A new Internal Revenue Service ruling on wrap fee payments may allow investors to preserve more of the cash they’ve accumulated in their individual retirement accounts, according to financial advisors.
In a private letter ruling (PLR) released last month, the IRS clarified the treatment of various wrap fee structures for both IRAs and Roth IRAs, which are becoming increasingly popular among advisors’ clients. The IRS declared that payments of wrap fees won’t be treated as “deemed contributions” to IRAs and/or Roth IRAs if the clients pay the wrap fees with money from outside accounts. The practice now is to pay wrap fees from the IRA accounts, which reduces the retirement money compounding within them. “The question was whether fees paid with outside dollars should actually be considered a contribution, thereby causing a reduction to an IRA account holders’ already limited contribution of $4,000, or $4,500 if over 50 years of age,” says Joe Campisi, a planner with Campisi Financial Network in Fairview Village, Pennsylvania. “This is very important since wrap fees can easily exceed the (annual) IRA contribution limit.”
If the fee is paid with outside dollars, Campisi notes, “the IRA account is not being reduced by that amount and therefore [the investor is] preserving a higher balance to continue to grow tax deferred.” Michael Kitces, director of financial planning for the Pinnacle Advisory Group in Columbia, Maryland, says this has been an ongoing conundrum for advisors. “It has been a question of whether it was okay to pay the account fees with outside money–many custodians have [done it anyway], but many were assuming that it was okay, when in reality it was a very gray area,” he says.
The PLR is “really good news for the average person saving for an IRA and particularly good for those holding a Roth IRA,” particularly a large one, adds William Suplee, president of Structured Asset Management in Paoli, Pennsylvania. The money inside the IRAs can now grow from a larger base, Suplee notes, because wrap fees, when paid as an expense or deemed contribution from the Roth account, cut into the total retirement funds compounding. The benefit is somewhat mitigated by the fact that most contributory Roth accounts aren’t very large, Kitces adds, but due to the occasional Roth conversion, there definitely are some larger Roth IRAs where the fee that can be paid with outside funds is substantial.
The IRS guidance also states that even a full-service brokerage account fee qualifies for exclusion from the deemed contribution, as long as it is not an individual transaction fee, Suplee says. Thus, if the fees are for the overall portfolio, including trades, but obviously weighted with administrative and custodial fees, the IRS will allow the entire fee to be paid from a separate or out-of-pocket account, according to the guidance. The PLR uses an example where ‘Company M’ has calculated that trading costs for portfolio A, B, C, and D total approximately 15% of the overall wrap fees collected and where clients who participate in these portfolios are predominantly paying for investment advisory, money management, and other administrative services.
Another selling point for the new guidance is that investors may be able to deduct the wrap fee if it is paid from a separate taxable account. The deductibility of a miscellaneous itemized amount would be subject to the 2% floor of adjusted gross income. Currently, if the wrap fee is deducted from the IRA account, then the fee is not deductible.
However, this is still a gray area, advisors concede. Since Roth IRAs are structured to produce tax-free earnings, the fee may not be deductible, although non-qualified withdrawals from a Roth are still taxable, so the deductibility could still come into play. A private letter ruling or PLR doesn’t have the force of law and won’t hold up in court as a defense but instead is guidance issued in response to taxpayer queries, especially those in an ambiguous but popular investment situation. To read the PLR, which was sent to the taxpayer in November but only released on the IRS web site in February, go to http://www.irs.ustreas.gov/pub/irs-wd/0507021.pdf
The Lowdown on Pension Plans’ Solvency
The Department of Labor has proposed rules it hopes will foster better disclosure about the funding status of defined benefit plans. The rules fulfill provisions of the Pension Funding Equity Act of 2004, which require plan administrators of multi-employer pension plans to provide an annual notice to plan participants, beneficiaries, labor organizations, contributing employers and the Pension Benefit Guaranty Corporation (PBGC) on the financial situation of these plans. The information must include–in easily understood language–whether the plan is 100% funded, and if not, the plan’s current liability percentage. The goal is to “ensure sufficient assets are available to pay future benefits,” said Assistant Secretary of Labor Ann Combs in a prepared statement. The annual funding rule also requires a comparison of the plan’s assets to benefit payments, a description of the law governing insolvent plans, and the PBGC’s benefit guarantees; the PBGC guarantees only vested benefits. Although the agency has yet to issue the final rules, a spokeswoman says good faith compliance is expected.
Find the proposed rule, for which comments closed March 7th, at http://www.dol.gov/ebsa/regs/fedreg/proposed/2005002151.htm.
For more information about the PBGC and multi-employer benefit
guarantees, visit http://www.pbgc.gov.