joellewis/finance_skills/fee-billing

Fee Billing

Core Concepts

1. Fee Schedule Structures

Advisory firms employ a range of fee structures, often combining several within a single practice.

Flat Fee (Fixed Dollar). A predetermined dollar amount charged per period regardless of account size. Common for financial planning engagements or retainer-based advice. Straightforward to bill but disconnected from asset growth.

AUM-Based (Percentage of Assets). The most prevalent model for registered investment advisers. A single percentage (e.g., 1.00%) is applied to the market value of managed assets. Simple to communicate but can become expensive for large portfolios and cheap for small ones.

Tiered / Breakpoint (Declining Rate). A graduated schedule where successive tiers of assets are billed at progressively lower rates. For example:

Under a true tiered schedule each dollar is billed at the rate for the tier it falls within. Under a breakpoint schedule the entire balance is billed at the rate corresponding to the highest tier reached. The distinction matters significantly for large accounts and must be clearly defined in the advisory agreement.

Flat-Plus-AUM Hybrid. Combines a fixed planning fee with a lower AUM percentage. Useful for firms that want to be compensated for planning work independently of portfolio size.

Hourly. Charges based on advisor time. Rarely used as the sole billing method for ongoing relationships but common for project-based planning engagements.

Financial Planning Fees. One-time or recurring fees for plan creation and updates, often billed separately from investment management fees.

Performance-Based Fees. Permitted only for "qualified clients" under SEC Rule 205-3. Under the SEC's 2026 inflation adjustment (order issued April 2026, effective June 29, 2026), a qualified client must have at least $1.4 million in AUM with the adviser or a net worth exceeding $2.7 million — up from the $1.1 million / $2.2 million thresholds set in 2021. The SEC adjusts these thresholds for inflation every five years, and prior thresholds generally continue to apply to pre-existing contracts; verify current values. Requires a high-water mark or similar mechanism to prevent double-charging after drawdowns. Rarely used by typical RIAs due to complexity and regulatory constraints.

Family / Household Billing Aggregation. Assets across related accounts (spouses, trusts, custodial accounts, IRAs) are combined for fee-tier determination, then the calculated fee is allocated back to individual accounts. This gives the household the benefit of breakpoint pricing. The aggregation definition (who qualifies as "household") must be documented in the advisory agreement.

2. AUM Valuation for Billing

The accuracy and consistency of AUM valuation directly determines billing accuracy.

Valuation Date Selection. The most common approaches are:

• Quarter-end value: Assets valued as of the last business day of the billing quarter. Simple and widely used.
• Prior quarter-end value: Assets valued as of the end of the preceding quarter. Avoids billing on unrealized gains or losses that occurred during the period just ended. Common for advance billing.
• Period average: The average of daily or month-end values across the billing period. Smooths volatility but is operationally complex.

Market Value vs. Cost Basis. Nearly all advisory agreements specify market value. Cost basis would understate the true value being managed and is almost never used.

Held-Away Assets. Assets the adviser monitors but that are not custodied at the primary custodian (e.g., 401(k) plans, outside brokerage accounts, annuities). Whether these are included in the billable AUM depends on the advisory agreement. If included, obtaining timely and accurate valuations is a persistent operational challenge.

Accrued Income. Bond accrued interest and declared but unpaid dividends may be included or excluded. Most custodian feeds include accrued interest in the total market value, so the default is typically inclusion unless the fee schedule specifies otherwise.

Margin Debit Treatment. If a client uses margin, the question arises whether to bill on gross assets or net equity. The advisory agreement should specify. Most firms bill on net equity (gross market value minus margin balance).

Cash Inclusion / Exclusion. Some agreements exclude cash or money market positions from billable AUM, particularly if the adviser is not actively managing those balances. This is uncommon but must be handled when present.

New Account Proration. Accounts opened mid-period require proration. The standard method is to calculate the fee based on the number of days the account was open relative to the total days in the billing period. Some firms use a simpler approach and bill for the partial quarter only if the account was opened before the midpoint of the period.

3. Billing Cycle Mechanics

Quarterly Billing. The dominant cycle for RIAs. Billing quarters typically align with calendar quarters (Jan-Mar, Apr-Jun, Jul-Sep, Oct-Dec), though some firms use fiscal quarters.

Monthly Billing. Less common for investment management but used for financial planning retainers or firms that want to smooth revenue. Requires more operational overhead.

Annual Billing. Occasionally used for flat-fee or financial-planning-only arrangements. May be billed as a single payment or split into installments.

Advance vs. Arrears Billing.

• Advance (in advance): Fees are billed at the start of the period for services to be rendered. Creates a deferred revenue liability on the firm's balance sheet. Requires refund calculation for accounts terminated mid-period. Most common for RIAs.
• Arrears (in arrears): Fees are billed at the end of the period for services already rendered. Simpler from a revenue-recognition standpoint (revenue is earned when billed) but delays cash collection. Growing in popularity due to its alignment with the service delivery timeline.

Pro-Ration Rules. Events requiring proration include:

• Account openings mid-period
• Account closings or terminations mid-period
• Large contributions (some firms apply a materiality threshold, e.g., only prorate for contributions exceeding $10,000 or 10% of account value)
• Large withdrawals (same materiality threshold logic)
• Transfers between accounts within the same household (should be revenue-neutral)

The standard proration formula is:

Prorated Fee = Full-Period Fee * (Days in Period Account Was Active / Total Days in Period)

Billing Period Alignment. When a firm converts billing cycles (e.g., from quarterly to monthly), a transition period is needed. Clients should not be double-billed or under-billed during the switch. A reconciliation calculation comparing what was billed under the old cycle against what is owed under the new cycle is essential.

4. Fee Calculation Engine

A systematic fee calculation follows these steps:

Step 1: Determine Household Composition. Identify all accounts linked to the billing household. Include all account types per the advisory agreement (individual, joint, IRA, Roth IRA, trust, UGMA/UTMA, entity accounts).

Step 2: Retrieve Account Valuations. Pull market values as of the valuation date from the custodian or portfolio management system. Apply any exclusions (cash exclusion, held-away asset inclusion, margin debit netting).

Step 3: Aggregate Household AUM. Sum the billable market values across all accounts in the household to determine the household-level AUM for tier determination.

Step 4: Apply Fee Schedule. Using the household's assigned fee schedule, calculate the annual fee. For a tiered schedule:

Household AUM: $1,800,000
Tier 1: $500,000 * 1.00% = $5,000
Tier 2: $500,000 * 0.80% = $4,000
Tier 3: $800,000 * 0.60% = $4,800
Annual Fee: $13,800
Effective Rate: 0.767%

Step 5: Convert to Billing Period. Divide the annual fee by the number of billing periods (4 for quarterly, 12 for monthly).

Quarterly Fee: $13,800 / 4 = $3,450

Step 6: Apply Overrides and Adjustments. Check for negotiated rate overrides, minimum fee floors, fee caps, waivers, or credits. Apply in the correct order (typically: calculate standard fee, then apply negotiated rate, then apply minimum, then apply cap, then apply waivers).

Step 7: Allocate to Accounts. Distribute the household fee across individual accounts, typically pro-rata by market value:

Account A ($900,000 / $1,800,000) = 50% * $3,450 = $1,725.00
Account B ($500,000 / $1,800,000) = 27.78% * $3,450 = $958.33
Account C ($400,000 / $1,800,000) = 22.22% * $3,450 = $766.67

Step 8: Apply Proration. For any accounts opened or closed mid-period, prorate the allocated fee.

Step 9: Rounding. Apply consistent rounding rules (typically round to the nearest cent). Ensure rounding differences are allocated to a designated account (usually the largest) so the sum of account-level fees equals the household fee exactly.

Step 10: Generate Billing Output. Produce the custodian debit instruction file or invoice, the billing detail report, and the audit trail record.

Minimum Fee Application. Many firms set a minimum quarterly or annual fee (e.g., $250/quarter). If the calculated fee falls below the minimum, the minimum is charged instead. This should be applied at the household level, not the account level.

Fee Cap Application. Less common but sometimes offered to attract large accounts. A cap ensures the dollar fee does not exceed a maximum regardless of AUM growth.

Negotiated Rate Overrides. Individual clients or households may have rates that differ from the published fee schedule. The billing system must support per-household or per-account rate overrides while maintaining an audit trail of who authorized the deviation and when.

Rounding Rules. Define and document the rounding convention. Typical practice rounds each account fee to the nearest cent. Allocate any remainder (positive or negative) from rounding to the largest account in the household.

5. Collection Methods

Direct Debit from Custodian Account. The most common method for RIAs. The adviser sends fee debit instructions to the custodian (Schwab, Fidelity, Pershing, etc.), and the custodian debits the client's account directly. Requires:

• Written authorization in the advisory agreement or a separate billing authorization form
• Custodian-specific file format (varies by custodian; typically CSV or fixed-width)
• Submission within the custodian's billing window (often the first 10-15 business days of the quarter)
• The custodian sends a statement to the client showing the fee deduction, providing a layer of independent oversight

Invoice Billing. The adviser sends an invoice and the client pays by check, wire, or ACH. More common for institutional clients, financial planning fees, or clients who prefer not to authorize direct debits. Increases accounts receivable management burden.

Split Billing Across Accounts. When a household has multiple accounts, the fee can be debited from each account in proportion to its share of the household AUM (the most common approach) or debited entirely from one designated account.

Billing from Specific Accounts. Some clients designate a specific account for fee payment. Common when clients prefer fees to come from a taxable account (for potential tax deductibility) rather than a retirement account.