REVENUE RULING 73-333
1973-2 C.B. 218, distinguished by Rev. Rul. 74-189

[IRS Annotation]
Life insurance companies; contracts with reserves based on segregated asset accounts. Group annuity contracts between three life insurance companies and the trustee of a qualified employees' retirement plan trust qualify as contracts with reserves based on segregated asset accounts within the meaning of section 801(g)(1)(B) of the Code even though the trust may, under its option, make lump sum withdrawals when employees retire and itself administer the guaranteed retirement benefits. The provisions of section 801(g)(7) apply to the asset appreciation or depreciation periodically reflected in the group annuity contract reserves based on the companies' segregated asset accounts and the investment income or capital gains credited to the reserves do not constitute life insurance income taxable to the companies.

Rev. Rul. 73-333
Advice has been requested whether group annuity contracts between three life insurance companies, each taxable under section 802 of the Internal Revenue Code of 1954, and the trustee of an employees' retirement plan trust (Trust) qualify as contracts with reserves based on segregated asset accounts within the meaning of section 801(g) when the Trust has the option either to take lump-sum payments under the contracts so that it may itself administer the payment of retirement benefits that are guaranteed under its plan, or to purchase fixed benefit annuities in favor of retiring employees.

The retirement plan and the Trust established as part of it meet the requirements of a qualified plan under section 401(a) of the Code and the Trust is exempt from Federal income taxation under section 501(a).

The Trust has entered into a contract with each company that provides for the allocation of all or part of the amounts received under the contract to one or more asset accounts. Each company established its own asset accounts pursuant to resolution of its board of directors. Pursuant to State law or regulation, these asset accounts are segregated from the general asset accounts of each of the companies. Each company is required to submit annually, as part of its annual statement, a separate statement for the business of its own segregated asset accounts.

Amounts held in the segregated asset accounts under the contracts are invested in common stocks and other equity type investments. No amounts have been or will be invested in depreciable or depletable assets.

The pension plan administered by the Trust is of the defined benefit type, i.e., a fixed amount is payable monthly for the life of the retired employee. The Trust can satisfy the obligation to retiring employees by using funds accumulated in the segregated asset accounts to effect purchases of fixed-dollar or other conventional forms of annuities under its contracts [219] with the companies. Each contract contains a schedule of guaranteed rates at which annuities will be issued to retiring employees. Within the ranges specified in the contracts, these rates cannot be changed except at five-year intervals and then only at rates not less favorable than those being offered by the companies for other group annuity contracts under qualified pension plans. However, any such change in the rates shall not affect amounts in the segregated asset accounts prior to the effective date of the change.

Annuities are provided automatically under the contracts unless the Trust gives notice to the contrary at the beginning of each policy year. If notice is given at the beginning of a policy year, the Trust can subsequently elect during the year to purchase an annuity for a retiring employee by utilizing funds in the segregated asset account to effect such purchase. This annuity purchase can be made with any of the three companies, and provision has been made to have one company transfer cash held under its contract in payment for an annuity under another of the contracts.

When the Trust makes its payments to the companies, the portion of the payments that is credited to the segregated asset accounts pursuant to the contracts is used to purchase "units of participation" in the accounts. The value of each unit will fluctuate according to the success of the investments of the funds held in the accounts, and, therefore, when additional payments are made by the Trust to the insurance companies, such payments purchase units at the value in effect at the time of the payment.

Section 801(g)(1)(B) of the Code defines the term "contract with reserves based on a segregated asset account" as follows:

For purposes of this part, a "contract with reserves based on a segregated asset account" is a contract—

(i) which provides for the allocation of all or part of the amounts received under the contract to an account which, pursuant to State law or regulation, is segregated from the general asset accounts of the company,

(ii) which provides for the payment of annuities, and

(iii) under which the amounts paid in, or the amount paid as annuities, reflect the investment return and the market value of the segregated asset account.

If a contract ceases to reflect current investment return and current market value, such contract shall not be considered as meeting the requirements of clause (iii) after such cessation.

Section 801(g)(7) of the Code provides, in pertinent part, that in the case of contracts entered into with trusts described in section 401(a) and exempt from tax under section 501(a), the basis of each asset in a segregated asset account shall (in addition to all other adjustments to basis) be: (1) increased by the amount of any appreciation in value, and (2) decreased by the amount of any depreciation in value, to the extent that such appreciation and depreciation are from time to time reflected in the increases and decreases in reserves.

Pursuant to section 801(g)(5) of the Code, to the extent that investment income earned in each segregated asset account is not retained by the life insurance company and is credited either to life insurance reserves "based on segregated asset accounts or to reserves based on segregated asset accounts other than life insurance reserves," the policy and other contract liability requirements and the required interest are equal to the income so credited, with the effect that such income is excluded from taxable investment income under section 804(a)(1), from gain from operations pursuant to section 809(a)(1), and, ultimately, from life insurance company taxable income as defined by section 802(b).

The contracts here provide for previously guaranteed retirement benefits in the form of fixed annuities. The fixed annuities will be purchased automatically, at guaranteed rates, unless the Trust, under its option, gives notice that it will make lump sum withdrawals when employees retire so that it may, itself, pay the guaranteed retirement benefits. Since the Trust has the option, however, to call on the insurance companies to provide the fixed annuities at guaranteed rates, the insurance companies must provide for that contingency.

The amounts paid in reflect the investment return and market value of the segregated asset accounts. Since, under the group plan, the contracts guarantee rates at which fixed benefit annuities can be purchased, as the value of a unit of participation increases or decreases with the market value of the segregated asset accounts, fewer or more units will be needed to purchase an annuity as the case may be. In such an event, when the guaranteed retirement benefits are effected through the purchase of fixed annuities, the cost to the Trust will be lower or higher for each annuity purchased depending upon the market value of the segregated asset accounts at the time of purchase.

Accordingly, under the stated facts, it is held that:

(1) The group annuity contract issued by each of the life insurance companies to the Trust is a "contract with reserves based on a segregated asset account" as defined in section 801(g)(1)(B) of the Code.

(2) The provisions of section 801(g)(7) of the Code are applicable to appreciation and depreciation in value of assets in the segregated asset accounts of each life insurance company to the extent such appreciation and depreciation are from time to time reflected in reserves for the group annuity contracts based on such segregated asset accounts.

(3) Investment income and capital gains credited to reserves based on segregated asset accounts are not includible in the life insurance company taxable income of each of the companies.