With the 2023 tax season in full swing, this is one question our clients commonly ask. The short answer is no—but you can still tap into tax benefits through the fees.
Prior to 2018, investors could treat advisory fees as an itemized deduction if the fees exceeded 2% of their adjusted gross income (AGI). Unfortunately, you’re no longer able to file investment advisory fees paid from a taxable account as a miscellaneous itemized deduction on Schedule A. That’s because the Tax Cuts and Jobs Act of 2017 (TCJA) repealed all miscellaneous deductions beginning in 2018 through 2025, including:
- Investment advisory expenses
- Unreimbursed job expenses
- Tax preparation fees
- Hobby expenses
- Fees to fight the IRS
The repeal of the miscellaneous deduction doesn’t have a significant impact on some upper-income taxpayers. Yet for those who exceeded the AGI threshold and weren’t subject to the alternative minimum tax, the deduction did result in a tax savings (as long as the expenses were paid from a taxable account).
Even though the TCJA eliminated this deduction, there are still ways to recapture this tax benefit.
From your taxable account: While fees paid from a taxable account are no longer deductible, some advisory firms allow clients to pay the portion of the fee used to manage their IRA assets directly from the IRA itself. (Treasury regulation 1.404(a)-3(d) says a retirement account’s ongoing investment advisory fee can be paid directly from the account without being treated as a taxable distribution.)
Assuming the funds in the account are entirely pre-tax, the entire fee would be paid with pre-tax dollars, which is effectively the same as a tax deduction. You could argue it’s even better than a tax deduction under the old rules because, with the 2% AGI limitation, it was never possible to deduct 100% of the fee.
Some advisers would argue that investors should still pay fees and expenses from a taxable account even though they can no longer deduct the fee. Their reasoning is that there’s more value in leaving funds inside an IRA to keep growing on a tax-deferred basis, as the compound growth over many years could lead to a significant yield.
You’ll also want to consider that fees paid from a taxable account will reduce the value of that account. The remaining funds will continue to grow (although in a taxable account) and you might choose to invest them in assets that are taxed at a lower rate, such as long-term capital gains or qualified dividends. Funds that grow in an IRA will eventually be taxed when they’re withdrawn from the account. Note that IRA withdrawals are taxed as ordinary income, which is currently taxed at a higher rate than long-term capital gains.
With pre-tax dollars: There is also an immediate benefit to paying the investment advisory fee this year with pre-tax dollars, versus waiting for a potential benefit in the future. Allowing the IRA to pay its own fees reduces the balance in the account, which then reduces your required minimum distribution (RMD) when you reach age 73. This could be a particularly attractive strategy for retired investors who don’t need their entire RMD to fund living expenses.
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So what’s better—to pay advisory fees from your IRA with pre-tax dollars or to pay them from a taxable account? Investors in higher tax brackets may find it makes sense to use pre-tax dollars from their IRA. Investors in a lower tax bracket with a long time horizon may prefer to pay the fee outside the IRA.
Both investors will likely find it preferable to use dollars from a taxable account to pay the investment management fee for a Roth IRA, even though the fee won’t be deductible. It’s wise to protect any funds that can grow tax-free, like those in a Roth IRA.
Finally, if you choose to pay fees with pre-tax IRA dollars, make sure you’re only paying the fees associated with managing that account. Using an IRA to pay for expenses related to a taxable account or a Roth IRA would be considered a taxable distribution and could also be subject to early withdrawal penalties.