Pacific Life was one of eight companies to receive a favorable private letter ruling (see the linked PLRs below) from the IRS allowing for advisory fees to be withdrawn from a nonqualified annuity contract without creating a taxable event. According to the PLRs, advisory fees taken from nonqualified fee-based annuities will not result in a taxable event to the contract owner as long as the fee is no more than 1.5% of the annuity’s cash value. This is a change in how the IRS viewed this topic when it issued an adverse ruling back in 1993. 

Just a reminder that advisory fees can be taken from qualified (e.g., IRA) contracts without triggering a taxable event.

Some additional highlights associated with these PLRs include:

• Advisory fees cannot be taken from commission-based products.  
• The advisory fee cannot exceed 1.5% of the contract’s cash value and must be payable to the RIA.
• The advisory fee will be withdrawn first from the earnings of the annuity contract and will not reduce the cost basis.
• The advisory fee charged against the annuity contract must be for services performed by the RIA for that contract only.

The PLRs simply asked the IRS to change its position and consider advisory fees on nonqualified fee-based annuities to be treated like any other retirement account or internal mutual fund expense ratio (i.e., as expenses paid by the account itself rather than as a distribution to or on behalf of the annuity owner). And, given that these annuity contracts are specifically designed to be fee-based and therefore RIA supported, the IRS acquiesced. The ruling stated that because the payment of ongoing fees for advice is “integral to the operation of the contract,” those fees should be considered as an expense of the annuity itself, which is authorized by the annuity owner, withdrawn by the annuity company, and paid directly to the RIA.

Keep in mind, RIA advisory fees paid directly from a nonqualified fee-based annuity will reduce the contract value and may reduce the value of the death benefit as well as the value of any optional benefits. Financial professionals should speak with annuity carriers regarding operational procedures and the impact the withdrawal may have on the annuity contract.

Lastly, broker/dealers will need to review and approve whether or not their financial professionals can have advisory fees withdrawn from nonqualified fee-based annuity contracts.

For additional information about the PLRs and RIA advisory fees to be paid pretax directly from nonqualified fee-based annuities, please contact the Retirement Strategies Group at (800) 722-2333 or email us at RSG@PacificLife.com.

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