Tax Treatment Under Revenue Ruling 83-74

Revenue Ruling 83-74 is a guideline from the Internal Revenue Service that provides a path for individuals who receive a life insurance policy from a qualified retirement plan. It creates an exception to the general tax rules governing retirement plan distributions. This ruling allows a person to convert the value of that life insurance policy into an annuity contract without having to pay income tax on the transaction at that moment. The guidance offers a way to transition between financial products while deferring the tax obligation.

The Core Transaction Explained

The process addressed by Revenue Ruling 83-74 begins when a participant in a qualified retirement plan, such as a 401(k) or a pension plan, receives a distribution in the form of a life insurance policy. Instead of keeping the policy or cashing it out, the individual immediately surrenders it back to the issuing insurance company. This action converts its accumulated value into cash.

This cash surrender value is not taken as a personal payout. The participant must use the entire amount of these proceeds to purchase a new, single-premium annuity contract from the same insurance company. For example, an individual might receive a life insurance policy with a cash value of $50,000 from their former employer’s pension plan. Following the ruling, they would surrender that policy and use the full $50,000 to fund a new annuity.

This exchange is designed as a direct conversion of assets. The core idea is that the funds do not enter the participant’s hands for personal use but are instead immediately reinvested into a different retirement-oriented product. This process is intended to maintain the tax-deferred status of the retirement savings by keeping the value within a tax-sheltered structure.

Requirements for Tax Deferral

To benefit from the tax-deferred treatment outlined in Revenue Ruling 83-74, several requirements must be met. The life insurance policy itself must have been held within a retirement plan qualified under the Internal Revenue Code, and the policy must be non-transferable. This ensures the transaction originates from a legitimate, tax-advantaged retirement vehicle.

A condition is that the plan participant must make an irrevocable election to exchange the policy for an annuity. This decision must be made formally and in writing before the life insurance policy is distributed from the retirement plan. An irrevocable election means the choice is final and cannot be reversed, which prevents individuals from changing their minds after receiving the policy.

The entire transaction must be completed within a specific timeframe. The participant must surrender the life insurance policy and use the proceeds to purchase the new annuity contract within 60 days of receiving the policy distribution from the plan. This 60-day window aligns with the general rollover rules for retirement accounts.

Tax Consequences

When all conditions of Revenue Ruling 83-74 are satisfied, the exchange of the life insurance policy for an annuity is not a taxable event. The participant does not report the policy’s cash surrender value as income for that year. Instead, the tax obligation is deferred until payments from the new annuity begin, at which point they are taxed as ordinary income.

Conversely, failing to meet any of the ruling’s requirements results in immediate tax consequences. If the irrevocable election is not made beforehand or if the 60-day window for the exchange is missed, the transaction loses its protected status. In this scenario, the entire cash surrender value of the life insurance policy is treated as a taxable distribution in the year it is received.

This amount is included in the individual’s gross income and taxed at their ordinary income tax rate. If the participant is under the age of 59 ½, the distribution could also be subject to a 10% early withdrawal penalty. This transforms what could have been a tax-deferred rollover into a fully taxable event.