Direct payment of annuity advisory fees is not a taxable receipt by the owner

Plain-English summary

A life insurer offered variable deferred annuity contracts designed to work with ongoing investment advice about allocations among the available contract options. Owners could authorize the insurer to deduct advisory fees from contract value and remit them directly to the adviser. The fees were capped at 1.5 percent annually, compensated only advice about the annuity, and could not be redirected by the owner for another purpose. The IRS treated the fees as expenses integral to the contract, not as distributions to the owner. They therefore were not amounts received under IRC § 72(e), but the ruling did not protect payments for advice about other assets or for services unrelated to the annuity.

Ruling snapshot

• Question: Does the insurer's direct payment of contract-specific advisory fees from annuity cash value create an amount received by the owner under § 72(e)?
• Outcome: Approved (no owner receipt)
• Key authorities: IRC § 72(e); 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: 202109002                                              Third Party Communication: None
 Release Date: 3/5/2021                                         Date of Communication: Not Applicable
 Index Number: 72.00-00
                                                                Person To Contact:
 ------------------------------------------------------------   -----------------, ID No. -----------------
 -----------                                                    Telephone Number:
 ------------------------------------------------------------   --------------------
 ------------------------------                                 Refer Reply To:
 -------------------------------                                CC:FIP:04
                                                                PLR-113450-20
                                                                Date:
                                                                December 09, 2020




Legend

 Taxpayer = -------------------------------------------------------------------------------------
 Subsidiary = ---------------------------------------------------------------------------------------------
              ------------------------



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 section 72(e) of the
Internal Revenue Code (the “Code”).

                                                     FACTS

Taxpayer is a life insurance company within the meaning of section 816(a). Taxpayer is
the parent of Subsidiary and joins in the filing of a consolidated federal income tax
return with Subsidiary. Taxpayer offers a non-qualified deferred annuity contract
(referred to herein as the “Adviser Contract”). Each Adviser 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 section 72(u)(1) (the “Owner”).

Each Adviser Contract is an annuity contract under the law of the jurisdiction where
issued. Each Adviser Contract qualifies for treatment as an annuity contract for federal
income tax purposes, including by complying with the requirements of section 72(s).
Each Adviser Contract is comprised of an accumulation phase and a payout phase.
During the accumulation phase, the cash value of the Adviser Contract is credited with
PLR-113450-20                                2

earnings or interest based on investment options the Owner selects from a menu
provided by Taxpayer (the “Options”).

The Adviser Contract is a variable annuity contract within the meaning of section 817(d)
and will be registered as a security with the Security Exchange Commission. The
Options correspond to segregated asset accounts that hold diversified portfolios of
assets. The Adviser Contract’s cash value fluctuates up or down with the actual
investment performance and market value of the separate account assets
corresponding to the selected Options. Owners can select payments during the payout
phase for the single life of a designated annuitant or for the joint life of designated
annuitants, with a 10-year guaranteed term certain. Each Adviser Contract allows for
amounts to be allocated among the Options at the time the Adviser Contract is
purchased and for amounts to be re-allocated among the Options thereafter if the
Owner’s tolerance for investment risk changes over time.

The Adviser Contract is designed for Owners who will receive ongoing investment
advice from an investment adviser (the “Adviser”) on how to allocate an Adviser
Contract’s cash value (within the meaning of section 72(e)(3)(A)(i)) among the available
Options. The Adviser 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 Options available under the Adviser Contract, and (4) the
various other benefits and features available under the Adviser Contract. The Adviser
will be licensed to provide investment advice in accordance with all applicable laws and
regulations. The Adviser and the firm he or she is associated with (if any) may or may
not be affiliated with Taxpayer.

In consideration for its advice, the Owner will authorize investment advisory fees (the
“Fees”) to be paid periodically to the Adviser from the Adviser Contract’s cash value in a
separately-negotiated agreement (the “Authorization”). The Fees will be determined
based on an arms-length transaction between the Owner and the Adviser. The Fees
will not exceed an amount equal to an annual rate of 1.5% of the Adviser Contract’s
cash value (within the meaning of section 72(e)(3)(A)(i)), determined as a percentage of
the cash value as of the last day of the period in which the advisory services were
provided. The Fees will compensate the Adviser only for investment advice that the
Adviser provides to the Owner with respect to the Adviser Contract, and not for any
other services. The Fees will not result in any reduction in fees related to any other
asset or for any other service.

Taxpayer will pay the Fees directly to the Adviser. During any period for which the
Authorization is in effect, the Adviser 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 Contract from
Taxpayer, but the Adviser’s firm may receive a marketing or wholesaling allowance from
Taxpayer to promote Taxpayer’s products or to act as intermediary between the Owner
PLR-113450-20                                 3

and Taxpayer. In all cases, any wholesaling or marketing allowance Taxpayer may pay
will fall within requirements provided by state and federal regulatory agencies providing
oversight to the annuity industry.
                                   REQUESTED RULING

Taxpayer requests a ruling that the Fees Taxpayer deducts from the Adviser Contract’s
cash value and remits to the Adviser will not be treated as an “amount received” by the
Owner of the Adviser 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.” See
section 1.72-11 of the Regulations.

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 §1.72-4(b) [(the first day of the first period for which an amount is
      received as an annuity)];

      (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 [§1.72-2(b)(3) (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.”

Section 1.72-11(a)(1) of the Regulations describes “amounts not received as an
annuity” as “amounts received under a contract to which section 72 applies [i.e. an
annuity contract] if either:
PLR-113450-20                                 4

       (i) Paragraph (b) of §1.72-2 [(for amounts received as an annuity)] is inapplicable
       to such amounts.

       (ii) Paragraph (b) of §1.72-2 is applicable but the annuity payments received
       differ either in amount, duration, or both, from those originally provided under the
       contract, or

       (iii) Paragraph (b) of §1.72-2 is applicable, but such 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 Adviser 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 Contract so that the Owner may
properly utilize the Adviser Contract. The Adviser is expected to help the Owner select
Options related to the Adviser 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 Contract. Furthermore, Taxpayer has represented that
the Fees will not exceed an annual rate of 1.5% of the Adviser Contract’s cash value
based on the period to which the Fees relate. Based on Taxpayer’s representations,
the Fees will only be used to pay for ongoing investment advisory services relating to
the Adviser Contract. Because the Adviser Contract is designed to work with an
Adviser, the Adviser 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 Contract or any services other than investment advice services with respect
to the Adviser Contract. Therefore, the Fees are an expense of the Adviser Contract,
not a distribution to the Owner.

                                         RULING

The Fees Taxpayer deducts from the Adviser Contract’s cash value and remits to the
Adviser will not be treated as an “amount received” by the Owner of the Adviser
Contract for purposes of section 72(e).
PLR-113450-20                                  5


                                         CAVEATS

The ruling contained in this letter is based upon information and representations
submitted by Taxpayer and accompanied by a penalty of perjury statement executed by
an appropriate party. While this office has not verified any of the material submitted in
support of the request for rulings, 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 ongoing 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
Code or Regulations.

This letter ruling is directed only to the taxpayer requesting 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 the power of attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                        Sincerely,


                                        Rebecca L. Baxter
                                        Senior Technician Reviewer, Branch 4
                                        (Financial Institutions & Products)

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