Why I Charge a Monthly AUM Fee
In any business, it’s best to have a diversified stream of income. When you derive your income from multiple sources, you are better insulated against negative events, and hence, your business is more viable. To those of you who have been reading these posts I may repeat a few things, but it is necessary to provide a broad and concise perspective of my business income. My business is primarily fee-only and is derived from asset management fees, initial financial planning fees, financial planning renewal fees, and an occasional life insurance policy.
Like most of you, I charge a fee for managing client’s assets. Unlike many, I charge on a monthly basis. When I began, I analyzed this and found that not only does it provide me with a steadier income, but it actually works in the clients favor as it avoids the larger deductions of the quarterly cycle. As I have stated before, it works like dollar cost averaging in reverse. Smaller, more frequent deductions have a positive effect on a client’s portfolio when compared to the quarterly method. It is a little more work, but with technology, it’s really quite easy.
Financial Planning: Initial Fees
How much is a plan worth? How much are clients willing to pay? Assuming your planning document and advice are of high quality, this type of service can be worth a great deal. After all, how much is a client’s peace of mind worth? I typically charge between $1,500 and $4,000 per plan which includes all meetings, my time to put the document together, my advice, and any scenarios that may be needed. I collect the minimum (usually $1,500-$2,000) up front and the balance when I present the plan. <y planning agreement covers one full year.
Financial Planning Renewal Fees
After the first year, my planning fee is reduced and deducted quarterly from the clients account. The renewal fee covers: at least one plan update; an historical plan summary comparing the current plan with past plans; access to eVault, my online-central repository for client documents; and a membership with LifeLock Identity Theft Protection services. For this, I charge between $250 and $350 per quarter.
Life Insurance
I don’t do much here and when I do, I am compensated through a commission. I never lead with any product, including life insurance, but there are situations when it is prudent to acquire a policy.
Summary
I should mention that unless a client writes me a check, I deduct all fees from their taxable account. Any fee deducted from a client’s retirement account is not tax deductible. So if a client has a taxable account and an IRA, I deduct the entire fee from the taxable account.
I hope you find this informative and would love to hear how you approach this in your business.
“I should mention that unless a client writes me a check, I deduct all fees from their taxable account. Any fee deducted from a client’s retirement account is not tax deductible. So if a client has a taxable account and an IRA, I deduct the entire fee from the taxable account.”
Fees deductible subject to 3% of AGI limitation. How many of your clients actually are able to deduct fees?
You should consider deducting fees for investment management of a client’s retirement account from that account (instead of from their taxable account) in cases where they will get no tax benefit from paying it from their taxable account. Generally, that will be either if their Miscellaneous Itemized Deductions do not exceed 2% of their Adjusted Gross Income, or if they are regularly subject to AMT and thus their Misc Itemized Deductions will get “thrown out.” Management fees deducted from an IRA for the management of that IRA are not taxable distributions, and at least the client is paying for the service with pre-tax dollars — they will eventually get a tax benefit from not having those funds distributed and taxable. One caveat — never deduct fees from a Roth — those should come from the taxable account.
Mike,
Good post, does your annual fee also cover any contact with the advisor beyond the plan renewal and historical plan comparison? For example: A life event, market event, or similar event that requires phone time or an office visit? What type of pushback do you get on life lock in terms of “I can just pay that myself and pay you the difference.”
Mike
Contrary to your advice, I deduct the management fee portion attributable to the retirement account from the retirement account. Although it is not tax deductible, it is paid from pre-tax funds (just as beneficial). It is the only instance that I am aware of where you can “withdraw” funds from a deferred account without paying income tax. This is why the IRS permits only the fee allocable to the deferred account to be taken from that account.
Furthermore, many clients are “phased out” of the deduction if it is taken from the taxable account.
Bob Kelling
If you deduct from the taxable account, you’re losing part of the fee deduction that is below 2% of AGI. And for those in the AMT, you lose all miscellaneous itemized deductions. Why not deduct fees from traditional IRAs (not ROTHs) pro-rata on a pre-tax basis?
Mike,
I love your blog — thanks so much. I too started a practice around the same time as you and I think your approach is excellent.
I do agree with the others here about charging fees to pre-tax IRAs and leaving the Roths out of it.
Alan mentions deducting all fees from an IRA which I completely agree with as being the only solution that is 100% tax-deductible due to the 2% AGI misc. deduction limit as well as completely avoiding the Roths (that is the golden $!).
Bob Kelling says you can only deduct fees attributatble to a partiular IRA account. Bob, or anyone, do you have any IRS references to this particular subject as to whether or not you could deduct 100% of a ‘household’s assets’ from and IRA and leave the Roths and taxable out of it yet still get your fees?
Thanks again to all who have contributed.
My comments seem to get deleted and/or stuck in moderation:
Mike, I don’t believe that charging fees on a monthly basis makes the most business sense, especially for a solo advisor.
Add up the internal people-hours involved to gather the month-end data, export it to the fee calculator, generate fee invoices, upload fee debit instructions to custodians, deliver invoices (electronically or paper-based) to clients, collect manual payments, monitor A/R for outstanding invoices, and reconcile all payments to the expected total fee amount. Don’t make any mistakes along the way.
Do this quarterly and the hours are multiplied by 4.
Do this monthly and the effort is TRIPLE that of quarterly.
I also don’t see how billing monthly provides steadier income over quarterly billing. AUM fees are still subject to the volatility of the market which cannot be controlled. I would not say that an employee that is paid weekly has more stable income over an employee that is paid monthly.
Some of my clients are retired with a lower income and a large nest egg. For them, when you include fees for AUM, FP, CPA, and other Tier II deductions, it makes sense to deduct from the taxable account. Also, since the itemized deduction phase out is being “phased out,” in 2008-09 only 1/3 of the phased out amount will be treated as such. Therefore, they can use more of their itemized deductions.
Bob, Bob, and Kevin: I appreciate your comments about deducting the fee from the IRA. That makes sense. Thanks!
Maurice: My annual fee covers all of what you said.
Bill: I don’t know who your custodian is, but it sounds like deducting fees involves a lot of steps. With my custodian, it takes about 45 minutes to set up and then the process is completely automated. Very, very easy. Perhaps you should check around. You might find a different custodian with a more efficient platform than the one you currently have (though I understand it’s a real hassle to change).
To your pother point about the frequency of fee deductions, I built a spreadsheet and used MCS to simulate monthly and quarterly fee deductions. The monthly came out slightly better. If you haven’t thoroughly scrutinized it, I can certainly understand your comment.
Alan: I forgot to thank you since you were the first to bring up the point pf deducting from the IRA. Thanks!
Many clients have held-away accounts that cannot be moved to the firm’s custodian. It takes extra time and effort to gather data on those accounts unless data aggregation is employed.
Also, be careful if the custodian is performing the fee calculations. I’ve seen several instances where the custodian does not apply fee breakpoints, fails to aggregate household accounts properly, or incorrectly pro-rates fees on mid-quarter (or mid-month) asset transfers.
Trust, but verify, their work.
Bill,
You are correct about “held-away” accounts. I only have a few of these. About the custodian fee calculations…you are spot on! I have found a number of mistakes. We enter everything into an Excel spreadsheet and if the custodians numbers don’t match, we manually enter the correct amount.
I to adhere to Ronald Reagan’s advice, “Trust, but verify.”
Have a great Thanksgiving!