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IRS Rules for Nationwide and Lincoln on Annuity Advisory Fees

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The Internal Revenue Service staff has given at least two insurance organizations advice that could cut the cost of administering fee-based annuities.

The IRS has sent Nationwide Mutual Insurance Company and two affiliates a private letter ruling that affects the companies’ fee-based fixed annuity contracts and fee-based variable annuity contracts.

The new IRS ruling lets the companies exclude an annuity contract’s asset-based investment advisory fees from the customer’s taxable income, according to a copy of the letter provided by Nationwide.

Lincoln Financial Group told that it received a similar private letter ruling last week. A copy of the Lincoln private letter ruling was not immediately available.

(Related: IRS Rules on Wrap Fees)

The IRS uses private letter rulings to help taxpayers understand how the IRS staff sees specific situations. The IRS does not normally post the names of private letter recipients on the web. It’s possible that companies other than Nationwide and Lincoln have received similar private letter rulings.

The Background

A life insurer can sell an annuity for use in a retirement arrangement — such as an individual retirement account, a 401(k) plan account or a 403(b) plan account — that qualifies for federal income tax breaks from the IRS.

A life insurer can also sell an annuity to a customer who wants to use the annuity outside of a qualified plan.

People who have been using annuities inside IRAs and other qualified plans have already been able to keep a contract’s asset-based investment advisory fees out of their taxable income, according to Nationwide and Lincoln.

The new IRS rulings mean that owners of non-qualified annuity contracts can also keep a contract’s asset-based advisory fees out of their taxable income, the companies say.

“This new IRS ruling essentially conforms the tax treatment of properly structured advisory fees from non-qualified 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 says in its letter ruling announcement.

“This ruling serves to harmonize the treatment of advisory fee-withdrawals across both qualified and non-qualified annuities,” Lincoln says.

Nationwide Letter Details

John Glover, senior counsel for financial institutions and products at the IRS, addressed Private Letter Ruling 101342-19 to Eric Henderson, senior vice president for individual products and solutions at Nationwide Life Insurance Company.

The letter applies to Nationwide Life. The letter also applies to Nationwide Life’s parent company, Nationwide Mutual Insurance Company, and to another Nationwide Mutual affiliate, Nationwide Financial Services Inc.

The letter designates Nationwide Life as “the taxpayer.”

Nationwide Life described fee-based annuity contracts that could be set up as variable annuities, fixed annuities or hybrid products. Nationwide Life said contract issuers would pay an investment adviser an annual investment advisory fee based on a contract’s cash value.

For the specifications of the annuities covered by the new Nationwide letter ruling, see the idea cards in the slideshow above.

Nationwide Life asked for a ruling that “the fees taxpayer deducts from the contract’s cash value and remit[s] to the adviser will not be treated as an ‘amount received’ by the owner of the contract” for purposes of calculating the contract owner’s taxable annuity income.

Glover analyzed that question in light of Section 1.72-1 of the federal Income Tax Regulations.

Glover wrote that, in the product framework described by Nationwide, the asset-based investment advisory fees “are integral to the operation of the contract.”

“The adviser is expected to help the owner select options related to the contract,” Glover writes. “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.”

(Related: Adviser Versus Advisor: Does It Really Matter How You Spell It?)

The contract is solely liable for the fees, Glover writes.

“Based on the facts above, 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,” Glover writes. “Therefore, the fees are an expense of the contract, not a distribution to the owner.”

Glover notes that the ruling letter is directed only to Nationwide Life and may not be used or cited as a precedent.

What This Means

Executives from Nationwide and Lincoln say the new private letter rulings should make it easier for RIAs and fee-based advisors to offer annuities.

Craig Hawley, head of Nationwide Advisory Solutions, said in a statement that Nationwide has been seeking an advisory fee tax ruling for non-qualified annuities for years.

“This favorable ruling on the tax-treatment of advisory fees is another milestone in our mission to truly meet the unique needs of RIAs, fee-based advisors and the clients they serve,” Hawley said.

Tad Fifer, head of RIA distribution at Lincoln, said in a statement of his own that Lincoln is committed to removing the points of friction that fee-only advisors may face when they help clients use annuities.

“Lincoln is pleased with the favorable decision from the IRS and believes this new ruling will make it easier for investment advisors to incorporate non-qualified annuity solutions as part of their planning strategies,” Fifer said.

— Read 7 Things to Know About IRS Private Letter Rulings, on ThinkAdvisor.

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