Investment Advisory Fees Paid Out of Variable Annuity Are Not Considered Taxable Distributions from the Annuity
In a ruling that may provide an option for a deduction of what had become otherwise nondeductible investment advisory fees, the IRS in PLR 201945001[1] (and a series of nearly identical rulings issued at the same time) allowed an insurance company to treat investment advisory fees paid out of an annuity contract as an amount not received by the owner of the annuity under IRC §72(e).
Although investment advisory fees are considered expenses related to the production of income under IRC §212, they are treated as a miscellaneous itemized deduction for individuals. For tax years beginning after 2017 and before January 1, 2026, such items are not deductible for individuals pursuant to IRC §67(g).
In order to address this issue, the insurance company in this ruling proposed to pay investment advisory fees directly out of a tax deferred annuity. The ruling describes the annuities as follows:
Taxpayer intends to offer three non-qualified deferred annuity contracts (referred to herein as “Contracts”). The Contract will be issued to and owned by an individual, or issued to and owned by “a trust or other entity as an agent for a natural person” within the meaning of section 72(u)(1) (the “Owner”).
The Contract is an annuity contract under the law of the jurisdiction where issued. The Contract qualifies for treatment as an annuity contract for federal income tax purposes, including by complying with the requirements of section 72(s). One of the Contracts is a variable contract under section 817(d) while two of the Contracts are not variable contracts under section 817(d). The Contract is not part of any qualified retirement plan within the meaning of section 4974(c).
The Contract is comprised of an accumulation phase and a payout phase. During the accumulation phase, the cash value of the Contract is credited with earnings or interest based on options the Owner selects from a menu provided by Taxpayer (the “Options”), consistent with applicable nonforfeiture law.[2]
The annuities are designed to be used with the assistance of an investment adviser. The ruling goes on to describe the products as follows:
The Contract is designed for Owners who will receive ongoing investment advice from an investment adviser (the “Adviser”) on how to allocate the Contract's cash value (within the meaning of section 72(e)(3)(A)(i)) among the available Options. The Adviser is expected to take into account factors such as (1) the Owner's personal risk tolerance and investment timeline, (2) the interest rate and market environment, (3) the menu of Options available under the Contract, and (4) the various other benefits and features available under the Contract. The Adviser will be an appropriately licensed professional who is in the business of providing investment advice.
In consideration for its advice, the Owner will authorize investment advisory fees (the “Fees”) to be paid periodically to the Adviser from the Contract's cash value (the “Authorization”). The Fees will be determined based on an arms-length transaction between the Owner and the Adviser. The Fees will not exceed an amount equal to an annual rate of 1.5% of the Contract's cash value (within the meaning of section 72(e)(3)(A)(i)), determined at the time and in the manner provided in the Authorization or other written agreement with the Adviser but in all events based on such cash value during the period to which the Fees relate. The Fees will compensate the Adviser only for investment advice that the Adviser provides to the Owner with respect to the Contract, and not for any other services. The Fees will not result in any reduction in fees related to any other asset or for any other service.
Taxpayer will pay the Fees directly to the Adviser. During any period for which the Authorization is in effect, the Contract will be solely liable for paying the Fees and the Fees will not be paid directly by the Owner. The Owner will not have the right to direct payment of the Fees for any other purpose or to any other person. The Adviser will not receive a commission for the sale of the Contract from Taxpayer.[3]
The insurance company (the Taxpayer) asked for the following ruling:
Taxpayer requests a ruling that the Fees Taxpayer deducts from the Contract's cash value and remit to the Adviser will not be treated as an “amount received” by the Owner of the Contract for purposes of section 72(e).[4]
The IRS came to the following conclusions when applying the law to these facts:
In this case, the Fees are integral to the operation of the Contract. During any period for which the Authorization is in effect, the Owner will receive ongoing investment advice from the Adviser with respect to the Contract so that the Owner may properly utilize the Contract. The Adviser is expected to help the Owner select Options related to the Contract. Taxpayer has represented that the Fees will not serve as consideration for anything other than investment advice provided by the Adviser in relation to the Contract. Furthermore, Taxpayer has represented that the Fees will not exceed an annual rate of 1.5% of the Contract's cash value based on the period in which the fees related. Based on Taxpayer's representations, the Fees will only be used to pay for investment advisory services relating to the Contract. Because the Contracts are designed to work with an Adviser, the Contract is solely liable for the Fees. The Fees do not constitute compensation to the Advisor for services related to any assets of the Owner other than the Contract or any services other than investment advice services with respect to the Contract. Therefore, the Fees are an expense of the Contract, not a distribution to the Owner.[5]
Thus, the following ruling was granted:
Based solely on the information submitted and the representations made, the Fees Taxpayer deducts from the Contract's cash value and remit to the Adviser will not be treated as an “amount received” by the Owner of the Contract for purposes of section 72(e).[6]
The caveats section does emphasize that the fees must be directly related to the management of assets in the contract, noting:
The ruling contained in this letter does not apply to any amount paid by Taxpayer that compensate the Advisor for services related to assets other than the Contract or for any services provided other than investment advice services with respect to the Contract. Any such amount would be an “amount received” by the Owner of the Contract for purposes of section 72(e).[7]