IRAs and the IRS

A recent clarification from the Internal Revenue Service could change the way clients fund their individual retirement accounts and may eventually cut into a rep's IRA-related fees. In a recently released response to a financial firm's inquiry (the IRS withheld the firm's name), the IRS said IRA wrap fees paid with moneys outside the IRA itself do not count toward IRA contribution limits. These limits

A recent clarification from the Internal Revenue Service could change the way clients fund their individual retirement accounts — and may eventually cut into a rep's IRA-related fees.

In a recently released response to a financial firm's inquiry (the IRS withheld the firm's name), the IRS said IRA wrap fees paid with moneys outside the IRA itself do not count toward IRA contribution limits. These limits currently stand at $4,000 per year.

In the past, according to several sources, advisors have favored drawing their fees directly from the IRA, in part because this made the fees easier for clients to swallow. But under the IRS' recent guidance, a client who writes a check for the fees (rather than letting them be drawn directly from the IRA) will be able to plow that much more into his RIA. But he will also be “a lot more conscious of these fees, since it's not something that's just going to be a line in their statements,” says one IRA expert.

Assuming reps do the right thing and encourage clients to pay fees out of their pockets, it's not hard to see clients starting to question exactly what they're paying for. “This could very well lead to a reduction in fees,” another source says. “This is going to make proponents of these fees really have to justify exactly what they're providing.”

At the same time, though, the IRS guidance essentially gives a boost to IRA contribution limits. “This makes fee accounts a little bit more attractive,” says the IRA expert, who requested anonymity.

The IRS emphasized that the ruling applies only to the (anonymous) firm that asked for the recommendation and should not be taken as regulation. But many believe that the letter gives an idea of the agency's thinking on this matter and that a formal ruling would likely follow along these lines.

According to Cerulli Associates, $397 billion of fee-based assets were held in tax-advantaged accounts as of late 2004.

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