Guidelines for Deduction Filing
Before 2018, unlike tax preparation costs, investment management fees and financial planning fees could be deducted as miscellaneous itemized deductions on your tax return, but only to the extent that they exceeded 2% of your adjusted gross income (AGI).1
If your adjusted gross income (AGI) was $100,000 and you spent $3,000 in financial planning, accounting, and/or investment management fees, you would be allowed to deduct $1,000 (the amount that exceeds $2,000 of 2% of your AGI).
Tip
Even while it’s convenient to pay these costs out of pocket, after taxes, a check may not be the best option if you have retirement savings in an individual retirement account (IRA).
Use of IRA Funds for Expenses
Fees for financial planning and investment management might be deducted straight from the managed account or taken as a percentage of the account balance. When fees are paid in this manner, they are not treated as a withdrawal from the IRA.2 Since the fees are an investing expense, they can be deducted from your taxable income.
Due to the inevitable taxation of traditional IRA assets, it is prudent to make direct fee payments from these accounts whenever possible. If you pay the fees using the tax-free component of the account, you won’t have to report the money as income.
The only amount you can contribute is the share of the charge that applies to your IRA. If you have $500,000 in an IRA and $100,000 in a non-retirement account, and both accounts incur costs of 1% per year, you can deduct the $5,000 in IRA fees from your IRA but not the $1,000 in non-IRA expenses.
The Use of Roth IRA Funds
Since distributions from a Roth IRA are tax-free, it would be counterproductive to utilize them to cover administrative costs. After paying taxes, contributors can put that money into a Roth IRA. Put the money into a Roth IRA and let it grow tax-free for as long as you can.3
Trading and Administrative Expenses inside the Mutual Fund
Expense ratios are the standard method by which mutual funds collect their fees.This fee is deducted from the fund’s return before determining who gets what.5 This is a profit or return that was hidden from you because it was utilized to cover out-of-pocket costs.
For this reason, you need not tally up your mutual fund fees and submit them as a deduction.
Tip
If you acquire a stock and pay $10 for the trade, that $10 will be added to the stock’s cost basis. When calculating capital gain or loss, the trading cost is deducted from the sale price of the stock.
Advice Purchases
You can find investment advisors who also provide tax preparation and financial planning services. They are typically included in bundled service packages and priced as a percentage of managed assets. Looking at the expenditures on an after-tax basis for tax years in which these expenses are deductible may reveal that these services are surprisingly affordable.
The expense ratio of actively managed mutual funds is a further factor to think about. Managers at these firms use research analysts to sift through stock market data in search of profitable opportunities. Fund fees for actively managed funds can be as high as 0.71% annually to cover the cost of employing a full team of research analysts.6
To avoid the high costs associated with actively managed funds, you might engage a fee-only investment advisor. Some of these funds even offer nil-percentage expense ratios.7 If services are organized in this fashion, customers may be able to get far more individualized guidance for the same price.
Accounts That Are Kept Independently
For high-net-worth families with a substantial amount of invested capital, many financial counselors suggest independently managed accounts rather than mutual funds. You are not charged any fees because you are the sole owner of the stocks. Investment management fees are deducted directly from the account and serve as the sole form of payment.
When you pay fees out of your IRA, you do it with after-tax money. Prior to the 2018 tax year, fees could be deducted under the 2% limit for miscellaneous itemized deductions.8
Questions and Answers (FAQs)
When Choosing Between a Roth and a Traditional IRA, What Are the Key Differences?
The way that contributions to a Roth IRA and a standard IRA are taxed is the primary distinction between the two types of retirement accounts. Contributions to a typical IRA are deductible for tax purposes but will be taxed when withdrawn. Since there is no tax break for Roth contributions, the money and any growth is put in after taxes, but if you withdraw it in retirement, you won’t owe taxes on it. That’s why it’s not a great idea to pay for financial advice with money from a Roth IRA.
If I’m Self-Employed, Can I Still Deduct Financial Investment Advice Fees?
If you’re self-employed, you can write off the money you spend on legal and professional services on Schedule C, Profit or Loss From Business. If you want to deduct certain expenses from your taxes, you should check with an expert beforehand.
