The Internal Revenue Service has announced that billing advisory fees from an annuity in a non-qualified account will not trigger a taxable distribution.

Columbus, Ohio-based Nationwide announced on Friday that it, along with seven other insurers, received a private letter ruling from the IRS stating that the payment of advisory fees from variable, fixed-indexed or hybrid non-qualified annuities would not cause a taxable distribution.

“It’s a big win for our industry,” said Craig Hawley, head of Nationwide Advisory Solutions. “Over the last decade, we’ev been focused on building out in the fee-based advisory space, and one of the biggest friction points has been the ability to pull an advisory fee out of a non-qualified annuity. We’re excited that we’ve gotten this accomplished.”

The IRS’s ruling only applies to fee-based, non-qualified annuities where the advisor receives no commission related to the sale.

Nationwide, citing the IRS letter, said that to avoid a taxable distribution, the advisory fees for the non-qualified annuity, the advisory fees can’t exceed 1.5% of the annuity’s cash value.

“The IRS didn’t want the contract to become a source of payment for fees outside the of the contract,” said Hawley.

The fee would be paid for investment advice to the contract owner specifically related to the non-qualified annuity, according to Nationwide.

Hawley explained that previously, in annuities funded with non-qualified money, advisory fees were taxed like any other distribution of funds from the plan. If the fees were withdrawn before the client turned 59½, the money distributed to pay advisory fees could also face a 10% early withdrawal penalty.

The taxation and penalty issues led some advisors to take their asset-based fees out of other accounts in lieu of taking them from the annuity, which ultimately led to advisory fee “double dipping,” from a non-annuity account to pay for the fees associated with managing the annuity said Hawley.

The ruling aligns the tax treatment of properly structured advisory fees from non-qualified annuities with those from annuities in qualified accounts like IRAs, 401(k)s and 403(b)s.

The ruling could also allow more fee-based advisors and RIAs to incorporate insurance and annuity products into their clients’ financial plans, said Hawley.

“In the conversations we’ve had with advisors over the last three days, we’ve heard that this is a huge friction point that’s being relieved,” said Hawley. “Advisors are telling us that this is something that will allow them to use annuities more often.”

Seven other insurance carriers also requested the IRS guidance. Rob Fishbein, vice president in Prudential tax and legal department, noted, "The IRS was willing to rule favorably only if we limited the facts of the ruling request to situations where fees do not exceed 1.5% of the annuity contract’s cash value and relate solely to services provided for the annuity contract.  The IRS asked for these elements to ensure that no contract value other than that for adviser fees is sent out of the contract tax free. 

"Of course, an annuity issuer is not a party to the agreement between the advisor and the policyholder, and there may be fee arrangements that exceed the 1.5% threshold," Fishbein continued.  "But the IRS ruling does not address those arrangements – it only confirms the favorable tax treatment for arrangements that meet the 1.5% cap.  In our experience, most fee arrangements would meet the cap, so we were happy to limit the facts of our ruling request in this manner.  Even with this limitation, we think the ruling covers virtually all of the fee-based arrangements involving our non-qualified annuity products." 

However, fees associated with investment advisory arrangements other than for annuity contracts "have no bearing on the annuity contract fee arrangement," Fishbein said. "Each should reflect the investment advisory support appropriate for the separate arrangement."