I am a Registered Investment Advisor who charges a management fee (based on a % of account value). The fee can be either debited from the client”s IRA directly or invoiced separately and paid from outside funds. The Investment Adviser’s Act of 1940 also allows “qualified clients” (net worth over $1.5 million) to pay for services via a “Base Fee” (like the management fee … based on a % of account value) and an “Incentive/Performance fee” which often is 10-20% of the account’s net profits for the year. The advisor essentially shares in the client’s profits (and losses sometimes) when an incentive/performance fee is used. I know for a fact that incentive/performance fees can be debited from an IRA directly, just like asset-based management fees. Three questions please:
1. Is it ok for an incentive fee to also be billed separately and paid outside the IRA? I had read somewhere a few years ago that if an investment manager shares in a client’s IRA profits and takes his share of the profits (essentially the incentive fee) from funds outside the IRA, that the entire IRA could be disqualified. Thoughts?
2. If the client loses money, some contracts allow for the advisor to pay the client. However, with IRAs, would a fee credited (advisor’s share of losses reimbursed) to the account risk being considered a contribution instead of a fee credit?
3. Also if the client loses money, with IRAs, the fee credit could be paid by the advisor directly to the client outside of the IRA; however I am concerned that this could be considered taxable income because in theory I’d think that the fee credit should go into the IRA where eventually the IRS would have the opportunity to tax it. Basically in questions 2 and 3 I know it’s ok to reimburse a percentage of losses via a performance fee for non-IRA accounts, but don’t know if there are any issues for IRAs.
Thanks in advance for your thoughts.