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The Internal Revenue Service has reversed course, allowingNationwide and Lincoln Financial in privateletter rulings to treat the payment of an advisory fee from avariable, fixed indexed or hybrid nonqualified annuity to qualify as a nontaxabledistribution.

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The move is being hailed by fee-only advisors as a means forthem to get compensated for their advice.

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Over the last 10 years, “the most consistent piece of frictionthat advisors have come to us about [is] how not being able to taketheir fee out of a nonqualified annuity was really a headache forthem in using this type of product,” Craig Hawley, head ofNationwide Advisory Solutions, told ThinkAdvisor in a Mondayinterview.

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The IRS ruling essentially conforms the tax treatment ofproperly structured advisory fees from nonqualifiedannuities with those from qualified accounts such as401(k)s, 403(b)s and IRAs, which typically are not treated astaxable distributions, Nationwide explained.

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IRA expert Ed Slott told the reporter for BenefitsPRO’s sistersite ThinkAdvisor on Monday that the IRS’ ruling is a good one,“for both advisors and consumers,” for two reasons.

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Under this ruling, which Slott says is “for Nationwide only, thenonqualified annuities will receive the same treatment that IRS hasallowed for IRAs and 401(k)s, where paying the fees directly fromthe account would not be considered a taxable distribution, butrather an expense of the account, eliminating any potential tax ona fee, which would be a double expense.”

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Also, “since investment fees are no longer deductible under thenew tax law — The Tax Cuts and Jobs Act — (before 2018 sometaxpayers who itemized deductions could deduct those fees), payingthe fees from the account (the annuity) could effectively restorethe deduction since the fees are being paid with funds that mightotherwise be taxable when withdrawn, reducing the tax bill at thatpoint.”

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Slott pointed out that “no two annuities are exactlyalike. Other annuity companies or clients cannot rely onthis [Nationwide or Lincoln IRS] ruling, but it does provideinsight on how IRS would rule on an annuity with the samefeatures.”

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Historically, Hawley explained, the IRS has “interpreted howadvisory fees should be taxed depending on whether the advice wasbeing given on a qualified account or on a nonqualifiedaccount.”

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In the qualified account, in any qualified plan or if an annuityhad been funded with an IRA or 401(k), “the IRS took the positionthat the advice was part of the plan itself, and therefore was notdeemed to be a taxable distribution,” Haley said.

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“A customer could get advice from an advisor in those accountsand would not be taxed on paying for that advice,” heexplained.

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On the nonqualified side, the IRS “took the position that themoney was coming out of the annuity, whether the customer took thatmoney and bought a house with it, paid their mortgage, paid fortheir groceries or paid for investment advice, it was all the same— they were going to get a taxable distribution.”

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Nationwide Advisory Solutions has been one of the only carrierswith a technology platform that gives advisors an automatedsolution to be paid their fee directly from the annuity, Hawleysaid. But the “favorable ruling on the tax treatment of advisoryfees is another milestone in our mission to truly meet the uniqueneeds of RIAs, fee-based advisors and the clients they serve.”

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Darin Shebesta, vice president of Jackson/Roskelley WealthAdvisors Inc. in Scottsdale, Arizona, told ThinkAdvisor in a Mondayemail message that he sees the IRS’ move as “a step in the rightdirection.” The ruling “helps level the playing field to allow alltypes of advisors to make annuities available as a strategy forclients. It reduces the barrier for fee-only advisors to becompensated for their advice.”

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Advisory fees for the nonqualified annuity cannotexceed 1.5% of its cash value, according to the IRS ruling. Theruling applies only to fee-based nonqualified annuities, where theadvisor does not receive a commission related to the sale,according to Nationwide, and the fee is paid with respect tothe investment advice received by the contractowner specifically related to the non-qualified annuity.

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By including the 1.5% cap, Hawley said, the IRS “wanted to makesure that it was only advice tied to the annuity,” and that theadvisor would not “be able to pull the entire fee from the moneythey’re managing outside of the annuity tax free.”

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Lincoln Financial Group also received an IRS private letterruling on the matter, and Hawley suspects other carriers will get aletter of our own, if they haven’t already.

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“Operationally we’re already prepared to deal with this, whereasI suspect some carriers will have some work to do,” Hawleysaid.

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Tad Fifer, vice president and head of RIA distribution atLincoln Financial Group, said in a statement thatLincoln’s advocacy “for this [IRS] decision underscores the focuswe’ve placed on understanding the unique needs of this channel, andsimplifying advisor experiences as they continue to provideprotected lifetime income for their clients. Lincoln is pleasedwith the favorable decision from the IRS and believes this newruling will make it easier for investment advisors to incorporatenonqualified annuity solutions as part of their planningstrategies.”

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Melanie Waddell

Melanie is senior editor and Washington bureau chief of ThinkAdvisor. Her ThinkAdvisor coverage zeros in on how politics, policy, legislation and regulations affect the investment advisory space. Melanie’s coverage has been cited in various lawmakers’ reports, letters and bills, and in the Labor Department’s fiduciary rule in 2024. In 2019, Melanie received an Honorable Mention, Range of Work by a Single Author award from @Folio. Melanie joined Investment Advisor magazine as New York bureau chief in 2000. She has been a columnist since 2002. She started her career in Washington in 1994, covering financial issues at American Banker. Since 1997, Melanie has been covering investment-related issues, holding senior editorial positions at American Banker publications in both Washington and New York. Briefly, she was content chief for Internet Capital Group’s EFinancialWorld in New York and wrote freelance articles for Institutional Investor. Melanie holds a bachelor’s degree in English from Towson University. She interned at The Baltimore Sun and its suburban edition.