Outside voices and views for advisers

Repeal of investment expense deduction may change advisers' fee strategy

The change may not be that big a deal for many clients, but they need to understand their options

Jan 24, 2018 @ 10:48 am

By Tim Steffen

The last two months of 2017 were a blur of activity when it came to income taxes, as financial advisers and clients scrambled to decipher what was rumor, what was actually proposed and what finally became law.

One change that may have slipped by some clients, but certainly caught the attention of advisers, was the repeal of the deduction for investment expenses, including quarterly asset management fees. (In fact, all miscellaneous deductions were repealed — which includes things like unreimbursed business expenses, tax preparation fees and union dues.)

The following are some of the issues advisers should be prepared to discuss in the wake of this lost deduction.

Just because the IRS allowed a deduction for fees paid to manage investments doesn't mean that always resulted in a lower tax bill. The limitations on the deduction precluded many from actually getting a tax benefit.

First off, only fees incurred to produce taxable income were deductible. That means fees paid to manage a tax-exempt bond portfolio were excluded. It also means fees paid using IRA assets were non-deductible. Basically, only fees paid from a taxable account that held taxable-income producing assets were eligible.

Not Always a Savings

Secondly, the combined amount of miscellaneous deductions had to exceed 2% of adjusted gross income before they provided a benefit. Lastly, miscellaneous deductions weren't allowed under the alternative minimum tax, meaning an investor who was subject to or close to the AMT wasn't able to claim the deduction. These two limits kept many high- or even medium-income taxpayers from benefiting.

In other words, even under the old rules, investors might not have been able to use their fees to reduce taxes, making the repeal of the deduction a moot point.

For those who could exceed the AGI threshold and for whom the AMT wasn't an issue, these fees did result in a tax savings — but only if paid from a taxable account. To maximize this tax benefit, some firms allow investors to pay the fee to manage their IRA assets from a taxable account. Does that still make sense under the new rule?

By continuing to pay the fee from the taxable account, the investor leaves more funds inside the IRA to keep growing on a tax-deferred basis (or in the case of a Roth IRA, tax-free). Over enough years, this can be a meaningful addition to the value of the account.

Conversely, paying the fee from the IRA is not considered a taxable withdrawal, meaning an investor is paying an expense with dollars that have never been taxed. How many investors would jump at the chance to pay their monthly phone or internet bill on a pretax basis? While that's not possible, using an IRA for the investment fee can be a tax-efficient way to use those IRA dollars. But beware — using the IRA to pay the fee for a taxable account would be considered a withdrawal.

So which is better? As usual, that depends. Investors in higher tax brackets may find that using IRA dollars without paying tax on them is an attractive option. On the other hand, those in the lower tax brackets may prefer to pay the fee outside the IRA.

Charging the IRA for its own fees also reduces the balance in the account, which then reduces the required minimum distribution during retirement. For those retirees who find their RMD is more than they actually need from their IRA, this might be an attractive strategy.

Regardless of the approach, advisers should be prepared to have these discussions with their clients — hopefully before the next billing cycle.


What do you think?

View comments

Recommended for you

Sponsored financial news

Upcoming Event

Mar 13



arjuna-design is honoring female financial advisers and industry executives who are distinguished leaders at their firms. These women have advanced the business of providing advice through their passion, creativity, inclusive approach and... Learn more

All of the noise in the District of Columbia is distracting your clients. Ben Phillips of Event Shares explains what deserves your attention (and what doesn't) as we head into 2018.

Recommended Video


Latest news & opinion

Wells Fargo, Morgan Stanley use contrary tactics to keep advisers

Wells is helping brokers transition to independence within the firm, while Morgan is taking them to court.

Fidelity pushes Vanguard to compete on brand in 401(k) plans

With Fidelity imposing an additional fee, Vanguard likely will look less attractive compared with comparably priced index-fund providers, advisers said.

Goldman's measure of risk appetite hits record

Global stocks and U.S. Treasuries are seeing their most "extreme" start to a year ever, bank says.

Wells Fargo erasing hurdles for advisers looking to move to its IBD

If advisers commit to staying at FiNet for a two-to-three year period, they will not have to pay Wells the fees it currently charges advisers switching channels.

El-Erian warns advisers on ETF liquidity

If investors decide to exit exchange-traded funds en masse, things could get nasty, economist says.


Hi! Glad you're here and we hope you like all the great work we do here at arjuna-design. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting arjuna-design.com? It'll help us continue to serve you.

Yes, show me how to whitelist arjuna-design.com

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Last News

franklin temple investments american century value inv www.benefits.ml.com merrill lynch ferrari f50 value zacks investment management performance blackrock high yield fund t rowe price institutional high yield fund tax free dividend stocks tax on surrender of life insurance policy psafx t rowe price participant 401k rollover rules vanguard high yield tax exempt fund admiral shares whole life insurance vs indexed universal life 401 k rollover to roth ira vanguard s&p 500 index mutual fund franklin federal tax free income fund what is the fedex cup payout co signing mortgage loan with parents vanguard high yield corporate fund investor shares section 72 t of the irs code when does ira contribution have to be made franklin federal limited term tax free income fund franklin templeton asset allocation funds qualified dividend tax rate 2014 how much does a ferrari f50 cost td ameritrade trade fees investors business daily editorials ira withdrawal for education when do you pay taxes on a roth ira vanguard california tax exempt bny alternative investment services mandatory distribution from ira 2nd mortgage tax deduction types of wells fargo accounts