Rev. Rul. 73-56

Advice has been requested whether, under the circumstances described below, the transfer of a retirement income contract from an exempt employees' trust to an owner-employee was a premature distribution for purposes of section 401(d)(4) of the Internal Revenue Code of 1954 and section 1.401-12(m)(1) of the Income Tax Regulations.

A sole proprietorship adopted a trusteed pension plan that included the proprietor, an owner-employee within the meaning of section 401(c)(3) of the Code. The plan was qualified under section 401 of the Code, and the trust forming a part thereof was exempt under section 501(a). The plan benefits were funded through individual retirement income contracts.

After the plan had been in effect for a few years, the sole proprietorship terminated the pension plan and substituted therefor a nontrusteed annuity plan. The annuity plan, like the trusteed pension plan it replaced, provided that no distribution could be made to any owner-employee prior to the time he attained the age of 59 1/2 years or became disabled.

The annuity plan met the requirements of section 401(a)(3) through (10) and section 401(d) of the Code. In the process of replacing the trusteed pension plan with the nontrusteed annuity plan, the nontransferable retirement income contract was delivered to the owner-employee, who did not convert it to an annuity contract within 60 days. The contract, together with a similar nontransferable annuity contract purchased under the nontrusteed plan, was intended to produce the annuity plan benefits. After the change in plans, the employer paid premiums on the contracts directly to the insurance company rather than indirectly to a trustee. The owner-employee was neither disabled nor at least 59 1/2 years old at the time of the transfer.

Section 401(d)(4)(B) of the Code and section 1.401-12(m)(1) of the regulations provide that the plan must not permit distributions to be made on behalf of any owner-employee before he attains age 59 1/2 or becomes disabled. Section 1.401-12(m)(1) of the regulations indicates that an amount is prematurely distributed if it is paid to or on behalf of an owner-employee before he attains age 59 1/2 or becomes disabled.

Section 1.402(a)-1(a)(2) of the regulations provides that, if an exempt employees' trust distributes a retirement income, endowment, or other life insurance contract to an employee after October 26, 1956, the entire cash value of such contract at the time of distribution must be included in the distributee's income in accordance with the provisions of section 402(a) of the Code, except to the extent that, within 60 days after the distribution of such contract all or any portion of such value is irrevocably converted into a contract under which no part of any proceeds payable on death at any time would be excludable under section 101(a).

In this case there was a transfer of a retirement income contract to the owner-employee. This transfer was a distribution of the retirement income contract which comes within the literal language of section 1.402(a)-1(a)(2) of the regulations. As such, the entire cash value of the contract, at the time of the distribution, must be included in the owner-employee's income in accordance with the provisions of section 402(a) of the Code.

For purposes of section 401(d) of the Code, and section 1.401-12(m)(1) of the regulations, a premature distribution occurs if the taxpayer is taxable under section 402 of the Code for failing to convert his retirement income contract into an annuity contract within 60 days after the distribution pursuant to section 1.402(a)-1(a)(2). See, Revenue Ruling 68-160, 1968-1 C.B. 167.

Accordingly, it is held that the owner-employee's retention of the retirement income contract for more than 60 days after its delivery to him results in a premature distribution for purposes of section 401(d) of the Code and section 1.401-12(m)(1) of the regulations.

Revenue Rulings 55-368, 1955-1 C.B. 40, 55-427, 1955-2 C.B. 27, 68-160, 1968-1 C.B. 167, and 71-541, 1971-2 C.B. 209, which hold that certain transfers of participants' interests from one plan to another did not result in the transferred amounts being distributed or made available to the participants, are distinguishable on their facts. None of those Revenue Rulings involves the distribution of a retirement income contract within the literal language of section 1.402(a)-1(a)(2) of the regulations.