The Internal Revenue Service has reversed course in private letter rulings, allowing Nationwide and Lincoln Financial to treat the payment of an advisory fee from a variable, fixed indexed or hybrid nonqualified annuity as a nontaxable distribution. The move is being hailed by fee-only advisors as a means for them to get compensated for their advice.
Over the last 10 years, "the most consistent piece of friction that advisors have come to us about [is] how not being able to take their fee out of a nonqualified annuity was really a headache for them in using this type of product," Craig Hawley, head of Nationwide Advisory Solutions, said in an interview.
The IRS ruling essentially conforms the tax treatment of properly structured advisory fees from nonqualified annuities with those from qualified accounts such as 401(k)s, 403(b)s and IRAs, which typically are not treated as taxable distributions, Nationwide explained.
Expert's Opinion
IRA expert Ed Slott explained that the IRS' ruling is a good one, "for both advisors and consumers," for two reasons. Under this ruling, which Slott says is "for Nationwide only, the nonqualified annuities will receive the same treatment that IRS has allowed for IRAs and 401(k)s, where paying the fees directly from the account would not be considered a taxable distribution, but rather an expense of the account, eliminating any potential tax on a fee, which would be a double expense."
Also, "since investment fees are no longer deductible under the new tax law — The Tax Cuts and Jobs Act — (before 2018 some taxpayers who itemized deductions could deduct those fees), paying the fees from the account (the annuity) could effectively restore the deduction since the fees are being paid with funds that might otherwise be taxable when withdrawn, reducing the tax bill at that point," he said.
Slott pointed out that "no two annuities are exactly alike. Other annuity companies or clients cannot rely on this [Nationwide or Lincoln IRS] ruling, but it does provide insight on how IRS would rule on an annuity with the same features."
Tax Context
Historically, Hawley explained, the IRS has "interpreted how advisory fees should be taxed depending on whether the advice was being given on a qualified account or on a nonqualified account."
In the qualified account, in any qualified plan or if an annuity had been funded with an IRA or 401(k), "the IRS took the position that the advice was part of the plan itself, and therefore was not deemed to be a taxable distribution," Haley said.
