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IRS Rules on Hybrid Annuity Advisory Fee Proposals

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The Internal Revenue Service has issued three new private letter rulings that may help life insurers offer registered index-linked annuities through fee-based advisors.


  • Copies of the new letter rulings are available herehere and here.
  • An earlier article about annuity advisory fee letter rulings is available here.

IRS official Rebecca Baxter addressed each letter to a life insurer that wants to sell traditional variable annuity contracts, non-variable indexed annuity contracts, and “hybrid advisor contracts” through fee-based advisors.

Baxter told each insurer that it can pay advisory fees directly to an annuity owner’s investment advisor, from the cash value of all three types of contracts, without the annuity owner having to pay federal income taxes on the cash flowing to the advisor.

Section 72(e) of the Internal Revenue Code describes the kinds of annuity-related payments that may end up in a contract owner’s taxable income.

In the scenarios described by the three life insurers asking for the new letter rulings, “the fees are an expense of the adviser contract, not a distribution to the owner,” Baxter writes in the letters. “We rule that fees taxpayer deducts from the adviser contract’s cash value and remits to the adviser will not be treated as an ‘amount received’ by the owner of the adviser contract for purposes of Section 72(e).

Baxter applies the same legal provisions, regulatory provisions and analytical principles to the hybrid annuities that the IRS applies to the variable annuities and the fixed indexed annuities.

The life insurers that asked for the letter rulings said the advisory payments could amount to up 1.5% of the cash value in a hybrid advisor contract per year.


Many life insurers once called all indexed annuities, or annuities with crediting rates based at least partly on the performance of an investment index, “equity indexed annuities,” or EIA contracts.

Annuity issuers and sellers began a major push to call the products “fixed indexed annuities” around 2006, when the National Association of Securities Dealers and the U.S. Securities and Exchange Commission were trying to have the SEC regulate EIA contracts as securities, just as the SEC regulates variable annuity contracts and variable insurance policies as securities.

Issuers of “fixed indexed annuities” wanted to emphasize that the products offer consumers guaranteed protection of account value, just as traditional fixed annuity contracts do, and that the index-linked provisions always served to increase the contract owner’s income and contract value, never to reduce income and value below what a traditional fixed annuity would provide.

Issuers of non-variable indexed annuities ended up winning a hard-fought war with the SEC and persuading Congress to leave regulation of non-variable indexed annuities to state insurance regulators.

In recent years, insurers have been expanding their menus and adding new types of annuity contracts that are registered with the SEC as variable products, and that tie part or all of a contract owner’s crediting rate to the performance of one or more investment indexes. Life insurers rely mainly on hedging instruments, such as derivatives, to support the new SEC-registered indexed annuities, rather than investing the annuity assets directly in stocks, bonds or mutual funds.

Some life insurers call the indexed annuities that are registered with the SEC “variable indexed annuities.”

Other life insurers and industry groups avoid the possibility that use of the term “variable indexed annuity” could revive the old regulatory turf wars. They refer to the new annuities with terms such as “buffer annuity,” “structured annuity,” “registered index-linked annuity” (RILA) or “hybrid annuity.”

Baxter gives the following description of the contracts to be sold by the life insurers that asked for the new letter rulings:

[The hybrid contracts] do not provide benefits that vary with the performance of separate account assets. Rather, the options under a hybrid adviser contract are declared rate and index-based crediting strategies that are supported by taxpayer’s general account and certain hedging instruments held in a non-unitized separate account. The cash value of a hybrid adviser contract is credited with interest in accordance with formulas reflected in those options. The declared rate option credits interest based on an interest rate that is set by taxpayer in advance of each crediting period, subject to a guaranteed minimum rate set in accordance with state standard nonforfeiture law. The index-based options credit interest based on the positive or negative performance of a specified market index over each crediting period, subject to a cap, floor, participation rate, buffer, or other limit, and the results are not dependent on the performance of the separate account. The hybrid adviser contracts will be registered as securities with the SEC.

Letter Ruling Program

The IRS uses the private letter ruling program to communicate with taxpayers, accountants and tax lawyers about what it thinks about how federal tax rules apply to a specific set of facts.

Baxter includes a standard disclaimer about the scope of a letter ruling in each of the three new letter rulings.

“Except as specifically set forth above, no opinion is expressed or implied concerning the federal tax consequences of the proposed transaction under any other provision of the [Internal Revenue] Code or regulations,” Baxter writes. “This letter is directed only to the taxpayer requesting it.”

The provision in the Internal Revenue Code that governs a letter ruling “provides that it may not be used or cited as precedent,” Baxter writes.

— Read IRS Rules for Nationwide and Lincoln on Annuity Advisory Feeson ThinkAdvisor.

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