Good to Know

We will take a very short break from our Social Security blog series with late-breaking news – potentially good news for advisors who charge only investment advisory fees.

First, we’ll frame the issue then present the potentially good news.

But before we frame the issue, let’s unpack the word “nonqualified” as it is used herein.

  • An annuity purchased with after-tax personal funds is called a nonqualified annuity.
  • An annuity purchased with funds from an employer-sponsored qualified retirement plan (e.g., 401(k)) OR an IRA may be referred to, cleverly enough, as a “qualified annuity.
The Issue

Historically, the IRS punished taxpayers when investment advisory fees were paid from a nonqualified annuity’s cash value. How? The tax-deferred portion of the fees paid were treated as a taxable distribution subject to immediate income taxation and, potentially, a premature distribution penalty (for taxpayers under age 59½).

If you’re questioning why the investment advisory fees couldn’t be paid with a taxpayer’s personal funds and then deducted as an itemized deduction on the taxpayer’s tax return – that’s a great question! That was a common practice before the Tax Cuts and Jobs Act suspended the entire category of itemized expenses that included deduction of investment advisory fees. But the story doesn’t end there. Recent IRS rulings may indicate good news.

The Good News for Advisors Charging Investment Advisory Fees

In recent Private Letter Rulings (PLRs), the IRS signaled a willingness to reconsider its historical position. Although Private Letter Rulings can only be relied upon by the taxpayer requesting the PLR, multiple PLRs with the same outcome are considered by many as an indicator of an evolving IRS position. Recent PLRs allow the direct payment of investment advisory fees from a nonqualified annuity’s cash value to the advisor without punitive tax treatment. Specifically, investment advisory fees were NOT considered a distribution to the taxpayer according to these PLRs; no income tax or penalty will be assessed against the taxpayer when these fees are paid.

Are there conditions in the PLRs? Of course - this is the IRS after all! The conditions follow:

  • The annual investment advisory fee cannot exceed 1.5% of the annuity’s cash value.
  • The advisor cannot collect commissions in addition to the investment advisory fee.
  • Only nonqualified variable, fixed-indexed, or certain hybrid annuities qualify.

Prudence suggests it’s too early to assume complete victory, but these PLRs are steps in the right direction.

bottom-line-img While nonqualified annuities are not the only tool an advisor uses to help a client achieve a desired retirement lifestyle, they may be part of a comprehensive retirement plan in the right situation. These Private Letter Rulings may signal the IRS’s willingness to put this tool back into the advisor’s tool chest.

Check with your compliance team before making any representations to clients in these matters. Unless you are employed by or associated with one of the firms receiving the PLRs, you should not assume that the favorable treatment of investment advisory fees paid from the cash value of a nonqualified annuity is available to you or your firm.

Stay tuned! In our last Social Security blog, we illustrated how delayed claiming of Social Security Retirement benefits until age 70 could increase the monthly benefit over 70% vs. claiming at age 62. In our next blog, you will see ideas to make the peanut butter and jelly come out even (pay the bills) until age 70.