Rev. Rul. 69-254

Advice has been requested whether the receipt by a sole proprietor of the cash surrender value of a contract issued under a qualified pension plan was a premature distribution, for purposes of section 401(d) of the Internal Revenue Code of 1954 and section 1.401-12(m)(i) of the Income Tax Regulations, under the circumstances described below.

A sole proprietor who had no common-law employees established a qualified pension plan covering himself as an owner-employee. The annuity contract issued to provide the benefits under the plan was delivered to the owner-employee and was not transferable to any person other than the issuer thereof.

Subsequently, the sole proprietor established another qualified pension plan with a bank acting as custodian of the assets under the terms of the plan. He then delivered the annuity contract, purchased under the first plan, to the issuer thereof for its cash surrender value and paid the cash received therefor to the custodian under the second plan. At that time the sole proprietor had not attained age 591/2 and was not disabled.

Section 401(d)(4)(B) of the Code provides that a trust forming part of a pension plan that provides contributions or benefits for employees, some or all of whom are owner-employees, shall constitute a qualified trust only if, among other conditions, the plan does not permit distributions to be made on behalf of any owner-employee before he attains age 591/2 or becomes disabled. Section 1.401-12(m)(1) of the regulations indicates that an amount is prematurely distributed or made available, within the meaning of section 401(d) of the Code, if it is paid to or on behalf of such a participant before he attains age 591/2 or becomes disabled. In addition section 72(m)(5) of the Code and section 1.72-17(e) of the regulations set forth certain penalties applicable to such premature distributions.

In the instant case the amount received upon surrendering the annuity contract was, in fact, distributed to the sole proprietor, an owner-employee, before he attained age 591/2 or became disabled, notwithstanding the fact that he later paid that amount to the custodian under another qualified plan. Accordingly, the receipt of this amount by the sole proprietor resulted in a premature distribution for purposes of section 401(d) of the Code and section 1.401-12(m) of the regulations.

This case is distinguishable from Revenue Ruling 68-160, C.B. 1968-1, 167, which holds that the transfer of an annuity contract from a trust forming part of a qualified pension plan covering an owner-employee to the bank custodian of a second pension plan covering the same owner-employee was not a premature distribution. In Revenue Ruling 68-160, the transaction was between the trustee and the custodian. Neither the annuity contract nor any part of the cash surrender value thereof was distributed to the owner-employee.

This case is also distinguishable from Revenue Ruling 55-368, C.B. 1955-1, 40. That Revenue Ruling holds that the distribution of the funds of a qualified pension trust to the employee-participants, each of whom had previously executed and who thereafter carried out a legally enforceable agreement to pay over his distributive share to a new qualified pension trust, is considered a transfer of such funds from one trust to another through the agency of the employees. The facts in this case reveal no legal obligation on the part of the owner-employee to pay the bank custodian the amount received upon surrender of the annuity contract. The amount was held by the owner-employee, without any conditions or limitation on its disposition, until deposited with the custodian under the new plan.

Revenue Rulings 55-368 and 68-160 are distinguished.