IRS Ruling Could Help Fee-Only Advisors Use Life Insurance

What You Need to Know

The letter ruling lets Protective use policy cash value to pay investment advisory fees.
The annual advisory fees can amount to up to 1.5% of the policy cash surrender value.
A fees will count as an expense of the life policy, not a distribution to the owner.

The Internal Revenue Service has issued two new private letter rulings that could help life insurers create a new generation of life insurance policies aimed at fee-based and fee-only advisors.

The IRS sent at least one of the letters to Protective Life.

The letter would affect a variable universal life insurance policy that’s registered with the Securities and Exchange Commission as a security, as well as being registered with state insurance regulators as a life insurance policy.

Protective told the IRS it wants to use the policy’s cash value to pay fees to a policy owner’s investment advisor, without the fee payments counting as “amounts received,” or potentially taxable income, for the owner. The policy could pay investment advisory fees equal to up to 1.5% of the policy’s cash surrender value per year.

The fee payments will not “constitute compensation to the advisor for services related to any assets of the owner other than the advisor life contract,” according to Protective.

What it means: The new rulings could simplify operations for advisors who want to use permanent life insurance as a vehicle for helping clients plan for long-range expenses or fund estate plans.

Permanent life: Term life policies provide death benefit protection for a specified term, or number of years. Some term policies may include provisions that give the owners an automatic or nearly automatic right to buy permanent life insurance, but the underlying policy provides no cash value.

A permanent life insurance policy provides death benefit protection and also builds up cash value. The policy owner can borrow against the cash value and may be able to withdraw part or all of the cash value.

A variable universal life policy lets the owner tie the growth of the cash value to the performance of one or more investment funds.

Traditionally, the tax rules have made rolling retirement account assets into annuities more attractive for middle-income clients interested in retirement income planning but have made buying permanent life insurance more attractive for high-net-worth clients who are interested in estate planning and who may have concerns about estate taxes.

The fee-based product market: Life insurers have been working to build fee-based annuity sales for years, but commission-based sales continue to be much more common.

Wink, a Des Moines, Iowa-based firm that conducts quarterly U.S. annuity market surveys, reported in August that 35 companies offered fee-based annuities in the second quarter. Fee-based annuities accounted for only 2.35% of all Wink survey participants’ second-quarter annuity sales.

Letter rulings: The IRS uses letter rulings to give taxpayers advice about specific tax questions about how to interpret tax rulings.