RIABiz

IRS alleviates suffering of RIAs who use fee-based annuities by ending the need for an excruciating tax conversation that brought their own fees into focus

RIA clients practically needed a CPA to understand the tax and the compassion of a mystic to accept it with aplomb; the Internal Revenue Service took pity

Brooke's Note: It hardly seemed fair. Not only were commission-based annuities the ones deserving of more scrutiny. But they received less than their fee-based brethren -- thanks to the IRS. The federal tax extractor asked RIAs that use fee-based annuities to (all but) collect a tax for them -- and explain it on their behalf, too. The IRS demand made a fee-based product into one that called for a very decided sale be made -- of accepting its tax. Now the IRS is doing what it never does -- forgoing revenue. It's a good outcome. It's a particularly good outcome for the fast-growing fee-based annuity cottage industry.

RIAs who use fee-based annuities to round out portfolios are doing cartwheels after the IRS removed a convoluted tax that was hard to understand, harder to explain and annoying for the client to grasp - if they ever did.

It was never so much about the money; it was the agony associated with having to explain it to clients, which usually meant a painful discussion as well about an advisor's own fees.

The pain was inflicted when advisory fees were pulled from annuity accounts. Under the IRS rule, the move was "deemed a taxable distribution,” says Craig Hawley, head of Nationwide Advisory Solutions.

Previously, money withdrawn from an account to pay the advisory fee was treated as income to the client, making it taxable, even though the client never actually pocketed the money.  

But the IRS finally put an end to the unpleasantness in ruling Aug. 7 delivered in a private letter to Lincoln Financial Group and Nationwide Insurance. It stated an advisor could vacuum out as much as 1.5% of the annuity's value as a fee without requiring clients to report it as income.

"[It's] the most consistent friction point around the use of annuities," says Hawley.

Fresh look

Annuities have historically been loaded with fees, and this additional tax was one more reason RIAs hated them. In fact, the tax seemed to single out RIAs because it was levied solely on fee-based annuities.  See: LPL Financial tries to solve two 'digital' problems with one new hire; the broker-dealer admits high 'friction' with clients for onboarding and matching them to the right annuity

Right now, fee-based  variable annuities (VA) are still a tiny fish in the giant annuity ocean; they make up only 3% of all annuity sales. But the insurance industry argues the fee-based annuity market is growing rapidly. For instance, $3.2 billion in 2018 sales were up 42% from 2017.

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