Pay AUM fee in cash?

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Pay AUM fee in cash?

Postby umfundi » Sat Mar 16, 2013 6:20 am

I told my advisor I would pay my IRA AUM (assets under management) fees in cash, rather than have them withdrawn from my tax-advantaged accounts. Not a problem, they said. They sent a statement, I sent a check.

Seems to me, this is another way to avoid a drag on your tax-advantaged returns. Now that I think about it, the actual fee (some fraction of a percent on a seven-figure account.)is about the same as my allowed IRA contribution!

I did not ever think about it before. Never pay current fees out of tax advantaged funds, if you can avoid it.

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Re: Pay AUM fee in cash?

Postby Gill » Sat Mar 16, 2013 7:50 am

And it also is tax deductible if you exceed the 2% threshold.
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Re: Pay AUM fee in cash?

Postby nisiprius » Sat Mar 16, 2013 8:04 am

A good way to be cost-conscious in the most literal sense of the word. Every time you are forced to take conscious action on a purchase is another time you are forced to think about how much it is worth and whether you can afford it.

Automatically-paid monthly fees are real budget-killers.

In one's financial life it's a good idea to make savings automatic, as much as possible, and payments manual, as much as possible.

But it's still mental accounting, of course. The fee you paid is still money that wasn't invested. It still went to an advisor instead of paying for something else. Assuming you had the money to pay the fee, if it had been paid automatically out of your investments there would not have been anything stopping you from sending in an amount of money equal to the fee to be invested. That is not to say anything against advisors; "the laborer is worthy of his hire," and money spent on professional services is often well-spent.

Similarly, I could, at the end of the year, figure out the grand total it has cost me in mutual fund expense ratios for every much fund I own, and make an additional purchase of that fund equal to that amount. I could, but of course I don't.
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Re: Pay AUM fee in cash?

Postby Gill » Sat Mar 16, 2013 8:30 am

nisiprius wrote:Assuming you had the money to pay the fee, if it had been paid automatically out of your investments there would not have been anything stopping you from sending in an amount of money equal to the fee to be invested.

Not in an IRA if you have already contributed the maximum.
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Re: Pay AUM fee in cash?

Postby umfundi » Sat Mar 16, 2013 11:32 am

MBMiner wrote:
nisiprius wrote:Assuming you had the money to pay the fee, if it had been paid automatically out of your investments there would not have been anything stopping you from sending in an amount of money equal to the fee to be invested.

Not in an IRA if you have already contributed the maximum.
Bruce

My point exactly, that the fee effectively eats up contribution space.

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Re: Pay AUM fee in cash?

Postby NewtonsApple » Sat Mar 16, 2013 12:19 pm

I am charged an administrator fee in my 401K. Luckily it is a flat rate (71.99/month) that is divided between all plan members based on asset weighting. I am at a small company and my assets make up a large percent of the total plan assets so this fee is a few hundred dollars each year. I considered trying to convince the people in charge to let us pay this fee from outside money. Most of my money is in a traditional 401K, so the cost of paying from there is not so bad. I estimate the extra cost at about 10%, which is the difference in taxes between on trad 401K money and taxable funds. The taxes on the taxable funds includes long term capital gains and the annual tax drag on 2% dividends. I assume I will pull 401K money out at 15%. Is this the correct way to think about analyze this?
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Re: Pay AUM fee in cash?

Postby EDN » Sat Mar 16, 2013 12:27 pm

umfundi wrote:
MBMiner wrote:
nisiprius wrote:Assuming you had the money to pay the fee, if it had been paid automatically out of your investments there would not have been anything stopping you from sending in an amount of money equal to the fee to be invested.

Not in an IRA if you have already contributed the maximum.
Bruce

My point exactly, that the fee effectively eats up contribution space.

Keith


That's not true. Everyone can make the same contributions to an IRA assuming same income thresholds. Some choose to pay their AUM fee out of the account, which of course reduces the IRA balance, but they aren't penalized by being allowed to put less into an IRA and get a lower amount of tax deduction. Assuming a Trad IRA, all investors get the same tax deduction whether some wind up spending that contribution on AUM. It would be unfair to those without an advisor if you could add more $ to an IRA just to pay the AUM fee, because they would be able to claim a higher amount of tax deductibility.

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Re: Pay AUM fee in cash?

Postby Sam I Am » Sat Mar 16, 2013 12:38 pm

Message deleted.
Last edited by Sam I Am on Sun Oct 06, 2013 2:36 pm, edited 2 times in total.
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Re: Pay AUM fee in cash?

Postby umfundi » Sat Mar 16, 2013 12:56 pm

EDN wrote:
umfundi wrote:
MBMiner wrote:
nisiprius wrote:Assuming you had the money to pay the fee, if it had been paid automatically out of your investments there would not have been anything stopping you from sending in an amount of money equal to the fee to be invested.

Not in an IRA if you have already contributed the maximum.
Bruce

My point exactly, that the fee effectively eats up contribution space.

Keith


That's not true. Everyone can make the same contributions to an IRA assuming same income thresholds. Some choose to pay their AUM fee out of the account, which of course reduces the IRA balance, but they aren't penalized by being allowed to put less into an IRA and get a lower amount of tax deduction. Assuming a Trad IRA, all investors get the same tax deduction whether some wind up spending that contribution on AUM. It would be unfair to those without an advisor if you could add more $ to an IRA just to pay the AUM fee, because they would be able to claim a higher amount of tax deductibility.

Eric

Eric,

The scenarios I have in mind:

1. Make a $5,000 IRA contribution into existing large account. Pay $2,000 AUM fee deducted from IRA account.

2. Make $5,000 IRA contribution. Pay $2,000 AUM fee in cash.

In scenario 1 I end up with $2,000 less in my tax advantaged account and no way to replenish it. The advisor (in my case) did not mention the option of paying the fee in cash until I asked.

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Re: Pay AUM fee in cash?

Postby EDN » Sat Mar 16, 2013 1:13 pm

umfundi wrote:
EDN wrote:
umfundi wrote:
MBMiner wrote:
nisiprius wrote:Assuming you had the money to pay the fee, if it had been paid automatically out of your investments there would not have been anything stopping you from sending in an amount of money equal to the fee to be invested.

Not in an IRA if you have already contributed the maximum.
Bruce

My point exactly, that the fee effectively eats up contribution space.

Keith


That's not true. Everyone can make the same contributions to an IRA assuming same income thresholds. Some choose to pay their AUM fee out of the account, which of course reduces the IRA balance, but they aren't penalized by being allowed to put less into an IRA and get a lower amount of tax deduction. Assuming a Trad IRA, all investors get the same tax deduction whether some wind up spending that contribution on AUM. It would be unfair to those without an advisor if you could add more $ to an IRA just to pay the AUM fee, because they would be able to claim a higher amount of tax deductibility.

Eric

Eric,

The scenarios I have in mind:

1. Make a $5,000 IRA contribution into existing large account. Pay $2,000 AUM fee deducted from IRA account.

2. Make $5,000 IRA contribution. Pay $2,000 AUM fee in cash.

In scenario 1 I end up with $2,000 less in my tax advantaged account and no way to replenish it. The advisor (in my case) did not mention the option of paying the fee in cash until I asked.

Keith


OK, but for many investors, maximizing the growth of traditional IRAs is far from optimal, as future withdrawals and RMDs will be taxed at ordinary income vs the (current) preferential treatment on dividends and long-term capital gains. For them, it is the contributions that are valuable (getting a tax deduction), but they'll pay for that in the end with ordinary income taxes applied to even higher values. ROTHs of course are another situation.

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Re: Pay AUM fee in cash?

Postby gatorking » Sat Mar 16, 2013 3:27 pm

The scenarios I have in mind:

1. Make a $5,000 IRA contribution into existing large account. Pay $2,000 AUM fee deducted from IRA account.

2. Make $5,000 IRA contribution. Pay $2,000 AUM fee in cash.

In scenario 1 I end up with $2,000 less in my tax advantaged account and no way to replenish it. The advisor (in my case) did not mention the option of paying the fee in cash until I asked.

Keith


I think this also depends on whether the IRA is being funded pre-tax or post-tax. In scenario 1, your IRA ends up being smaller and you pay less on the withdrawn money (assuming this is not a Roth IRA). In scenario 2 you are paying the AUM money with post-tax money that could have been invested in a Roth IRA and withdrawn tax-free or invested in a regular account and withdrawn with a 15% Long term cap gains tax. You should re-run the numbers. The advantages might not be so significant.
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Re: Pay AUM fee in cash?

Postby umfundi » Sat Mar 16, 2013 3:53 pm

gatorking wrote:
The scenarios I have in mind:

1. Make a $5,000 IRA contribution into existing large account. Pay $2,000 AUM fee deducted from IRA account.

2. Make $5,000 IRA contribution. Pay $2,000 AUM fee in cash.

In scenario 1 I end up with $2,000 less in my tax advantaged account and no way to replenish it. The advisor (in my case) did not mention the option of paying the fee in cash until I asked.

Keith


I think this also depends on whether the IRA is being funded pre-tax or post-tax. In scenario 1, your IRA ends up being smaller and you pay less on the withdrawn money (assuming this is not a Roth IRA). In scenario 2 you are paying the AUM money with post-tax money that could have been invested in a Roth IRA and withdrawn tax-free or invested in a regular account and withdrawn with a 15% Long term cap gains tax. You should re-run the numbers. The advantages might not be so significant.

Is this turning into a can of worms?

I was originally trying just to make the point that for any tax-advantaged account where you max out your contributions, pay the fees from outside the account if you can. As a rule, I think that is correct. Is it? For everything from an HSA used as a long-term investment, through a ROTH, a deductible tIRA and a non-deductible tIRA?

I did not want to start a debate about which flavor of IRA is better.

gatorking, are you implying that fees paid inside a tax-advantaged account are withdrawals? If so, I did not get a 1099. Or that there's an advantage that they are taken out tax free? Is the IRS cool with that?

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Re: Pay AUM fee in cash?

Postby gatorking » Sat Mar 16, 2013 4:57 pm

umfundi wrote: Or that there's an advantage that they are taken out tax free? Is the IRS cool with that?
Keith

Yes, I think it's an advantage. I don't know what the IRS rules are for this. Shouldn't your advisor be able to run the numbers for you and confirm your thoughts?
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Re: Pay AUM fee in cash?

Postby umfundi » Sat Mar 16, 2013 5:19 pm

gatorking wrote:
umfundi wrote: Or that there's an advantage that they are taken out tax free? Is the IRS cool with that?
Keith

Yes, I think it's an advantage. I don't know what the IRS rules are for this. Shouldn't your advisor be able to run the numbers for you and confirm your thoughts?


I will ask. A web search brings up this thread as the first hit, then inconsistent answers. The answer will likely take a couple of days.

Keith
Last edited by umfundi on Sat Mar 16, 2013 5:33 pm, edited 1 time in total.
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Re: Pay AUM fee in cash?

Postby SpringMan » Sat Mar 16, 2013 5:24 pm

Similarly never have taxes withheld from a Roth conversion, converting x dollars will result in (x-taxes) dollars in the Roth. It is always better to come up with the taxes from taxable account sources. BTW, $2000 on a seven figure account is a very reasonable AUM fee.
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Re: Pay AUM fee in cash?

Postby umfundi » Sat Mar 16, 2013 5:35 pm

SpringMan wrote:BTW, $2000 on a seven figure account is a very reasonable AUM fee.

The $2,000 was for my example, though the actual fee is still low, well below 0.5%.

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Re: Pay AUM fee in cash?

Postby Leesbro63 » Sat Mar 16, 2013 5:40 pm

nisiprius wrote:
In one's financial life it's a good idea to make savings automatic, as much as possible, and payments manual, as much as possible.


While I understand your intent here, I have to disagree. Automating most of my payments is one of the single best personal finance things I've done. People who are prudent with their money will examine monthly automatic payment bills as closely as those that have to be paid manually. And people who are not as prudent will just pay it either way...or NOT pay it either way.
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Re: Pay AUM fee in cash?

Postby umfundi » Sat Mar 16, 2013 5:45 pm

I found an advisor who thinks that AUM fees should come out of the IRA because they can count towards the RMD, except that the 2% of AGI itemized deduction is subject to AMT.

I can TLA with the best of them! :wink:

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Re: Pay AUM fee in cash?

Postby pkcrafter » Sat Mar 16, 2013 8:31 pm

Nothing will make a person more aware of costs than having to pay out of pocket. If all investors had to pay fees directly from a check, 90% of advisors would go out of business.


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Re: Pay AUM fee in cash?

Postby Epsilon Delta » Sat Mar 16, 2013 11:07 pm

http://www.kitces.com/blog/archives/117-IRS-Re-Affirms-Paying-IRA-Wrap-Fees-With-Outside-Dollars.html

This also refers to a Private Letter Ruling, so somebody who doesn't believe random web sites can look it up.
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Re: Pay AUM fee in cash?

Postby billern » Sat Mar 16, 2013 11:26 pm

I don't see the benefit to this. If your AGI is high, the investment management fees are almost certainly non-deductible. Pay them out of money in your IRA and you exclude those IRA funds from income.

Yes you will end up with more money in your IRA by paying the fees with outside funds. But why is it better to pay an expense with post-tax funds than with pre-tax funds?
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Re: Pay AUM fee in cash?

Postby umfundi » Sat Mar 16, 2013 11:50 pm

Epsilon Delta wrote:http://www.kitces.com/blog/archives/117-IRS-Re-Affirms-Paying-IRA-Wrap-Fees-With-Outside-Dollars.html

This also refers to a Private Letter Ruling, so somebody who doesn't believe random web sites can look it up.

So, my understanding is only slightly clearer:
The bottom line is that the latest private letter ruling appears to continue support for the view that it is acceptable for clients to pay IRA wrap (and investment advisory) fees with outside dollars if they so wish, without having them treated as a deemed contribution to the IRA, and while also being eligible for deductibility as a Section 212 expense.

"... support for the view that it is acceptable ..." does not sound very definitive to me. And then to put "(and investment advisory)" in parentheses is another caveat.

My questions are:

If I pay an advisory fee for my IRA account,

1. May I pay it with "outside" dollars and have those not considered to be a contribution?
2. May I pay it with "inside" dollars and have those not considered to be a withdrawal?

For extra credit: If my fees cover both Roth and Traditional IRA accounts at the same advisor/custodian, may I direct that all fees be paid out of one particular account (the Roth or the tIRA)?

This can of worms is bigger and more alive than I imagined!

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Re: Pay AUM fee in cash?

Postby joe8d » Sat Mar 16, 2013 11:55 pm

billern wrote:I don't see the benefit to this. If your AGI is high, the investment management fees are almost certainly non-deductible. Pay them out of money in your IRA and you exclude those IRA funds from income.

Yes you will end up with more money in your IRA by paying the fees with outside funds. But why is it better to pay an expense with post-tax funds than with pre-tax funds?


Exactly.Any fees paid from within a TD account are essentially automatically tax deducted.
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Re: Pay AUM fee in cash?

Postby umfundi » Sun Mar 17, 2013 12:08 am

billern wrote:I don't see the benefit to this. If your AGI is high, the investment management fees are almost certainly non-deductible. Pay them out of money in your IRA and you exclude those IRA funds from income.

Yes you will end up with more money in your IRA by paying the fees with outside funds. But why is it better to pay an expense with post-tax funds than with pre-tax funds?

billern,

I am still in the stage of figuring out what is allowed, not what is optimal. :?:

My IRA includes

1. After-tax contributions to tIRAs.
2. Tax deductible contributions to tIRAS.
3. Roth IRA (after-tax) contributions.
4. Earnings on tIRA contributions.
5. Earnings on Roth contributions.

How may I pay expenses and fees?

After that, how should I pay expenses and fees?

Keith
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Re: Pay AUM fee in cash?

Postby NewtonsApple » Sun Mar 17, 2013 1:16 am

How should you pay first:
So I believe it is clear that for Roth accounts it would be preferable to pay fees with outside money.

For traditional accounts though, paying for fees with outside money is equivalent (only to you, not to IRS AFAIK) to making a non deductible traditional contribution, which is not recommended for most people.

Start with $1,000,000 trad and $2000 taxable

$1,000,000 trad + $2000 non deductible trad contribution from taxable -$2000 fees from trad = $1,000,000 trad, $0 taxable

$1,000,000 trad -$2000 fees from from taxable= $1,000,000 trad, $0 taxable

How may you pay:
Imagine you have two separate advisors with the same fee structure. One controls all your roth accounts and the other controls all your traditional. It would seem reasonable to only ask the roth goy to let you pay fees with outside money.

Now I wonder if your advisor can send you a bill for only the Roth fees and automatically deduct from your traditional accounts. Roth and traditional accounts are generally kept separate at brokers, so this could be an option for each account.
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Re: Pay AUM fee in cash?

Postby Epsilon Delta » Sun Mar 17, 2013 2:11 am

NewtonsApple wrote:For traditional accounts though, paying for fees with outside money is equivalent (only to you, not to IRS AFAIK) to making a non deductible traditional contribution, which is not recommended for most people.

Paying the fees with outside money is actually a little worse than a non-deductible contribution, since a non-deductible contribution adds basis to the IRA which you get back tax free :!: (albeit pennies at a time, many years later :annoyed ).

However in the few cases where a non-deductible contribution would be recommended it probably does not make much difference so in these rare cases paying the fee with outside money would also make sense.
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Re: Pay AUM fee in cash?

Postby umfundi » Mon Mar 18, 2013 11:21 am

My financial advisor came back with a sort of non answer.

He says Schwab (the custodian) does not issue 1099s for fees drawn from (IRA) accounts. Then he said I should talk to my tax advisor.

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