A fee-based account is where a fee is charged based on the market value of the assets being managed. This is distinctly different than a transactional account, where commissions are charged for every buy and sell transaction. When clients open 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 which accounts are to be fee-based.
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 financial adviser. If fees are based on the market value of the account, then the only way a financial adviser will be compensated more is if they can grow your account in value. If your account declines in value, then so does the compensation paid to your adviser.
Another benefit of a fee-based account is the additional services clients receive from their financial adviser. 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, protection strategies, education planning, retirement planning 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 of our services being much more than the buying and selling of stocks, the amount billed for fee-based accounts is referred to as an “investment council fee” for income tax purposes. The main benefit of this is that 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, then your fees have a net cost to you of only 0.70 per cent.
Fees are typically charged quarterly. As an example, Jane Smith opened a new fee-based account and invested $1,250,000 on Jan. 1 with an agreed upon annual fee of one per cent. Jane will have no fees charged for three months. Around the middle of April, the first quarterly fees would be charged at $3,125 ($1,250,000 x 0.25 per cent). Jane’s fees are effectively 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 a wealth adviser to be successful with a fee-based business they need 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 the fees out 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 John Smith who has three investment accounts totaling $1,500,000: $1,000,000 in a non-registered account, $400,000 in his Registered Retirement Savings Plan account, and the remaining $100,000 is in a Tax Free Savings Account. There are a few different options for how John can cover the quarterly fees. The first option is to have the fees charged to each of the respective accounts. John 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 John is $2,500 for the non-registered account, $1,000 for the RRSP, and $250 for the TFSA. John may keep cash in each account to cover the fees, depositing cash quarterly, or selling investments. Note: You are not able to claim a tax deduction for investment counsel fees for registered accounts.
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 commission 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 — this is referred to as “house-holding.” Clients with children and grandchildren often would like to 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. A couple of examples 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 to execute.
One of the benefits of having a fee based account is the ability to also have a managed account. Next week we will outline the many benefits of managed accounts.
Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the Times Colonist. Call 250-389-2138.