Self-Directed IRA owners face two main custodian fee structures: flat fees or asset-based fees. While asset-based fees may seem small in percentage terms, over time, they can erode a significant portion of your retirement savings. Let’s explore why paying asset-based fees is a bad choice compared to flat fees for your IRA, especially over the long term.
Why Do I Need an IRA Custodian?
Pursuant to Internal Revenue Code (IRC) Section 408, an IRA (individual retirement account) can only be established and administered by the following institutions:
- A bank,
- A Financial institution, or
- An Authorized trust company
An IRA Trustee (custodian) is the institution that administers your retirement account. By law, every IRA must have a custodian or trustee.
With a Self-Directed IRA, a special custodian, such as IRA Financial, will serve as the custodian of the IRA. All types of IRAs can be used in a self-directed structure including a traditional or Roth IRAs, SEP & SIMPLE IRAs, 401(k) rollovers, Coverdell ESAs and Health Savings Accounts.
Unlike a traditional financial institution, which generates fees by selling products and providing investment services, a Self-Directed IRA custodian earns fees by simply opening and maintaining the IRA and do not offer any financial investment products or platforms. The IRA funds are generally held with the custodian and the account owner will direct the custodian to invest the IRA funds in IRS-approved investments.
Self-Directed IRA Fee Structures
Flat Fee: A set fee, typically a fixed dollar amount per year for the administration of your IRA. The fee is charged annually, regardless of the account balance. In this example, we assume a flat fee of $500 per year.
Asset-Based Fee: An annual fee based on a percentage of the IRA account’s value as of December 31, charged annually. Here, we’ll use a typical fee of 0.75% of the asset value each year.
The Impact of Asset-Based Fees vs. Flat Fees: A 20-Year Example
Let’s assume our example has an IRA worth $100,000, and it grows at an average rate of 6% per year over the next 20 years. Here’s how the fees would compare under each structure.
Flat Fee Scenario:
- Flat Fee: Obviously, the annual fee would not change annually. It doesn’t matter if the IRA is worth $100,000 or $100 million. Keep in mind, over two decades, the flat fee will eventually go up. For our example, we will keep it the same.
Asset-Based Value Fee Scenario:
- Asset-Based Fee: Assume our investor selected a custodian that charged an annual asset valuation fee of 0.75% of the account value each year. The annual IRA fee increases as the value of the IRA account grows. To see the impact, let’s calculate how much our investor would pay in fees over time as the account appreciates.
At the end of 20 years, with an annual growth rate of 6%, the IRA’s balance would be approximately $320,714. Here’s how much the investor paid each year under the 0.75% asset-based fee model:
- Year 1: $100,000 * 0.0075 = $750
- Year 2: $106,000 * 0.0075 = $795
- Year 3: $112,360 * 0.0075 = $842
- (Fees continue to increase as the account grows)
- Year 20: $320,714 * 0.0075 = $2,405
By the 20th year, he or she would be paying over $2,400 annually in custodian fees.
Total IRA Custodian Fee Cost Over 20 Years
Let’s calculate the total amount our investor would pay in custodian fees over the full 20 years.
Total Flat Fees (Fixed):
$500 annually for 20 years = $10,000
Total fees paid: $10,000.
Total Asset-Based Fees (0.75% of Balance):
With an asset-based annual IRA custodian fee, the total fees would be significantly higher than the flat fee model. Assuming a 6% annual rate of return, after 20 years, our investor would have paid approximately $34,800 in total fees.
Key Takeaways: Why Flat Fees Win
- Flat Fees Remain Constant: Regardless of how much your Self-Directed IRA grows, flat fees do not increase. This means that as your wealth grows, you keep more of it. In our example, over 20 years, our investor would only pay $10,000 in total custodial fees.
- Asset-Based Fees Grow with Your Account: While 0.75% might not seem like much, as your IRA balance grows, the annual custodian fee increase dramatically. Our investor would end up paying $34,800 in total custodian fees, almost three and a half times as much as a flat fee-based IRA.
- Long-Term Impact on IRA Wealth: Annual asset-based IRA custodian fees compound against your IRA growth. The more you pay in IRA custodian fees, the less capital remains in your IRA to compound and grow in your account. Over decades, this can eliminate a significant portion of your potential wealth.
- It’s a Self–Directed IRA Account After All. As the name suggests, you are in total control of your IRA investment decisions. Why would you pay a custodian a percentage fee for the growth in your IRA if you are the one managing it!?
Conclusion: Choose Self-Directed IRA Custodian Fees Judiciously
When managing your Self-Directed IRA, flat annual IRA custodian fees almost always provide a much better deal than asset-based fees, especially if you have a growing IRA portfolio. Paying a small percentage of your assets in fees might seem harmless at first, but over 20 years (or longer), it can cost you tens of thousands of dollars in lost potential IRA value.
If your goal is to maximize retirement savings one should avoid the percentage-based IRA custodian fee model. Instead, opt for the annual flat-fee custodian fee structure where you know exactly what you’re paying each year, and more importantly, keep more of what you earn in your IRA for you and your family.
