What Is A Good IRA Management Fee?
Friday, February 23rd 2024
Before diving deeper into IRA management fees, it’s crucial to gain an understanding of Individual Retirement Accounts (IRAs). An IRA is an investment account designed to allow individuals save for retirement with tax efficiency; traditional and Roth IRAs are two commonly held accounts in this regard.
Context Behind IRA’s Fees
Traditional IRA contributions may be tax-deductible, meaning your contributions won’t incur tax until it comes time to withdraw your funds during retirement. By contrast, Roth IRA contributions are made using after-tax dollars; therefore, withdrawals during retirement should generally be tax-free. Together these tax advantages make IRAs an appealing retirement savings tool.
But the way IRAs grow over time is not solely determined by contributions you make; rather, your money is invested – often into various stocks, bonds, or mutual funds – in hopes that market performance leads to growth over time – thus necessitating management fees as an additional cost of doing business.
How IRA Management Fees Work
Management fees refer to costs associated with maintaining and overseeing an investment account such as an IRA. They cover fees such as investment advisory services fees, transaction costs and administrative charges.
Investment advisory fees are expenses you pay the advisor or firm guiding your investments, which help create an investment strategy to suit both your risk tolerance and financial goals. Transaction costs cover charges associated with buying or selling investments within an IRA while administrative fees cover administrative services like record-keeping and customer support.
Simply stated, these fees represent the price you must pay to gain the convenience and expertise provided by having someone else manage your IRA for you.
Impact of IRA Management Fees on Returns of Investment
At first glance, IRA management fees might seem inconsequential; after all, one percentage point here or there doesn’t sound like much. Yet with time comes compound interest which will have an adverse impact on returns from investment returns due to these fees’ compound effect.
Consider this: if you invest $100K and achieve an average return of 7% each year over 10 years without incurring fees or paying management fees of any sort, that amount would have become around $197,000 after 10 years – without fees at all! But paying even just one percent as management fees reduces returns to about 6% instead, leaving roughly $180,000 instead, which represents a difference of roughly $17,000 over longer timeframes.
Therefore, management fees play an essential part in your retirement savings efforts. The lower they are, the greater is your money’s chance for long-term investment growth and potential earnings potential.
What Makes Up an Ideal IRA Management Fee Structure?
Determining what constitutes an ideal IRA management fee may depend on the services you require; but as a general guideline, aim for annual fees under one percent of your account balance.
Many investment advisors charge annual management fees that range between 0.25-1 percent of assets under management and transaction and administrative fees that could add an extra 0.25 – 0.5% in transaction costs or administration.
One metric to gauge reasonable management fees is expense ratios from mutual and exchange-traded funds (ETFs). According to the Investment Company Institute, the average expense ratio for mutual funds stood at approximately 0.52% in 2020 – this can vary greatly according to index funds or ETFs (1), however.
How to Reduce IRA Management Fees
If you are paying over one percent in annual fees, there are strategies available to you in order to lower these expenses and bring costs under control:
- Robo-advisor: First of all, consider switching to a robo-advisor. These automated investing platforms use algorithms to manage your investments for you – helping reduce expenses along the way. In 2021 alone, according to Backend Benchmarking reports, their average fee stood at just 0.23 percent!
- Low-cost index: Second, consider investing in low-cost index funds or ETFs that replicate market index performances rather than trying to beat them; these passive management funds usually feature lower expense ratios than actively managed funds.
Don’t be afraid to negotiate with your advisor; some fees may not be negotiable, but others could be flexible.
Why Higher Fees May Be Justified
Although fees play an integral part in investment returns, they should not be the defining factor when selecting an IRA manager.
Investors with specific financial objectives might find higher fees worth it if the additional services or improved performance outweigh them. For instance, certain advisors provide comprehensive financial planning, tax advice or other valuable benefits which you find important.
In addition, some actively managed funds have outperformed their benchmarks with higher fees, yet consistently outperformed. However, maintaining these performances can be difficult, and past performance may not be a reliable indicator of future returns.
At first glance, IRA management fees might seem minor; but as we’ve shown here, these costs can have a major effect on your retirement savings. By becoming more familiar with them and striving to reduce them as much as possible, more of your money will remain working toward its goal of helping secure a comfortable retirement lifestyle for yourself and family members.
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