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At BWM Financial, our laser focus on giving clients a financial “edge” sets us apart from other wealth managers. Oftentimes this is through an ongoing relationship and comprehensive financial plan, but we delight whenever we can pass along an “easy win”. A great example of this is how we help structure the investment management fees our clients pay for our service, particularly considering tax requirements and tax code changes.
Are Investment Advisory Fees Tax Deductible?
Before the 2018 Tax Cuts and Jobs Act, advisory fees paid by non-retirement accounts could be deductible for federal income tax purposes, in some cases. This below-the-line deduction was for miscellaneous investment related expenses. Investors needed to itemize their income tax deductions and show expenses greater than 2% of their Adjusted Gross Income (AGI) for the tax year before they received any benefit.
In some cases, investors chose to pay fees for management of IRA accounts from non-retirement portfolios, in order to receive a potential deduction. At BWM Financial, we often see prospective clients and investors who still pay IRA fees from a non-retirement account. Many people who established this arrangement before the 2018 tax law changes simply have not realized they no longer receive a deduction. This is generally not beneficial and should be reconsidered.
The bottom line is that in 2021, investment management fees are no longer federally deducible for individual investors. This is regardless of whether the expenses are attributable to non-retirement, IRA, or Roth IRA accounts.
Are Investment Advisory Fees Tax Deductible in California or other states?
Keep in mind, although the Federal deduction has been eliminated, certain states might still allow for the deduction. Check with your CPA for the specifics in your case.
Are There Smart Ways to Pay Advisory Fees?
Although investment advisory fees are no longer Federally tax deductible, smart planning can still pay off. Here are some ways we help clients and some mistakes to avoid.
Expenses paid for the management of a Roth IRA can be paid from a non-retirement account.
Roth IRA investments grow tax free, and distributions can be taken without paying Federal or state income taxes. For this reason, Roth IRA accounts are valuable assets for investors. They can make great long-term investments and should hold assets which are expected to grow. Because investment management fees are a drag on long-term growth, it’s smart to pay Roth IRA fees from a non-retirement account. This allows the Roth account to grow more quickly. It may sound trivial, but the compounded effect of annual fees on a large Roth IRA over a long time-period add up. At BWM Financial, we recommend that clients with Roth IRAs and non-retirement accounts allow us to pay management fees for Roth IRAs from the non-retirement portfolio. This one-time set-up can create substantial savings over the course of a working career or retirement.
Expenses for the management of a traditional IRA account can be paid from the IRA account itself, without triggering income taxation.
Traditional IRA account distributions are usually fully taxable as income when money is taken from the IRA. There are very few exceptions to this rule. For example, some charitable giving can be done tax-free from an IRA. Another exception is when the IRA is used to pay its own expenses. This is typically a smart move. If you still have expenses for management of a traditional IRA being paid from a non-retirement account, consider making a change.
Many investors established directed IRA fees to be paid from their non-retirement accounts before 2018. They wanted to allow their IRA account to grow tax-deferred while receiving a tax deduction for the IRA fees. This no longer makes economic sense in most cases, because eventually you’ll have to pay tax on the IRA withdrawals. You’re able to avoid some of that if you pay the fees (tax-free) from the account now.
In short, investors likely benefit from paying traditional IRA fees directly from their IRA account. If you might be paying for IRA fees from a trust or other non-retirement account, check with your advisor or account custodian.
Some Strategies are a Clear “No”.
There are some creative ways to pay investment fees which should be avoided. Always check with your tax advisor to make sure any strategy you pursue is allowed. For example, many investors would like to use their traditional IRA account to pay fees attributable to their non-retirement accounts or Roth IRAs. The IRS would consider this a taxable distribution. In short, paying IRA fees from an IRA account is not taxable. Paying fees for a Roth IRA, a trust account or your monthly Verizon bill is considered a taxable distribution from an IRA.
What Else Should You Know?
A lot of work goes into designing a thoughtful financial plan and portfolio. Expenses are an important aspect to consider. However, this article highlights only “fee location” as an expense related example of our commitment to helping our clients find any possible financial edge. There are many other costs to be considered whether you work with a professional wealth manager or not. A great wealth management service can help investors save in a variety of ways – lowering expense ratios, capital loss harvesting, asset location, mistake avoidance, time savings, etc.
If you’re unsure whether you’re getting the best possible advice, come talk with us.
Investment advice offered through Stratos Wealth Partners, Ltd., a Registered Investment Advisor DBA BWM Financial. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stratos Wealth Partners and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.