Annuity-paid advisory fees were not treated as taxable amounts received by owners

Plain-English summary

A life insurance company proposed fixed and indexed non-qualified deferred annuity contracts whose owners could authorize the insurer to pay investment advisory fees directly from a contract's cash value. The fees would compensate a licensed adviser only for advice about allocating that contract among its available crediting strategies, would not exceed 1.5 percent of cash value annually, and could not be redirected by the owner. The IRS ruled that these fees were integral expenses of the annuity contract rather than distributions to the owner. As a result, the payments were not treated as amounts received by the owner under Section 72(e). The ruling does not cover payments for advice about other assets or for services other than investment advice concerning the contract.

Ruling snapshot

• Question: Are qualifying investment advisory fees paid directly from an annuity contract's cash value treated as amounts received by the owner under IRC § 72(e)?
• Outcome: approved, the qualifying fees are contract expenses rather than owner distributions
• Key authorities: IRC § 72(e); Treas. Reg. §§ 1.72-1, 1.72-2, 1.72-11

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 202431004                                            Third Party Communication: None
Release Date: 8/2/2024                                       Date of Communication: Not Applicable
Index Number: 72.00-00
                                                             Person To Contact:
------------------------                                     --------------------, ID No. -----------------
-------------------------                                    Telephone Number:
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-------------------------                                    Refer Reply To:
------------------------------                               CC:FIP:B04
                                                             PLR-121605-23
                                                             Date:
                                                             April 30, 2024




Taxpayer        = -------------------------------------------------------------------


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


This letter responds to Taxpayer’s request for a letter ruling that the payment of certain
investment advisory fees from an annuity contract will not be treated as an amount
received by the owner of that annuity contract for purposes of § 72(e) of the Internal
Revenue Code. This letter ruling is being issued electronically in accordance with
section 7.02(2) of Rev. Proc. 2023-1, 2023-1 I.R.B. 1.

                                                  FACTS

Taxpayer is a stock life insurance company within the meaning of § 816(a). Taxpayer
proposes to offer two types of non-qualified deferred annuity contracts (the “Contracts”).
Each Contract will be issued to and owned by an individual, or issued to and owned by
“a trust or other entity as an agent for a natural person” within the meaning of § 72(u)(1)
(the “Owner”).

Each Contract is an annuity contract under the law of the jurisdiction where issued.
Each Contract qualifies for treatment as an annuity contract for federal income tax
purposes, including by complying with the requirements of § 72(s). Each Contract is
comprised of an accumulation phase and a payout phase. During the accumulation
phase, the cash value (within the meaning of section 72(e)(3)(A)(i)) of a Contract is
credited with interest based on the Crediting Rate Strategies (the “Strategies”) that the
Owner selects from a menu provided by Taxpayer. The Strategies, described below,
may consist of one or more fixed rate (“Fixed Rate Strategies”) and/or index-based
(“Indexed Strategies”) interest crediting strategies that are supported by Taxpayer’s

PLR-121605-23                                 2

general account. The cash value of a Contract is credited with interest in accordance
with formulas reflected in those Strategies.

The Contracts are not variable contracts within the meaning of § 817(d) because they
do not provide benefits that vary with the performance of separate account assets. The
Fixed Rate Strategies credit interest based on an interest rate that is set by Taxpayer in
advance of each crediting period, subject to a guaranteed minimum rate. The Indexed
Strategies credit interest based on the positive performance of a specified market index
over each crediting period, subject to how the amount of interest is determined for each
Index Strategy. While negative performance of the index over the crediting period may
mean that a Contract is not credited with any interest for that period, the negative
performance of the index does not reduce the Contract’s cash value. In addition under
state standard nonforfeiture law, the Contract provides a guaranteed minimum
surrender value for the Contract as a whole, calculated using a specified percentage of
the initial premium payment(s), less any withdrawals from the contract effective date
and plus a standard nonforfeiture law annual interest rate credited from the contract
effective date.

The Contracts will have an Advisory Fee Endorsement, which is designed typically for
an Owner who will receive ongoing investment advice from a registered investment
advisor (“Advisor”) on how to allocate a Contract’s cash value (within the meaning of
§ 72(e)(3)(A)(i)) among the available Strategies. The Advisor is 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 Strategies
available under the Contract. The Advisor will be an appropriately licensed professional
who is in the business of providing investment advice.

Under the Contract, in consideration for the Advisor’s advice and services, the Owner
will authorize the Advisor in a separate agreement between the Owner and Taxpayer
(the “Authorization”) to withdraw funds from the Contract’s cash value to pay the
advisory fees (“Fees”). The Fees will be determined based on an arms-length
transaction between the Owner and the Advisor. The Fees will not exceed an annual
rate of 1.5% of the Contract’s cash value (within the meaning of § 72(e)(3)(A)(i)),
determined at the time and in the manner provided in the Authorization or other written
agreement with the Advisor but in all events based on such cash value during the period
to which the Fees relate. The Fees will compensate the Advisor only for investment
advice provided to the Owner with respect to the Contract, and not for any other
services. The Fees will not result in any reduction in fees related to any other asset or
any other service.

Taxpayer will pay the Fees directly to the Advisor. During any period for which the
Authorization is in effect, the Contract will be solely liable for paying the Fees, and the
Fees will not be paid directly by the Owner. The Owner will not have the right to direct
payment of the Fees for any other purpose or to any other person. The Advisor will not
receive a commission for the sale of the Contract from Taxpayer.

PLR-121605-23                                3


                                REQUESTED RULING

Taxpayer requests a ruling that the Fees Taxpayer deducts from the Contract’s cash
value and remits to the Advisor will not be treated as an “amount received” by the
Owner of the Contract for the purposes of § 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 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 section 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-121605-23                                 4

Section 1.72-11(a)(1) of the Regulations describes “amounts not received as an
annuity” as any amount received under an annuity contract 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) applies to any “amount not received as an annuity” under an annuity,
endowment, or life insurance contract. Section 72(e)(2)(A) provides that if any amount
which is not received as an annuity is received on or after the annuity starting date, it is
included in gross income. Section 72(e)(2)(B) provides that 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 Contracts. During any period
for which the Authorization is in effect, the Owner will receive ongoing investment
advice from the Advisor with respect to the Contract so that the Owner may properly
utilize the Contract. The Advisor is expected to help the Owner select Strategies for the
Contract. Taxpayer has represented that the Fees will not serve as consideration for
anything other than investment advice provided by the Advisor in relation to the
Contract. Furthermore, Taxpayer has represented that the Fees will not exceed an
annual rate of 1.5% of the Contract’s cash value based on the period in which the Fees
related. Based on Taxpayer’s representations, the Fees will only be used to pay for
investment advisory services relating to the Contract. Because the Contract is designed
to work with an Advisor, the Contract is solely liable for the Fees. The Fees do not
constitute compensation to the Advisor for services related to any assets of the Owner
other that the Contract or any services other than investment advice services with
respect to the Contract. Therefore, the Fees are an expense of the Contract, not a
distribution to the Owner.

PLR-121605-23                                  5

                                         RULING

The Fees Taxpayer deducts from the Contract’s cash value and remits to the Adviser
will not be treated as an “amount received” by the Owner of the 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
compensates the Adviser for services related to assets other than the Adviser Contract
or for any services provided other than investment advice services with respect to the
Adviser Contract. Any such amount would be an “amount received” by the Owner of the
Adviser 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)


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