Contract-paid life insurance advisory fees are not owner distributions

Plain-English summary

A life insurer proposed variable life insurance contracts designed for owners who receive ongoing advice about allocating contract value among investment options. Under a separate authorization, the insurer would deduct advisory fees from the contract's cash value and pay the adviser directly. The fees would cover only advice about that contract, would not reduce fees for other assets or services, and would not exceed 1.5 percent annually of the contract's cash surrender value. The IRS ruled that these fees are expenses of the insurance contract rather than distributions to the owner. They therefore are not amounts received by the owner under section 72(e), but that conclusion does not cover payments for advice about other assets or for other services.

Ruling snapshot

• Question: Are investment advisory fees paid directly from a variable life insurance contract's cash value treated as amounts received by the contract owner?
• Outcome: Approved, the qualifying fees are not owner distributions under section 72(e)
• Key authorities: IRC §§ 72(e), 816(a), 817(d), 817(h), 7702, and 7702A; Treas. Reg. §§ 1.72-1, 1.72-2, and 1.72-11

Full text (IRS public release)

Internal Revenue Service                                    Department of the Treasury
                                                             Washington, DC 20224

 Number: 202341002                                           Third Party Communication: None
 Release Date: 10/13/2023                                    Date of Communication: Not Applicable
 Index Number: 72.00-00
                                                             Person To Contact:
 --------------------                                        ---------------------, ID No. -----------------
 --------------------------------------------------------    Telephone Number:
 -----------------------------------------------             --------------------
 ----------------------------------                          Refer Reply To:
 ------------------------------                              CC:FIP:B04
                                                             PLR-101076-23
                                                             Date:
                                                             July 17, 2023




 Taxpayer = ----------------------------------------------------------------------
 Parent   = -----------------------------------------------------------------


Dear -----------------:

This letter responds to Taxpayer’s request for a letter ruling that the payment of certain
investment advisory fees from a life insurance contract will not be treated as an amount
received by the owner of that life insurance contract for purposes of section 72(e) of the
Internal Revenue Code. This letter ruling is being issued electronically in accordance
with section 7 of Rev. Proc. 2023-1, 2022-1 I.R.B. 1. A paper copy will not be mailed.

                                                     FACTS

Taxpayer is a life insurance company within the meaning of section 816(a). Taxpayer is
a subsidiary of Parent and joins in the filing of consolidated federal income tax returns
with Parent. Taxpayer proposes to offer variable life insurance contracts (each referred
to herein as an “Adviser Life Contract”). Each Adviser Life Contract will be issued to
and owned by an individual, or issued to and owned by a trust for an individual’s benefit
(the “Owner”).

Each Adviser Life Contract will be a life insurance contract under the applicable law of
the jurisdiction where issued. Each Adviser Life Contract will be a variable contract
under section 817(d), will qualify for treatment as a life insurance contract for federal
income purposes within the meaning of section 7702, will comply with the diversific ation
requirements of section 817(h), and will comply with all other federal income tax
requirements to be treated as a life insurance contract for federal income tax purposes.
Some of the Adviser Life Contracts will be modified endowment contracts (“MECs”)
under section 7702A.
PLR-101076-23                               2

Each Adviser Life Contract will have a cash value that is credited with earnings or
interest. Upon the death of the insured, the cash value will be used to support a death
benefit. Before the death of the insured, the cash value will be available to the Owner
for withdrawal. The earnings or interest that contribute to the Adviser Life Contract’s
cash value will be based on options the Owner selects from a menu provided by
Taxpayer (the “Options”). The Adviser Life Contract will allow the Owner to allocate
amounts of premiums and cash value between the Options upon purchasing an Adviser
Life Contract and to reallocate amounts among the Options thereafter.

The Options will correspond to segregated asset accounts. The Adviser Life Contract’s
cash value will fluctuate up or down with the actual investment performance and market
value of the segregated account assets corresponding to the selected Options. An
Adviser Life Contract may also offer one or more fixed rate Options that are supported
by Taxpayer’s general account. A fixed rate Option will credit 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 applicable state nonforfeiture law.
This will allow the Owner an alternative in allocating the cash value to market-based
investment Options. The Adviser Life Contracts will be registered as securities with the
Securities and Exchange Commission.

The Adviser Life Contracts are designed for an Owner who will receive ongoing
investment advice from an investment adviser (the “Adviser”) on how to allocate an
Adviser Life Contract’s premiums and cash value among the available Options. The
Adviser will be expected to take into account factors such as (1) the Owner’s personal
risk tolerance and investment timeline, (2) the interest rate and market environment, (3)
the menu of Options available under the Adviser Life Contract, and (4) the various other
benefits and features available under the Adviser Life Contract. The Adviser will be
licensed to provide investment advice in accordance with all applicable laws and
regulations. The Adviser and the firm the Adviser is associated with (if any) may or may
not be affiliated with Taxpayer.

In consideration for the Adviser’s investment advice, the Owner will authorize
investment advisory fees (the “Fees”) to be paid periodically to the Adviser from the
Adviser Life Contract’s cash value in a separate agreement between the Owner and
Taxpayer (the “Authorization”). The Fees will be determined based on an arms-length
transaction between the Owner and the Adviser, or, if the Owner and the Adviser are
related parties, the Fees will not exceed those the Adviser charges unrelated parties.
The Fees will not exceed an amount equal to an annual rate of 1.5% of the Adviser Life
Contract’s cash surrender value (within the meaning of section 7702(f)(2)(A)),
determined at the time and in the manner provided in the Authorization or other written
agreement between the Owner and the Adviser but in all events based on such cash
value during the period to which the Fees relate. The Fees will compensate the Adviser
only for investment advice that the Adviser provides to the Owner with respect to the
Adviser Life Contract, and not for any other services. The payment of the Fees will not
result in any reduction in fees related to any other asset or for any other service.
PLR-101076-23                                 3


Taxpayer will pay the Fees directly to the Adviser. During any period for which the
Authorization is in effect, the Adviser Life Contract will be solely liable for paying the
Fees, and the Fees will not be paid directly by the Owner. Similarly, the Owner will not
have the right to direct payment of the Fees for any other purpose or to any other
person. The Adviser will not receive a commission for the sale of the Adviser Life
Contract from Taxpayer, but in some cases, Taxpayer may pay the Adviser a
wholesaling fee or marketing allowance.

                                  REQUESTED RULING

Taxpayer requests a ruling that the Fees Taxpayer deducts from the Adviser Life
Contract’s cash value and remits to the Adviser will not be treated as an “amount
received” by the Owner of the Adviser Life Contract for purposes of section 72(e).

                                   LAW AND ANALYSIS

Law

Section 72 distinguishes between an “amount received as an annuity” under an annuity,
endowment, or life insurance contract and an “amount not received as an annuity”
under those contracts. Section 1.72-1(b) of the Income Tax Regulations (the
“Regulations”) provides that “amounts received as an annuity” are amounts which are
payable at regular intervals over a period of more than one full year from the date on
which they are deemed to begin, provided the total of the amounts so payable or the
period for which they are to be paid can be determined as of that date. See section
1.72-2(b)(2) and (3) of the Regulations. Any other amounts to which the provisions of
section 72 apply are considered to be “amounts not received as an annuity.”

Section 1.72-2(b)(2) of the Regulations provides that amounts are considered “amounts
received as an annuity” only in the event that the following tests are met:

       (i) They must be received on or after the “annuity starting date” as that term is
       defined in paragraph (b) of section 1.72-4(b) of the Regulations (the first day of
       the first period for which an amount is received as an annuity under the contract);

       (ii) They must be payable in periodic installments at regular intervals (whether
       annually, semiannually, quarterly, monthly, weekly, or otherwise) over a period of
       more than one full year from the annuity starting date; and

       (iii) Except as indicated in subparagraph 1.72-2(b)(3) of the Regulations (relating
       to variable contracts), the total of the amounts payable must be determinable at
       the annuity starting date either directly from the terms of the contract or indirectly
       by the use of either mortality tables or compound interest computations, or both,
       in conjunction with such terms and in accordance with sound actuarial theory.
PLR-101076-23                                 4


Section 1.72-11(a)(1) of the Regulations describes “amounts not received as an
annuity” as any amount received under a contract to which section 72 applies if the
amount:

       (i) does not meet the requirements set forth in section 1.72-2(b) of the
       Regulations for amounts received as an annuity;

       (ii) meets the requirements of section 1.72-2(b) of the Regulations for amounts
       received as an annuity but the annuity payments received differ in either amount,
       duration, or both, from those originally provided under the contract; or

       (iii) meets the requirements of section 1.72-2(b) of the Regulations for amounts
       received as an annuity but the annuity payments are received by a beneficiary
       after the death of an annuitant (or annuitants) in full discharge of the obligation
       under the contract and solely because of a guarantee.

Section 72(e) generally applies to any “amount not received as an annuity” under an
annuity, endowment, or life insurance contract. Section 72(e)(5)(A) and (C) provide
that, for life insurance contracts that are not MECs, the amount that is not received as
an annuity is included in gross income, but only to the extent it exceeds investment in
the contract. Section 72(e)(2)(B) and (e)(10) provides that, for life insurance contracts
that are MECs, if any amount which is not received as an annuity is received before the
annuity starting date, it is included in gross income to the extent allocable to income on
the contract and is not included in gross income to the extent allocable to the
investment in the contract.

Analysis

In this case, the Fees are integral to the operation of the Adviser Life Contract. During
any period for which the Authorization is in effect, the Owner will receive ongoing
investment advice from the Adviser with respect to the Adviser Life Contract so that the
Owner may properly utilize the Adviser Life Contract. The Adviser is expected to help
the Owner select Options related to the Adviser Life Contract. Taxpayer has
represented that the Fees will not serve as consideration for anything other than
investment advice provided by the Adviser in relation to the Adviser Life Contract.
Furthermore, Taxpayer has represented that the Fees will not exceed an annual rate of
1.5% of the Adviser Life Contract’s cash surrender value based on the period in which
the Fees relate. Based on Taxpayer’s representations, the Fees will only be used to
pay for investment advisory services relating to the Adviser Life Contract. Because the
Adviser Life Contracts are designed to work with an Adviser, the Adviser Life Contract is
solely liable for the Fees. The Fees do not constitute compensation to the Adviser for
services related to any assets of the Owner other than the Adviser Life Contract or any
services other than investment advice services with respect to the Adviser Life Contract.
PLR-101076-23                                  5

Therefore, the Fees are an expense of the Adviser Life Contract, not a distribution to the
Owner.

                                          RULING

The Fees that Taxpayer deducts from the Adviser Life Contract’s cash value and remits
to the Adviser will not be treated as an “amount received” by the Owner of the Adviser
Life Contract for purposes of section 72(e).

                                         CAVEATS

The ruling contained in this letter is based upon information and representations
Taxpayer submitted, accompanied by penalty of perjury statements executed by
appropriate parties. This office has not verified any of the material submitted in support
of the ruling request and it is subject to verification on examination.

The ruling contained in this letter does not apply to any amount paid by Taxpayer that
compensate the Adviser for services related to assets other than the Adviser Life
Contract or for any services provided other than investment advice services with respect
to the Adviser Life Contract. Any such amount would be an “amount received” by the
Owner of the Adviser Life Contract for purposes of section 72(e).

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.

This ruling letter is directed only to the taxpayer who requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent.

Taxpayer must attach a copy of this letter ruling to any tax return to which it is relevant.

In accordance with a power of attorney on file in this office, a copy of this ruling is being
furnished to your authorized representatives.


                                       Sincerely,


                                       Rebecca L. Baxter
                                       Senior Technician Reviewer, Branch 4
                                       Office of the Associate Chief Counsel
                                       (Financial Institutions & Products)
PLR-101076-23                                          6

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