contract is converted. 
Similarly, when a non-Roth individual retirement account holds an 
annuity contract as an account asset and the account is converted to a 
Roth IRA, the amount that is treated as distributed with respect to the 
annuity contract is the fair market value of the annuity contract on 
the date the annuity contract is converted (that is distributed or 
treated as distributed from the non-Roth IRA).
    One commentator suggested that the final regulations should clarify 
that where a conversion is made by surrendering an annuity without 
retaining or transferring rights, the amount converted, and hence the 
amount that must be included in income as a result of the conversion, 
is limited to the surrendered cash value (the actual proceeds to be 
deposited into the Roth IRA). Rev. Proc. 2006-13 provided that, in such 
a case, the valuation methods in the temporary regulations do not 
apply.
    The final regulations adopt this suggestion. Thus, to the extent an 
individual retirement annuity or an annuity contract held by an 
individual retirement account is surrendered with no retained or 
transferred rights, the amount treated as a distribution is limited to 
the surrendered cash value (the actual proceeds available to be 
deposited into the Roth IRA).
    The proposed regulations used a methodology from the gift tax 
regulations (Sec.  25.2512-6) to determine fair market value of an 
annuity contract. Those rules depend on how soon after purchase the 
contract was converted and whether future premiums were to be paid. The 
different time periods were ``soon after'' the contract was sold and 
after the contract ``has been in force for some time.'' A commentator 
stated that these terms are not defined and do not lend themselves to 
clear or uniform interpretation.
    In response to these comments, the final regulations modify the 
application of the valuation rules taken from the gift tax regulations 
(collectively referred to under these regulations as the gift tax 
method). The applicability of one valuation rule within the gift tax 
method is based upon whether the company which sold the initial 
contract sells comparable annuities. If there is such a comparable 
contract currently being sold, the fair market value of the contract is 
determined as the price of the comparable contract. For example, assume 
a taxpayer who is age 60 at the time of the conversion had purchased 
from an insurance company a contract at an earlier age which will pay 
him $500 per month for life beginning at age 70. If the insurance 
company is selling contracts that will provide a taxpayer who is age 60 
$500 per month for life at age 70, then the fair market value of the 
taxpayer's contract, for purposes of determining the amount converted, 
is the current price of the similar contract. (If the conversion occurs 
soon after the annuity was sold, the comparable contract is the annuity 
itself and, thus, the fair market value of the annuity is established 
by the actual premiums paid for such contract.) This comparable 
contract valuation rule subsumes the first two methods under the 
proposed regulations.
    The gift tax method under the final regulations includes a second 
alternative for situations where there is no comparable contract. If no 
comparable contract is available to make a comparison, the fair market 
value is established through an approximation that is based on the 
interpolated terminal reserve at the date of the conversion, plus the 
proportionate part of the gross premium paid before the date of the 
conversion which covers the period extending beyond that date. This 
reserve alternative is the same as the third method under the proposed 
regulations, except that it applies whenever there is no comparable 
contract.
    Rev. Proc. 2006-13 provided an alternative to the valuation method 
in the proposed regulations based on the accumulation of premiums and 
this alternative is included in the final regulations. Under this 
``accumulation

[[Page 43862]]

method'', the fair market value of an annuity contract is permitted to 
be determined using the methodology provided in Sec.  1.401(a)(9)-6, A-
12, with the following modifications. First, all front-end loads and 
other non-recurring charges assessed in the twelve months immediately 
preceding the conversion must be added to the account value. Second, 
future distributions are not to be assumed in the determination of the 
actuarial present value of additional benefits. Finally, the exclusions 
provided under Sec.  1.401(a)(9)-6, A-12(c)(1) and (c)(2), are not to 
be taken into account.
    These final regulations also provide authority for the Commissioner 
to issue additional guidance regarding the fair market value of an 
individual retirement annuity, including formulas to be used for 
determining fair market value.

Effective Date

    These regulations are applicable 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, taxpayers may 
instead apply the valuation methods in the temporary regulations and 
Rev. Proc. 2006-13 for annuity contracts distributed or treated as 
distributed from a traditional IRA on or before December 31, 2008. See 
Sec.  601.601 (d)(2)(ii)(b). Thus, for example, the adoption of these 
final regulations does not eliminate the special rule for 2005 
conversions set forth in section 4 of Rev. Proc. 2006-13.

Special Analyses

    It has been determined that these final regulations are not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these final regulations and because 
these regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, the proposed 
regulations preceding these final regulations were submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on their impact on small business.

Drafting Information

    The principal authors of these regulations are William Douglas 
Gibbs and Cathy V. Pastor of the Office of the Division Counsel/
Associate Chief Counsel (Tax Exempt and Government Entities). However, 
other personnel from the IRS and Treasury Department participated in 
the development of these regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read, in 
part, as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Section 1.408A-4T is removed.


Sec.  1.408A-4T  [Removed].

0
Par. 3. Section 1.408A-4 is amended by revising Q-14 and A-14 to read 
as follows:


Sec.  1.408A-4  Converting amounts to Roth IRAs.

* * * * *
    Q-14. What is the amount that is treated as a distribution, for 
purposes of determining income inclusion, when a conversion involves an 
annuity contract?
    A-14. (a) In general--(1) Distribution of Fair Market Value Upon 
Conversion. Notwithstanding Sec.  1.408-4(e), when part or all of a 
traditional IRA that is an individual retirement annuity described in 
section 408(b) is converted to a Roth IRA, for purposes of determining 
the amount includible in gross income as a distribution under Sec.  
1.408A-4, A-7, the amount that is treated as distributed is the fair 
market value of the annuity contract on the date the annuity contract 
is converted. Similarly, when a traditional IRA that is an individual 
retirement account described in section 408(a) holds an annuity 
contract as an account asset and the traditional IRA is converted to a 
Roth IRA, for purposes of determining the amount includible in gross 
income as a distribution under Sec.  1.408A-4, A-7, the amount that is 
treated as distributed with respect to the annuity contract is the fair 
market value of the annuity contract on the date that the annuity 
contract is distributed or treated as distributed from the traditional 
IRA. The rules in this A-14 also apply to conversions from SIMPLE IRAs.
    (2) Annuity contract surrendered. Paragraph (a)(1) of this 
paragraph A-14 does not apply to a conversion of a traditional IRA to 
the extent the conversion is accomplished by the complete surrender of 
an annuity contract for its cash value and the reinvestment of the cash 
proceeds in a Roth IRA, but only if the surrender extinguishes all 
benefits and other characteristics of the contract. In such a case, the 
cash from the surrendered contract is the amount reinvested in the Roth 
IRA.
    (3) Definitions. The definitions set forth in Sec.  1.408A-8 apply 
for purposes of this paragraph A-14.
    (b) Determination of fair market value--(1) Overview--(i) Use of 
alternative methods. This paragraph (b) sets forth methods which may be 
used to determine the fair market value of an individual retirement 
annuity for purposes of paragraph (a)(1) of this paragraph A-14. 
However, if, because of the unusual nature of the contract, the value 
determined under one of these methods does not reflect the full value 
of the contract, that method may not be used.
    (ii) Additional guidance. Additional guidance regarding the fair 
market value of an individual retirement annuity, including formulas to 
be used for determining fair market value, may be issued by the 
Commissioner in revenue rulings, notices, or other guidance published 
in the Internal Revenue Bulletin (see Sec.  601.601(d)(2)(ii)(b)).
    (2) Gift tax method--(i) Cost of contract or comparable contract. 
If with respect to an annuity, there is a comparable contract issued by 
the company which sold the annuity, the fair market value of the 
annuity may be established by the price of the comparable contract. If 
the conversion occurs soon after the annuity was sold, the comparable 
contract may be the annuity itself, and thus, the fair market value of 
the annuity may be established through the sale of the particular 
contract by the company (that is, the actual premiums paid for such 
contract).
    (ii) Use of reserves where no comparable contract available. If 
with respect to an annuity, there is no comparable contract available 
in order to make the comparison described in paragraph (b)(2)(i) of 
this paragraph A-14, the fair market value may be established through 
an approximation that is based on the interpolated terminal reserve at 
the date of the conversion, plus the proportionate part of the gross 
premium last paid before the date of the conversion which covers the 
period extending beyond that date.
    (3) Accumulation method. As an alternative to the gift tax method 
described in paragraph (b)(2) of this paragraph A-14, this paragraph 
(b)(3) provides a method that may be used for an annuity contract which 
has not been

[[Page 43863]]

annuitized. The fair market value of such an annuity contract is 
permitted to be determined using the methodology provided in Sec.  
1.401(a)(9)-6, A-12, with the following modifications:
    (i) All front-end loads and other non-recurring charges assessed in 
the twelve months immediately preceding the conversion must be added to 
the account value.
    (ii) Future distributions are not to be assumed in the 
determination of the actuarial present value of additional benefits.
    (iii) The exclusions provided under Sec.  1.401(a)(9)-6, A-12(c)(1) 
and (c)(2), are not to be taken into account.
    (c) Effective/applicability date. The provisions of this paragraph 
A-14 are applicable to any conversion in which an annuity contract is 
distributed or treated as distributed from a traditional IRA on or 
after August 19, 2005. However, for annuity contracts distributed or 
treated as distributed from a traditional IRA on or before December 31, 
2008, taxpayers may instead apply the valuation methods in Sec.  
1.408A-4T (as it appeared in the April 1, 2008, edition of 26 CFR part 
1) and Revenue Procedure 2006-13 (2006-1 CB 315) (See Sec.  
601.601(d)(2)(ii)(b)).

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.

    Approved: July 20, 2008.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. E8-17271 Filed 7-28-08; 8:45 am]
BILLING CODE 4830-01-P