Rev. Rul. 68-487

Rev. Rul. 68-487

Advice has been requested whether an employer's payments to a bank custodian under a contractual arrangement to buy mutual fund shares for its employees are contributions to purchase an annuity contract under the circumstances described below.

An organization exempt from Federal income tax under section 501(c)(3) of the Internal Revenue Code of 1954 entered into a contractual arrangement under which a bank custodian is designated to maintain individual investment accounts for employees of the employer. The employer made nonforfeitable contributions to the bank which, in turn, invested the contributions in mutual fund shares. An insurance company issued a group contract to the employer organization, under which variable annuities will be payable to the employees but only upon receipt by the insurance company of prescribed premiums from the custodian at the direction of a particular employee. The insurer may not enforce the payment of premiums and the employee may direct the disposition of monies in his custodial account in any manner.

Section 403(b) of the Code provides that if an annuity contract is purchased for an employee who performs services for an organization of the type described in this case and such annuity contract is not one purchased pursuant to a plan qualified under section 401(a) of the Code, then amounts contributed by such employer for such contract on or after the rights become nonforfeitable shall be excluded from the gross income of the employee for the taxable year to the extent that the aggregate of such amounts does not exceed the applicable exclusion allowance for such taxable year.

Revenue Ruling 68-488, below, holds that an employer's payments to a bank custodian under a contractual arrangement to make prescribed investments for employees are contributions to purchase an annuity contract, within the meaning of section 403(b) of the Code, where an initial payment is made to an insurance company that immediately becomes obligated to provide annuity benefits at a guaranteed rate regardless of whether the custodian fulfills its obligation to sell the investments and pay the proceeds to the insurance company.

This case is distinguishable from the case involved in Revenue Ruling 68-488, since the insurer is under no obligation to provide annuity benefits to the employee until premiums are paid. Section 403(b) of the Code requires the application of the employer contributions solely for the direct purchase of an annuity contract for the employee and does not provide for any other disposition of the monies, such as contributions to an investment fund maintained by a bank custodian where no annuity obligation is incurred.

Accordingly, the employer's payments to the bank custodian in this case are not contributions to purchase an annuity contract for the employee, within the purview of section 403(b) of the Code, even though amounts may subsequently be paid by the custodian to an insurance company as premiums for the purchase of annuity benefits for the employees.