Investment management and financial planning fees were tax deductible through tax year 2017. They fell into the category of miscellaneous itemized deductions, which were eliminated from the tax code by the Tax Cuts and Jobs Act (TCJA) effective tax year 2018.
All isn't necessarily lost, however, if you could have claimed these fees but didn’t. You can go back and amend a tax return for three years from the date you filed it, or for two years from the date you paid any resulting tax, whichever is later. And the TCJA is set to expire at the end of 2025 unless Congress renews it, so it’s not out of the question that this deduction could come back at that time.
Rules for Claiming a Deduction
Investment management fees and financial planning fees could be taken as a miscellaneous itemized deduction on your tax return, like tax preparation fees, but only to the extent that they exceeded 2% of your adjusted gross income (AGI).
For example, you'd get no deduction for the first $2,000 of fees you paid, but you would be able to deduct the last $1,000—the amount that exceeds 2% ($2,000) of your AGI—if your AGI was $100,000 and you paid $3,000 in financial planning, accounting, and/or investment management fees.
You might be tempted to pay these fees by check, using after-tax dollars, because it's easy, but there might be a better way if you have money in an IRA.
Paying Fees out of an IRA
You can pay investment management fees or financial planning fees that are structured as a percentage of assets directly out of the account that's being managed. It’s not considered a withdrawal from an IRA account when fees are paid this way. It's an investment expense, so you’re paying the fees with pre-tax dollars.
It would cost you $760 for every $1,000 of fees paid this way on an after-tax basis if you’re at the 24% marginal tax rate.
It makes sense to pay fees directly out of traditional IRAs when possible, because the funds held in a traditional IRA will be taxed one day. You’re avoiding paying income tax on that portion if you pay fees out of this type of account.
Unfortunately, you can only pay the portion of the fee attributable to that particular IRA from an IRA. For example, if you have $500,000 in an IRA and $100,000 in a non-retirement account, and you pay 1% a year in fees, the $5,000 attributable to the IRA can be deducted out of the IRA, but the $1,000 attributable to the non-IRA account cannot.
Paying from a Roth IRA
It doesn’t make sense to pay fees from a Roth IRA, because these IRA withdrawals aren't taxed. Contributions to Roth accounts are made with after-tax dollars. You’ll want to let the money grow tax-free in a Roth IRA as long as possible.
Internal Mutual Fund Fees and Trading Costs
Mutual fund fees are charged in the form of an expense ratio. This cost is deducted out of the return of the fund before your share is allocated to you.
This is a return or gain that was never reported to you, because that portion was used to directly pay the expenses. You don’t have to total up your mutual fund fees and claim them as a deduction for this reason.
The money is added to the cost basis of the stock if you buy a stock and pay $10 for the trade. The capital gain reported is reduced by the amount of the trading cost when you sell the stock.
Paying for Advice
Some investment advisors offer financial planning services as well as tax preparation services. They are usually provided as part of a bundled service offering and are charged based on a percentage of assets managed. You might find that these services are surprisingly reasonable when you view the costs on an after-tax basis for tax years in which these costs are deductible.
Another consideration is the cost of actively managed mutual funds, which employ a management team of research analysts who study stock market data in an attempt to earn higher returns. It costs more to pay for this team of research analysts, so actively managed funds have higher fund fees, sometimes as high as 1% a year.
You could hire a fee-only investment advisor who uses low-cost index funds to build the portfolio instead of using actively managed funds. These funds have low expense ratios, some of which may be 0%. You might be able to get far more personal advice for about the same cost by structuring services this way.
Separately Managed Accounts
Many financial advisors recommend separately managed accounts instead of mutual funds for high-net-worth families with a large number of invested assets. You own the stocks directly, so there's no expense ratio. Instead, all fees are paid in the form an investment management fee that's debited from the account.
The fees debited from an IRA are paid with pre-tax dollars. Fees qualified for the miscellaneous itemized deduction, subject to the 2% limit, prior to tax year 2018, and possibly will again by 2026.