Weekend Reading for Financial Planners (Jan 26-27)

Author: Michael Kitces

Team Kitces

Michael Kitces is Head of Planning Strategy at Buckingham Strategic Wealth, which provides an evidence-based approach to private wealth management for near- and current retirees, and Buckingham Strategic Partners, a turnkey wealth management services provider supporting thousands of independent financial advisors through the scaling phase of growth.

In addition, he is a co-founder of the XY Planning Network, AdvicePay, fpPathfinder, and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com, dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

Read all of Michael’s articles here.

Nevada Fiduciary Proposal Packs Punch With Broad Scope Of Coverage (Mark Schoeff, Investment News) - Back in 2017, Nevada implemented a law that would require advisors and brokers to meet a fiduciary duty when working with clients, and last week the Nevada Securities Division released an 8-page regulatory proposal about how the fiduciary rule will actually be implemented, with an open comment period running through March 1st (after which the Nevada regulators will decide whether or how to proceed). Notably, unlike the recent Regulation Best Interest proposal from the SEC, the Nevada proposal would uniformly apply the same fiduciary duty broadly to both advisers and brokers, as the duty is triggered both for managing clients' assets or even just creating periodic financial plans (amongst other factors), and the fiduciary requirement can even be applied transaction by transaction. Dual-registrants would also be held to a fiduciary duty, as it would apply to brokers across job titles as long as they're substantively "holding themselves out" as financial advisors. On the other hand, while the Nevada fiduciary proposal is broad in scope, it's light on detail about what is expected of fiduciaries to mitigate particular conflicts of interest (where prior fiduciary proposals have focused), and there are some questions about whether Nevada's proposal is so broad it would conflict with the ERISA fiduciary rules for advisors working with qualified plans. Nonetheless, as the SEC continues to move forward with a less-than-fully-fiduciary duty for brokers under Regulation Best Interest, states like Nevada appear determined to move forward with their own more stringent fiduciary rules.

Raymond James Bids To Be The Goldman Sachs Of RIA M&A Through Acquisition Of Silver Lane (Brooke Southall, RIABiz) - This week, Raymond James announced that it was acquiring Silver Lane Advisors, a boutique investment bank focused primarily on financial services mergers and acquisition that has been involved in a number of the biggest "marquee" M&A deals in the RIA community (from roll-up efforts with First Republic to Milstein's buyout of Hurley's Fiduciary Network and HighTower's purchase of WealthTrust). Notably, though, the sale of Silver Lane to Raymond James isn't about an exit for founder Liz Nesvold, but instead, an opportunity to leverage Raymond James' national presence to move even further into the market with more and larger deals, especially as the success of the Focus Financial IPO has made RIA acquisitions and aggregations an even hotter category than it already was. Accordingly, Silver Lane will actually become the "Asset & Wealth Management" practice of Raymond James' own Investment Banking group, which Nesvold (and her COO husband Peter) will lead. And while deal terms were not disclosed, Nesvold has indicated there are "significant incentives" for ongoing growth. Which means, simply put, that as much as RIA M&A activity has ramped up in recent years, one of the leading firms in front of the investment banking charge sees a lot more room for continued M&A in the RIA community.

Final Pass-Through Rules Deliver Good And Bad News For Advisers (Greg Iacurci, Investment News) - After issuing proposed regulations last summer, this week, the Treasury announced its Final Regulations regarding the new Section 199A Qualified Business Income deduction. For the most part, the final rules were consistent with the original proposal. However, the new rule did include a clearer safe harbor on how clients can claim the QBI deduction on profits from rental properties... as long as the owners themselves or employees or contractors spend at least 250 hours on the property each taxable year (where multiple properties can be bundled together, but triple net leases may not qualify). Other notable clarifications in the final regulations included: REITs held within mutual funds will still be eligible for the QBI pass-through deduction (as while it was already known that directly-held REITs would qualify for the 20% deduction, there was uncertainty about whether not-otherwise-qualifying mutual funds holding REITs would be eligible); tax deductions for retirement plan contributions (along with above-the-line deductions for self-employment taxes and self-employed health insurance) will dilute the QBI deduction; and unfortunately, high-income financial advisors are definitely not eligible for the QBI deduction as the final rules re-affirmed that they are Specified Service Businesses.

I'm Not A Natural Saver; Here's How I Manage To Do It Anyway (Charles Rotblut, Wall Street Journal) - The start of the year typically marks the onset of a slew of New Year's resolutions, from getting healthier at the gym, to getting control of one's finances by trying to save more and spend less. Of course, the caveat is that just knowing that it should be done isn't the same as actually being able to do it, especially for those who are not naturally thrifty and frugal. Rotblut notes that the primary way he's been able to lift his savings rate over time - despite being a self-professed "not naturally thrifty person" - is by taking not only a "pay yourself first" approach but by committing to incrementally raise his savings rate each year as his income rises. After all, it's much easier to commit to save future income - that hasn't even been earned yet - than to save more from your current income (which can only be done by taking a step backward from the lifestyle you're already enjoying!). Rotblut manages this by first simply tracking his income and savings each year in a spreadsheet and breaking up the savings activity and goals into each pay period (as it feels much more bite-sized and manageable to save another $40/pay period than to come up with another $1,000/year). Then, he sets up automatic deposits that coincide with each pay period to automatically move the money into various savings accounts as soon as it hits his checking account (or where possible, allocates it directly from his paycheck so it never reaches his checking account in the first place)... an approach known as the "Ulysses contract," where he binds himself upfront to the annual savings commitment and thus only has to think about adjustments once per year (and not be tempted each pay period). And once the baseline is set - and the savings are never "seen" in the first place - Rotblut simply ratchets up the savings rate incrementally each year, and then makes updates with his HR team to handle the new (higher) paycheck deductions.

How My Wife And I Use 4 Chase Cards To Maximize Our Ultimate Rewards Points (Eric Rosenberg, Business Insider) - Chase Ultimate Rewards are one of the most popular credit card reward programs available, given their breadth of airline and hotel transfer partners. But with a wide range of different cards, each of which having their own rewards points calculations and formulas, "maximizing" Chase Rewards points necessitates using several different cards for different types of purchases. For instance, Rosenberg does his restaurant and travel purchases on a Chase Sapphire Reserve card, which pays 3x the points per dollar spend for purchases in those categories, and is also offering a 50,000-point bonus for new cardholders potentially worth as much as $750 in travel use (awarded after spending $4,000 on purchases in the first 3 months, but still more than enough to offset the card's otherwise-steep $450 annual fee, especially when stacked on top of $300 in credits on additional travel purchases, a $100 credit towards TSA PreCheck, and more). Since the "everything else" purchases on Sapphire Reserve just give a normal 1-point-per-dollar, Rosenberg uses a Chase Freedom card as well, which gives a whopping 5% cash back award on all purchases up to $1,500 per quarter in various rotating bonus categories (which currently includes gas stations, drugstores, and toll purchases) and has no annual fee. For transactions that don't fit either the travel and restaurant categories for Chase Sapphire or the rotating categories of Chase Freedom, Rosenberg uses a Chase Freedom Unlimited card, which offers a 1.5% cash back rate (convertible into Freedom Rewards Points) on everything else. Though for those with small businesses, it may also be appealing to add a Chase Ink Business card (Cash or Preferred), which also give hefty upfront bonuses and 3x or 5x points rewards in certain business-popular categories (e.g., travel, shipping, telecom services, online advertising, office supplies, etc.).

Luxury Concierges Battle For The Attention Of The Very Rich (Sophie Alexander, ThinkAdvisor) - With the rise of "Uber-for-X" services and mobile apps, there are solutions to help you with anything from finding a taxi to making a dinner reservation or getting a dog walker or arranging your dry cleaning... which, traditionally, was the domain of concierge services. And so concierge service providers themselves have been moving "upmarket" to stay competitive, rolling out luxury concierge services that operate as "lifestyle managers" to provide truly unique access and opportunities to luxury experiences. For instance, Quintessentially in London charges from $7,500 up to a few hundred thousand dollars per year and offers "bespoke experiences" from private tours of the Sistine Chapel or balloon rides over Buddhist templates in Myanmar, dinner on an iceberg or a cocktail party in the Great Pyramids. In essence, the goal of the company is to do anything and everything under the sun for clients (as long as it's legal!). The average net worth of clients is a whopping $50M, and the typical member is 35 to 55 years old (which means the company is now adapting its services to be available via a mobile app as well to cater to their own next-generation clients!). The trend of the ultra-wealthy spending on experiences appears to be part of a larger trend towards spending on experiences, which over the past 3 years has grown at nearly 4X the rate of spending growth on goods. Thus far, the luxury concierge category is a small cottage industry, with competitors like Luxury Attache, Alberta La Grup, and Velocity Black, with somewhat varying price points and target clientele, but appears to be quickly becoming the hot new "thing" beyond just spending more on travel itself.

Does The "Bucket Approach" Actually Destroy Wealth? (Larry Swedroe, Advisor Perspectives) - The "bucket approach" to retirement, popularized early on by leading financial planners like Harold Evensky, allocates client portfolios in retirement by segmenting the dollars into "safe" liquid investments to cover short- or intermediate-term investing, while the traditional equity-centric portion of the portfolio is a separate bucket to cover long-term spending needs (which, ostensibly, have enough time to ride out the volatility). The appeal of the strategy is not only that it fits our "mental accounting" tendencies of wanting to segment short-term and long-term dollars apart from each other, but also that it literally provides a cash bucket that can be tapped in the event of market volatility to reduce the risk or need to draw down against investments that themselves have temporarily lost value. However, in a recent research paper entitled "The Bucket Approach for Retirement: A Suboptimal Behavioral Trick?," researcher Javier Estrada finds that when tested across a wide range of global markets throughout history, portfolios following a bucket approach underperform simple static strategies (e.g., a 60/40 rebalanced portfolio), whether evaluated by probability of success/failure, the average years of shortfall when the portfolios fail, or various risk-adjusted success metrics, extending a prior study showing similar results on this blog in 2014. In fact, consistent with prior research, the results simply get worse the more years of cash that are set aside! The reasons, simply put, are that by using buckets, retirees both tend to increase their cash allocation and therefore the cash drag on their portfolios (reducing long-term returns), and that by constructing buckets that shift dollars from the long-term aggressive to the short-term conservative bucket but not the other way around, the bucketed portfolios effectively never manage to rebalance into equities after a market decline.

Deferred Income Annuities Improve Retirement Readiness [For Those With Longevity] (Elizabeth Festa, ThinkAdvisor) - The "Deferred Income Annuity" (DIA, also known as a longevity annuity) is similar to a traditional single premium immediate annuity where a lump sum is exchanged for lifetime payments... except with a DIA, the payments don't begin immediately, and instead are delayed until some point in the future. For retirees, using such longevity annuities is an appealing option to protect against extreme longevity (e.g., living to age 100), by purchasing such an annuity early in retirement with payments that don't begin until very late retirement (e.g., at age 85). These results were further affirmed in a recent study from EBRI entitled "Deferred Income Annuity Purchases: Optimal Levels for Retirement Income Adequacy," which finds that DIAs purchased without any death benefits or other guarantees improve overall retirement readiness, no matter the age of death. The outcome is driven by the fact that, with a delayed payment date, it only takes a very modest portion of the overall portfolio to provide substantial payments in the later years of retirement. Accordingly, retirees who allocated 5% to 20% of their retirement plan balance to a DIA saw an improvement, as those who died in the earlier years of retirement still had more than enough liquid assets to provide for their needs, while those who lived to age 90+ benefitted greatly from the outsized DIA payments in the later years (just at the point that the rest of their retirement portfolio may be waning). Notably, though, it's still important that the DIA leaves enough liquidity to handle the rest of the household's needs; thus, the EBRI study found that DIA benefits were actually best for higher-income households than those in the lowest wage quartiles.

This First Year Of Early Retirement Has Been One Of The Hardest Of My Life (Chris Mamula, Marketwatch) - Last year, Mamula retired from his career as a physical therapist at the age of 41, and he and his wife moved across the country to start a new life as early retirees. Yet in practice, the "FIRE" (Financial Independence, Retire Early) movement has not turned out exactly as anticipated. The primary (unanticipated) challenges that cropped up as early retirees included: 1) Mamula was driven to retire early because he wanted to save in order to spend later to fulfill his goals (i.e., it was "goals-driven" savings), while his wife saved (and lived frugally) primarily out of a desire to create safety and security... but as a result, the couple has found that it's much harder than anticipated to actually switch from saving to spending in retirement, as the decumulation stage is an exhilarating opportunity to him but "terrifying" to his security-minded wife; 2) moving away from the workplace is harder than most realize, not just for the change in work place but the loss of social connections that come (as for many, co-workers are almost a second family, and often people you spend more time with than your actual family!), and the problem was only amplified by then relocating to fulfill their retirement lifestyle dreams (which in turn further uprooted their lifestyle with emotionally turbulent change); 3) transitioning doesn't necessarily get easier with time, as learning to prioritize your day when there's no job or boss telling you what to do is actually an entire new skillset to learn; 4) you'll never have enough time, as often people who retire and take on new commitments find themselves as busy or even busier than they were before "retirement" (so don't over-commit with all of your new "free time" when you finally retire early!); and 5) recognize that it's still hard to change your priorities and what you're accustomed to, such that even though Mamula planned to also volunteer a lot more in retirement, when the end of the first year came, he found that he primarily had just spent more time doing things he already enjoyed (e.g., skiing) but had actually struggled to really take up new activities and priorities (despite planning/intending to do so).

Oxfam Finds World's 26 Richest People Own As Much As Poorest 50% (Larry Elliott, The Guardian) - While income and wealth inequality has increasingly been in the news for much of the past decade, it seems to have taken up a more fevered pitch in recent months and weeks. For 2019, the issue kicked off with the latest "wealth check" report from development charity Oxfam, which found that the world's 26 richest billionaires own as many assets as the 3.8 billion people who make up the poorest half of the planet's population, and 82% of the world's wealth increase in the past year accrued to the top 1% (while overall, the wealth of 2,200 billionaires was up 12% in 2018, even as the poorest half of the world saw an 11% decrease in wealth last year). Other key points included: in the 10 years since the financial crisis, the number of billionaires has nearly doubled; between 2017 and 2018, a new billionaire was created every 2 days; just 1% of Jeff Bezos' Amazon fortunate is equivalent to the entire health budget for Ethiopia (a country with 105 million people); and in countries like Briton, the poorest are actually paying a higher effective tax rate than the rich (49% vs 34%, respectively) once consumption and other VAT taxes are considered. From Oxfam's perspective, the widening wealth gap is hindering the fight against poverty (Oxfam's primary mission), and limiting key investments into countries' infrastructure, and notes that a "mere" 1% annual wealth tax on the 1% (akin to what Piketty has proposed) would raise an estimated $418B/year, enough to educate every child not already in school and provide healthcare that would prevent 3 million deaths.

Democrat Elizabeth Warren Proposes Wealth Tax On Rich Households (Richard Rubin, Wall Street Journal) - This week, it was revealed that Democratic presidential candidate Elizabeth Warren is planning to propose an annual wealth tax of 2% on household wealth above $50M, plus an additional 1% tax on wealth above $1B, as part of the growing interest from legislators to combat income and wealth inequality. The tax is estimated to affect about 75,000 households, and raise as much as $2.75T over the next decade, according to economists Emmanuel Saez and Gabriel Zucman who analyzed the plan (revealed alongside two other progressive groups, the Washington Center for Equitable Growth, and the Institute on Taxation and Economic Policy, who also released papers on wealth taxes this week). Notably, the annual wealth tax would simply apply to all assets above the thresholds, not tied to whether they were liquidated or not (as compared to the current capital gains system, which in theory reduces tax deferral/avoidance strategies), nor even whether the assets were up or down in value (as a reduced value would simply mean the wealth tax applies to a reduced account balance, but would still apply nonetheless). In fact, because of the breadth of the proposed wealth tax, it is projected to actually drive substantially more revenue than the current Federal estate and gift tax system, with funds initially being earmarked towards programs like child care, relief of student loan debt, environmental initiatives, or health care. Of course, wealth taxes are a highly controversial topic, and one that historically hasn't even had much traction amongst Democrats in Congress, especially given concerns about both the risk of capital flight (high-net-worth households simply moving assets out of the US and its tax jurisdiction), and the difficulties in valuing assets to apply the wealth tax in the first place (especially illiquid assets like businesses and real estate and art). Although Warren's proposal would try to address this by increasing IRS resources to enforce the tax, offer taxpayers the ability to defer payment (with interest) for up to five years if facing illiquidity, and applying a 40% exit tax on assets above $50M for those who attempt to renounce their US citizenship to avoid the tax. Ultimately, it remains to be seen whether the proposal will actually gain traction, though with growing discussions about tax policy changes and income inequality, it seems unlikely Warren's proposal will be the last exploration of wealth tax possibilities.

How Wealthy Americans Like Jack Benny Avoided Paying A 70% Tax Rate (Laura Saunders, Wall Street Journal) - In addition to Senator Warren's recent proposal of a 2% to 3% wealth tax, New York Representative Alexandria Ocasio-Cortez also sparked a new discussion around income inequality by recently suggesting that the top tax bracket be raised as high as 70% on those with income above $10M/year. While the proposal was initially met with strong objections that such high tax rates (especially compared to today's 37% top tax bracket) couldn't possibly be viable in a modern economy, supporters have pointed out that the top tax bracket actually already was above 70% from the 1940s up until 1980 (peaking as high as 91% in 1950s on $400,000 of taxable income, which would have been the equivalent of about $3.7M today). The caveat, however, is that even at the time, few people actually paid at those top tax rates, and in the 1950s the top 1% of taxpayers actually had an average rate of just 32%, which is still higher than the average rate on high-income individuals today... but only slightly. And the difference between the stated rate and the actual rates that applied wasn't just a matter of progressive tax brackets (where lower income was taxed at lower rates before reaching that top rate), but also becomes the rules around defining types of income were looser then as well. For instance, performer Jack Benny earned $2M to bring his radio show to the TV network, but was able to treat the transaction as a capital gain, taxed at just 25% instead of 90%+ on ordinary income; similarly, General Eisenhower successfully argued that the $635,000 he earned from his 1948 memoir should be treated as a capital gain. Other high-income entertainers like Bing Crosby, Errol Flynn, and Bette Davis made strategic use of corporations, which had lower rates than individuals' 90%+ tax brackets, and then later collapsed the corporations in a capital gains transaction (again avoiding those high-income brackets). Of course, illegal tax avoidance also happened at the time (especially in an era where it was harder for the IRS to track), and a wide range of tax shelters also emerged at the time (some of which were terrible economic deals). In fact, a key aspect of President Reagan's Tax Reform Act of 1986, which cut the top tax rate down to "just" 39.6%, was in exchange for eliminating the tax shelters that were allowing so many high-income individuals to avoid those top tax brackets anyway. The key point, though, is simply to recognize that while income tax brackets were much higher in the past, so too were the available tax strategies to shelter (or "transmute") that income for more favorable tax status, and that the true effective tax rate on high-income individuals has actually been much more stable throughout history than most realize (with the effective tax rate across the top 1% at 33% today, almost exactly where it was in 1980 when the top tax bracket was still 70%).

I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!

In the meantime, if you're interested in more news and information regarding advisor technology, I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors as well.