A fee-based account is a tranparent way of paying your financial advisor. The fee is charged based on the market value of the assets being managed, and it is distinctly different than a transactional account, where commissions are charged for every buy-and-sell transaction.
When clients open up a fee-based account, they sign a fee-based agreement that establishes the agreed upon fee, how the fees are calculated, when the fees will be charged and the accounts involved.
There are a number of benefits for clients in moving to a fee-based account.
Working on a “fee for service” basis, rather than a commission or transactional fee basis, means the best interests of the client are more aligned with those of the advisor. If fees are based on the market value of the account, then the only way an advisor will be compensated further is if they can grow your account in value. If your account declines in value, then so does the compensation paid to your advisor.
Another benefit of a fee-based account is the additional services clients receive from their financial advisor. Financial professionals today are rarely called stock brokers because the services offered extend well beyond buying and selling stocks. Financial planning meetings cover many topics such as tax and insurance as well as education, retirement and estate planning.
Financial professionals today spend a significant amount of time understanding each client’s needs and integrating this into an increasingly complex tax and regulatory environment.
As a result, the amount billed for fee-based accounts is referred to as an “investment council fee” for income tax purposes. The main benefit is the fees relating to non-registered accounts can be deducted on your income tax return as a carrying charge. If your fee is one per cent before tax, and your marginal income tax bracket is 30 per cent, your fees have a net cost to you of only 0.70 per cent.
Fees are typically charged quarterly. As an example, Jane Wilson opened a new fee-based account and invested $750,000 on Jan. 1 with an annual fee of one per cent. She will have no fees charged for three months. Around the middle of April, the first quarterly fees would be charged at $1,875 ($750,000 x 0.25 per cent). Wilson’s fees are one-quarter of one percent after each quarterly period.
Other methods of compensating that are not fee-based often have commission charges upward as high as five percent on the first day of buying the investments. For an advisor to be successful with a fee-based business, he or she needs to establish good long term relationships.
The periodic payment of fees better aligns the interests of clients and financial professionals. When explained to clients, most would prefer to spread out the fees over time as services are provided versus paying a large amount on the first day.
One question we are asked is how the quarterly fees are actually paid. To illustrate we will use Don Spalding, who has three investment accounts totaling $750,000 – $500,000 in a non-registered account, $200,000 in his RRSP account, and the remaining $50,000 is in a Tax Free Savings Account.
There are a few different options for how Spalding can cover the quarterly fees.
The first option is to have the fees charged to each of the respective accounts. Wilson had only one account and the fee of $1,875 was simply charged to that one account. Mr. Spalding has three accounts and each account is charged the respective amount based on one-quarter of one percent of the market value of each account.
The first quarterly amount for Spalding is $1,250 for the non-registered account, $500 for the RRSP, and $125 for the TFSA. He has the option of keeping cash in each account to cover the fees, depositing cash quarterly or selling investments.
With fee-based accounts, Spalding has the option to instruct us to designate the billing of the fees to come out of one account. Don could instruct us to pay the fees for his RRSP and TFSA accounts from the non-registered account. This enables him to maximize the amount he maintains in his registered accounts keeping it tax sheltered.
The payment of fees from a designated account enables an advisor to fully invest the non-designated accounts and to utilize compounding growth strategies such as the dividend reinvestment plan. Fee-based accounts can assist with income splitting as the higher income spouse can pay the account fees of the lower income spouse.
Liquidity is another benefit of fee-based accounts. As there is no cost to buy investments, the same applies to changing or selling investments. If you require money for any reason, there is no commissions payable for selling or rebalancing your investments. Rebalancing can include reducing a position that has performed well, dollar cost averaging on a position that has underperformed, adjusting sector exposure, modifying asset mix, and changing the geography of your investments.
Another benefit of fee-based is the ability to link additional family members to the platform. Clients with children and grandchildren often would like introduce them to the benefits of full service brokerage, but do not individually have the capital to be able to open accounts on their own. This could include parents wishing to assist adult children in opening and funding Tax Free Savings Accounts and grandparents who wish to open Registered Education Savings Plans for their grandchildren. Fee-based accounts that are linked can make wealth transfer strategies within the family group of accounts significantly easier.