SEC Answers a Comment About Tax Talk in Annuity Ads

What You Need to Know

The SEC recently adopted new registration form rules for RILAs and market-value-adjusted annuities.
Officials also talked about how to apply the rule on misleading statements in sales literature.
Benji Johnson, a lawyer who used to sell annuities, helped SEC officials think that through.

Benji Johnson, a lawyer who used to sell annuities, helped U.S. Securities and Exchange Commission officials write guidelines for how marketers should describe tax benefits in annuity ads.

Johnson drew the advice out of the SEC by commenting on its draft annuity registration form regulations for registered index-linked annuities and annuities with market-value-adjusted features.

He mentioned what he believes to be unrealistically positive portrayals of annuity tax benefits in RILA and MVA annuity ads in his comment letter.

Fewer than 20 commenters weighed in on the draft annuity registration form regulations, the SEC took a comprehensive approach to addressing the comments, and the result was that the SEC ended up including a guideline responding directly to Johnson’s concerns.

Under the new final rule, “consideration should be given to whether portrayals of the tax-deferred value of the annuity, especially where this value is compared to the value of a taxable account, should reflect the advantages of taxable accounts,” if the taxable accounts have any advantages, SEC officials write in advice given in the preamble, or official introduction, to the final rule.

If, for example, cash coming out of a taxable account could be taxed at a lower rate than the cash coming out of a RILA contract or an MVA annuity at the same point, the ad should mention that, officials say.

What it means: Sometimes, ordinary agents and brokers can affect how federal agencies operate simply be sending in a comment letter on draft regulations.

The annuity registration form project: Life insurers had been asking the SEC to let them update annuity registration rules for more than 20 years.

Insurers could file traditional variable annuity separate accounts using the relatively simple SEC Form N-3, which serves accounts registered as management companies, and Form N-4, which serves accounts registered as unit investment trusts.

Companies have used Form N-6 for separate accounts inside variable life policies.

Insurers have had to file RILA contracts and MVA annuities using Form S-1 or Form S-3, which are the same forms an insurance company would use to register with the SEC to sell stock to the public.

The kind of annuity that U.S. life insurance companies sell today is an “upside down life insurance policy.” It can turn cash into a stream of benefits, rather than turning premiums into one lump-sum death benefit payment.

In practice, annuities and life insurance policies can perform similar functions in similar ways, but they operate under different laws and regulations, based on policymakers’ thinking that life insurance policies exist primarily to manage the risk of premature death and annuities exist primarily to provide retirement income.

A RILA contract is an annuity with a crediting rate tied to the performance of investment indexes.

An MVA annuity is an annuity with a feature that may cut the asset value if the annuity owner takes cash out early. The insurer cuts, or “adjusts,” the value based on where an interest rate index stands on the day the contract owner takes the cash out. Usually, a MVA feature comes with a multi-year guaranteed annuity, or MYGA, contract.

Insurers argued that it was absurd for them to have to put their office rent, executive salary information and other generation aimed mainly at shareholders in documents aimed at annuity buyers.

The SEC finally made a simpler RILA and MVA annuity filing process possible through a provision tucked into a 2022 appropriations bill.

The new final rule, which was released in July, will let insurers file new RILA contracts and MVA annuities on Form N-4 and may increase the supply of RILAs and MVA features, by simplifying the filing process.

Taxes and the new registration rules: SEC officials talk about annuity tax provisions because the new annuity registration form regulations will require any annuity that has to be registered with the SEC to include a “key information table.”

One section in the key information table will have the subhead “Taxes.” Under the subhead, in the left-hand column, the issuer will put the question: “What Are the Contract’s Tax Implications?”

In the right-hand column, the issuer will describe the tax implications.

Questions also came up when SEC officials were discussing how RILA and MVA registration rules interact with SEC Rule 156, “Materially Misleading Statements and Representations.”

“Rule 156 does not prohibit or permit any particular representations or presentation,” SEC officials write in the annuity registration rule preamble. “Rather, it is an interpretive rule that provides factors to be weighed in considering whether, in the specific context of investment company sales literature, a statement involving a material fact is or might be misleading for purposes of the Federal securities laws.”