Rev. Rul. 74-115

Advice has been requested whether the insurance contract described below may be treated as an annuity contract for purposes of section 403(b) of the Internal Revenue Code of 1954.

An organization, exempt from Federal income tax under section 501(c)(3) of the Code, purchased a modified endowment policy with an annuity rider for one of its employees. Each unit of the contract provides for (1) and endowment policy with a face amount of 500x dollars and a maturity value at age 65 of 500x dollars, and (2) a deferred retirement annuity with a maturity value at age 65 of 1,240x dollars. Based on the total maturity value of 1,740x dollars, a settlement option could be selected providing a male employee, age 65, with a monthly retirement income of 11x dollars for ten years certain and life thereafter.

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 issued after December 31, 1962, which provides incidental life insurance protection may be purchased as an annuity contract.

Rev. Rul. 61-121, 1961-2 C.B. 65, holds that preretirement death benefits under a pension plan may be regarded as incidental if such benefits do not exceed those that would be payable had they been funded under typical retirement income contracts providing a death benefit prior to retirement equal to the greater of 100 times the anticipated monthly lifetime pension or the accumulated reserve. Furthermore, in accordance with Rev. Rul. 70-611, 1970-2 C.B. 89, life insurance protection under a pension plan is within "incidental limits" where the cost does not exceed 25 percent of the total cost.

Both the "100 to 1" and "25 percent" rules stem from Raymond J. Moore v. Commissioner, 45 B.T.A. 1073 (1941), acq., 1944 C.B. 20, which held that the retirement income policies, under which the pension benefits were funded, provided incidental life insurance protection. In that case, the initial life insurance protection equalled 100 times the monthly annuity and the cost of pure life insurance protection varied according to the age at issue, but in every case was less than 25 percent of the total premiums. In this regard, see Rev. Rul. 66-143, 1966-1 C.B. 79.

Although Rev. Ruls. 66-143, 61-121, and 70-611 involve the qualification of plans under section 401(a) of the Code, the principles set forth therein, including the principles derived from the Moore case, are equally applicable in determining whether the life insurance protection under an individual contract is "incidental" for purposes of section 1.403(b)-1(c)(3) of the regulations.

In this case, actuarial computations reveal that during most policy years, the death benefit under the combination endowment policy is substantially smaller than the death benefit under a typical retirement income policy providing the same retirement benefit, but is slightly larger during some later policy years. However, a comparison of premium rates under each of these policies (computed on the basis of the same actuarial assumptions) discloses that at all ages the net level premiums under the endowment policy are smaller than the net level premiums under the retirement income contract. This indicates that the value of the preretirement death benefit under the endowment contract is less than the value of such benefit under a typical retirement income policy and, therefore, the endowment contract meets the incidental death benefit limitation of section 1.403(b)-1(c)(3) of the regulations.

Accordingly, under the specific facts in this case, the insurance contract may be treated as an annuity contract for purposes of section 403(b) of the Code.