Understanding Wrap Fees for Retirement Accounts

Fee-based accounts—also known as wrap or managed accounts—are rising in popularity. These typically impose an annual percentage fee based on the amount of assets under management. If your retirement account is managed under a wrap fee program, you need to consider whether you should pay the fee out of your retirement account balance or out-of-pocket.

Key Takeaways

• Paying wrap fees with your retirement account can limit its earning potential.
• If you pay wrap fees out-of-pocket, tread cautiously. You need to be sure the payments are not counted as contributions to the account.
• Check with your account provider on the correct procedure.

Paying with Your Account Balance

Your first consideration is how paying the fee out of your account balance decreases the return on your investments.

A wrap fee reduces your account balance. This, in turn, reduces the amount of assets that continue to accrue earnings on a tax-deferred basis, if it’s a traditional individual retirement account (IRA), or on a tax-free basis, if it’s a Roth IRA. Over time, this reduction of the balance can have a significant impact on the overall performance of your retirement account investments.

Important

Paying wrap fees out of your account can have a significant, long-term impact on your retirement savings.

For example, say you have an account that earns a return of 10% and charges a fee of 1%. By paying your wrap fee out of your retirement account, you decrease the return on your investment by 8% over a five-year period.

The chart below illustrates this decrease. It shows the yearly difference in return over a five-year period for an investor who starts with an IRA balance of $1 million, gets an annual return of 10%, and pays a 1% wrap fee per year. You can see how dramatically that 1% fee, small as it sounds, affects the yearly return.

In this example, after five years, the total difference in the retirement account balance is $71,851, and the amount will increase each year thereafter.

Paying out-of-Pocket

The alternative is to pay out-of-pocket—that is, use money that has already been taxed to pay the fee.

In the example demonstrated by Table 1, paying out-of-pocket results in an account balance increase of $71,851.

However, when this amount is eventually distributed from the retirement account, it will be subject to income tax at your applicable tax rate (assuming it’s a traditional account, not a Roth). The higher account balance would owe more taxes.

Important

The answer depends on the type of account. If it’s a Roth account, the distributed amount will be tax-free, so paying out-of-pocket seems to be the more advantageous option. But for traditional retirement accounts, this may not be the case.

Is Paying Out-of-Pocket Allowed?

A long-standing debate on whether wrap fees can be paid out-of-pocket was addressed by the Internal Revenue Service (IRS) in the private letter ruling (PLR)200507021.

The debate centered on whether commissions (which are part of a wrap fee) for a retirement account could be paid out-of-pocket. The debate also questioned whether, under current regulatory guidelines, such payment would be treated as a contribution to the retirement account.

In PLR 200507021, the IRS concluded that a wrap fee payment would not be treated as contributions to the retirement account.

As a result of this PLR, many retirement-account services providers that were hesitant to allow wrap fees to be paid out-of-pocket are now doing so. If you maintain a wrap account, check with your provider to determine their position on the matter.

While the IRS allowed the wrap fee to be paid out-of-pocket under PLR 200507021, it did not address the existing rule disallowing the reimbursement of fees paid from the retirement account. Therefore, if you want to pay your wrap fee out-of-pocket, check with your retirement-account provider to determine if they offer a billing service or other provision to allow you to pay the fee before it is debited from your retirement account.

Generally, if your provider offers a billing service, you get an invoice for your wrap fee, which will include a deadline by which the payment must be made. If you fail to make your payment by the stated deadline, the fee is generally debited from your retirement account. If you send in your fee after the payment has been debited, the payment is considered a contribution, which is subject to the applicable limit.

An Example of Using Wrap Fees

Julio, who’s 45, sent in a check for $5,000 for his wrap fee to his IRA provider, who received it after the wrap already debited Julio’s IRA. Since the payment was received after the fee had been debited, the IRA provider deposited the check as an IRA contribution.

However, Julio had already made a contribution of $4,000 to his IRA. The $5,000 late payment resulted in an excess contribution.

What Is the Contribution Limit for an IRA in 2025?

The most you can contribute to an IRA for 2025 is $7,000 if you’re under age 50 or $8,000 if you’re age 50 or older. (The amounts are the same for 2024.)

What Is the Contribution Limit for a 401(k) in 2025?

For a 401(k), the most you can contribute for 2025 is $23,500 if you’re under age 50 or $31,000 if you’re age 50 or older, except if you’re age 60, 61, 62, or 63. In that case, you can contribute up to $34,750. For 2024, you can contribute up to $23,000 if you’re under age 50 or $30,500 if you’re age 50 or older.

What Is a Fiduciary?

A fiduciary is a financial services professional who is bound by a legal standard to put the client’s interests first.

The Bottom Line

When deciding whether you should pay your wrap fee from your retirement account balance, the main factor to consider is the impact on the investment return.

If you decide to pay out-of-pocket, check with your retirement account provider to determine whether they offer such a service and exactly what policies and procedures apply.