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IRS Ruling Favors Fee-Based Annuities

UPDATED: August 27, 2019

Allianz Life Insurance Company of North America has become the fourth insurer to receive a tax ruling from the IRS allowing advisors to get their fees directly from the assets inside a client’s annuity contract, without creating any tax consequences. The ruling, which was passed down via private letter, applies to individual variable annuities held outside individual retirement accounts and indexed annuities that are filed as fixed insurance products and held outside qualified accounts. 

Great American, Nationwide and Lincoln Financial have also received similar letters in recent weeks. 

President of Allianz Life’s Allianz Life Financial Services LLC unit, Corey Walther, stated that the ruling will help the company meet consumers’ growing demand. 

“It will allow registered investment advisors (RIAs) and fee-based advisors to more easily integrate annuities into their clients’ holistic financial plans,” Walther said. 

Original story published August 10, 2019:

A new tax ruling from the Internal Revenue Service has the potential to increase the use of annuities by registered investment advisers, according to an article from InvestmentNews. A private letter furnished by the IRS to insurer Nationwide issued a ruling that allows RIAs to pull advisory fees from the cash value of a non-qualified fee-based annuity without any tax consequences, contradictory to previous rules. 

“That’s a game changer for fee-based annuities,” said Sheryl Moore, president and CEO of consulting firm Moore Market Intelligence. “That’s been one of the huge issues: People were concerned that if you take a withdrawal from the annuity to pay the adviser’s fee you create a taxable event.” 

Pulling an annual asset-based fee rather than a commission from a non-qualified annuity policy, which is sold outside a retirement account like an IRA, has always counted as a taxable distribution for the client at ordinary income rates and reflected on a 1099 tax form. If the client were less than 59 ½ years old there was also a 10% penalty tacked on to the distribution. The recent IRS ruling addressed this conundrum.

The rules are not the same for qualified annuities that are sold in retirement accounts, which have always been allowed to pull advisory fees without tax consequences. 

The previous rules on non-qualified annuities were obviously a nuisance for clients but also made advice from adviser’s more expensive. There were workarounds, such as pulling the fee from other client accounts, but these had their drawbacks too. Not only did it give the appearance to clients of a diluted performance of those accounts, but also for advisers who didn’t manage other client assets, this option was not available. 

“This is a big win for RIAs and fee-based advisers,” said Craig Hawley, head of Nationwide Advisory Solutions. 

Despite the previous rules, fee-based, or no-load annuities, have become more popular in recent times. In 2018, fee-based variable annuity sales were up 42% from the year before, according to the Limra Secure Retirement Institute. They represent around 3% of overall VA market share, double their share in 2016, and the August 6 ruling stands to boost those numbers even more. 

The now defunct Department of Labor fiduciary rule looked as if it would encourage more clients into fee-based arrangements which is why insurers launched a plethora of products in 2016 and 2017. 

The recent private letter ruling does technically only apply to Nationwide and its annuity products, but Mr. Hawley believes it will be “impactful across the industry,” potentially leading other insurers to seek a similar ruling. 

An additional limitation to the ruling states that the advisory fee can’t exceed 1.5% of the annuity contract’s cash value. The fee must also  apply only to management of the annuity contract and cannot be pulled as the fee for managing other client accounts.

Written by Rachel Summit

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