The IRS has changed the rules—and it might benefit you and your clients. Previously, registered investment advisers (RIAs) could not pull an advisory fee from an annuity in their client’s account without creating a “taxable event.” Now, the IRS has reversed that rule, allowing RIAs to pull advisory fees from the cash value of a non-qualified fee-based annuity without any adverse tax consequences.
The tax rules addressed in the recent IRS ruling had created a conundrum for RIAs that are compensated with an annual asset-based fee rather than a commission. Pulling an adviser’s fee from a non-qualified annuity policy, which is sold outside a retirement account such as an IRA, counted as a taxable distribution for the client at ordinary income rates, as reflected on a 1099 tax form. Further, if the client were less than 59 ½ years old there was also a 10% penalty on the distribution.
The rules are different for qualified annuities sold in retirement accounts — the IRS allows advisory fees to be pulled from these annuities without tax consequence to the client.
The rules on non-qualified annuities were not only a nuisance for the client, but also effectively made the adviser’s advice more expensive. Advisers had workarounds, such as pulling the annuity fee from other client accounts. That had drawbacks, though, since it may have appeared to the client to dilute performance of those accounts. Advisers who didn’t manage other client assets also didn’t have this option available.
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