Weekend Reading for Financial Planners (Apr 14-15)

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.

Weekend reading for April 14th – 15th:

SEC To Meet Next Week To Consider Advice-Standards Proposal (Mark Schoeff, Investment News) - According to a recent notice posted to its website on Wednesday, the SEC Commissioners are planning an Open Meeting next Wednesday (April 18th) to consider three new fiduciary-related proposals: the first would require a new "relationship summary" that all RIAs and broker-dealers would have to provide to consumers (which may be a step towards necessary title reform for financial advisors); the second would potentially establish a new standard of conduct for broker-dealers when making recommendations; and the last would provide additional "interpretations" of the (fiduciary) standard of conduct for investment advisers. The initiative is being framed by SEC Commissioner Jay Clayton as a way to improve advice for Main Street investors he has dubbed "Mr. and Mrs. 401(k)",  and the SEC's push to issue its own fiduciary proposal - which it was actually first authorized to do back in 2010 but has stalled for nearly a decade – comes just as the Department of Labor's own fiduciary rule hangs in limbo after the recent 5th Circuit Court of Appeals moved to vacate the rule, and in the face of rising momentum from individual states to take up their own fiduciary rules in the absence of a stringent Federal rule. Fiduciary opponents have harshly criticized the DoL's fiduciary rule, and called on the SEC to issue an alternative that would better 'harmonize' regulation between broker-dealers and RIAs, while fiduciary advocates continue to raise concerns that the SEC will not be stringent enough in writing a new fiduciary rule for advice being delivered via broker-dealers.

SIFMA Issues Guidelines For Using Data Aggregation (Ryan Neal, Investment News) - Account aggregation software that pulls in disparate financial information to a single dashboard is increasingly popular both for consumers and for financial advisors themselves, but the technology does not conform well to existing regulations for banks and broker-dealers, raising concerns about how to standardized both security and also privacy, which even prompted FINRA last month to issue a warning to both the industry and investors about the dangers of sharing account data with third parties (an issue that has only become even more top-of-mind in recent weeks with recent privacy lapses at Facebook). In this context, SIFMA (the primary lobbying organization for the brokerage industry) issued what they are calling a series of four "Data Aggregation Principles" that brokerage firms should follow to ensure client data privacy and security. A key tenet of the guidance is that SIFMA suggests firms should make it easier for customers to have accounts linked directly, without requiring them to share their actual account IDs and passwords with third parties just to gain access to their data (to obviate the need for "screen-scraping" technology), and that financial institutions should provide a "clear and conspicuous explanation" of how a third party can access or use data (for which customers should affirmatively consent before aggregation begins, and be able to withdraw consent easily at any time). SIFMA also suggested that while data on holdings, balances, and transactional information should be OK to share, firms should not share other nonpublic or confidential personal information (i.e., that actities like trading, money movement, and other services beyond data aggregation alone should have separate agreements).

Advisors’ Use of Fixed Planning Fees on the Rise (Diana Britton, Wealth Management) - According to a new report from Cerulli Associates, nearly half of financial advisors are now offering financial planning services to clients, up from just 1/3rd a mere four years ago. And along with the rise of financial planning is a rise in advisors charging fixed fees for financial planning, with about 36% of advisors (and 62% of Millennial advisors) charging a standalone planning fee. However, financial planning fees are still a very small proportion of total revenue for most advisors, averaging just 4% of advisors' revenue (and anticipated to increase 25% in the coming year, albeit to "just" 5% of revenue), with the highest adoption rate at independent RIAs and hybrid RIAs, followed by independent broker-dealers (with wirehouses and insurance broker-dealers doing the least in financial planning fees). The dominant advisory fee structure continues to be asset-based (i.e., AUM fees), though, which vary from 64 to 130 basis points on accounts between $100k and $10M according to Cerulli's data (which is generally consistent with other industry analyses of advisory fees). Cerulli notes that the significance of the rise of fixed planning fees is not merely that they represent a new line of revenue for a new or expanded service (actual financial planning), but also that fixed planning fees by their nature don't vary with market volatility, and as such can smooth out revenue volatility for the firm, in addition to the fact that they provide a means to assess a minimum amount of revenue per client to ensure that the firm can still profitably serve "small" clients. On the other hand, a significant caveat of fixed planning fees is that any increase or change in fees must be discussed with clients, which can draw undue attention to the advisor's costs (at least until/unless advisors adopt software that better automates the fixed-fee or retainer-fee billing process).

Fidelity Is Revamping How It Charges You For Financial Advice (Sarah Krouse, Wall Street Journal) - Starting this July, Fidelity has announced that it is converting all of its financial advice solutions into a standardized AUM fee, with a price schedule that starts at 1.7% but appears to have an offset applied for the cost of Fidelity's underlying funds if they're used in the account (i.e., the fee if using all Fidelity funds would start at only 1.5% instead), and Fidelity has indicated they will provide other "credits" to the net advisory fee based on other fees Fidelity earns (e.g., servicing fees). In other words, Fidelity appears to be converting to an entire "all-in" AUM fee, that is levelized on a net basis regardless of what underlying funds or solutions the investor uses with their Fidelity advisor. Notably, the Department of Labor's fiduciary rule has already been encouraging such a shift, with its "Level Fee Fiduciary" streamlined exemption (which would allow firms to avoid the full Best Interests Contract Exemption requirements if the firm charged a single level fee), and the fact that firms would have actually been prohibited under the DoL rule from earning different compensation on different investments in a discretionary account. And despite the fact that the DoL fiduciary rule hangs in limbo, Fidelity has decided to move forward with its "unified offering for a single fee schedule" solution anyway, citing customer demand (and perhaps anticipating that future fiduciary rulemaking will require a similar solution anyway?). Nonetheless, in a world where many independent financial advisors are questioning the long-term viability of the AUM fee, it is notable that one of the world's largest asset managers (with a growing base of financial advisors) is going all-in on the AUM fee... which on the one hand, suggests that it won't be going away anytime soon, but also raises even more challenging questions for independent advisors about how they will compete with large mega-national firms that run substantially similar AUM-fee models.

Pershing Study Finds Holistic Advisors Don't Feel Fee Pressure (Michael Thrasher, Wealth Management) - At its latest Elite Advisor Summit, Pershing Advisor Solutions polled several dozen of their top advisors, and found that the majority (58%) don't feel increased pressure from clients to cut their fees in the current landscape, and as a result 84% of advisors made no changes to their pricing in 2017 (and of the 16% who did, 10% raised the firms indicated that they do feel pressure to offer new and value-added services to justify their current fees, while only 6% lowered fees). However, noting that amongst ultra-high-net-worth clientele in particular (that Pershing's top advisors serve), the top three areas driving business growth now are tax planning, alternative and philanthropic investments, and private banking solutions. Other notable results from the Elite Advisor survey included: 36% of advisors cite the dearth of young advisors entering the industry as the biggest challenge; 29% of advisors said meaningful and impactful marketing and branding strategies to differentiate themselves are now their biggest growth driver; and 26% of advisors stated that implementing new technologies in their practice is now one of their greatest challenges (a paradoxical outcome of the rapid growth of potential FinTech solutions for advisors in recent years!).

SEC Warns Advisers To Toe The Line On Fees (Jeff Benjamin, Investment News) - This week, the SEC's Office of Compliance Inspections and Examinations (OCIE) issued a new Risk Alert on RIAs charging advisory fees, and specifically on the billing issues that OCIE is finding are cropping up more often than they should be amongst investment advisory firms. The most common violations were situations where RIAs failed to implement proper systems and reviews to verify that their billing practices actually matched what they stated clients would be billed; for instance, missing situations where clients reached fee breakpoints but their actual fees weren't adjusted, stating that fees would be based on daily average billing but then billing on the end-of-quarter balance instead (or that they would be billed monthly but actually billing quarterly), or other even more basic miscalculations of fees (e.g., simply doing the math wrong on their own fee schedule!). Other scenarios included "lax" or inaccurate fee disclosures (e.g., stating a "maximum" fee in Form ADV but then charging a client more than the maximum fee, or failing to disclose additional fees the firm might earn such as revenue-sharing arrangements with third parties), failing to apply rebates or discounts properly (e.g., stating that account values would be aggregated across the household to reach higher breakpoints, and then failing to actually bill accordingly), or charging clients performance-based fees when those clients weren't "qualified clients" eligible for performance-fee arrangements. Notably, many such fee errors are likely the result of poor systems and operational procedures – not any form of intentional malfeasance – but nonetheless, the Risk Alert means that RIAs are being put on notice that the SEC will likely be further scrutinizing billing practices on RIA examinations in the coming year.

What You Can Learn From Your [Client's] 2017 Tax Return (Christine Benz, Morningstar) - As the 2017 tax season comes to a close, advisors have the opportunity to gather and review their clients' 2017 tax returns, in the hopes of identifying tax planning opportunities for the coming 2018 tax year (which itself will be substantially different as this is the first tax year that the Tax Cuts and Jobs Act will take effect). Key line items to review on the 2017 tax return (some of which may be especially relevant in 2018) include: Personal Exemptions on Line 6 (which will no longer be available as a deduction at all in 2018, albeit partially offset by a higher standard deduction and a higher child tax credit also taking effect this year); Interest Income on Line 8 (a good opportunity to evaluate whether taxable bonds should be shifted into municipal bonds instead, and/or whether the client's asset location should be revisited); Dividend Income on Line 9 (which again raises asset location questions about whether some of those high-dividend stocks should be in an IRA, especially if a substantial portion of the dividends are non-qualified); Alimony Received on Line 11 or Paid on Line 31a (which could potentially be changed to non-taxable starting in 2019 under the Tax Cuts and Jobs Act if the ex-couple agree to it and establish an updated/amended divorce agreement); Capital Gains (or Losses) on Line 13 (and more generally whether the client has substantial embedded capital gains to plan for); Health Savings Account deductions for contributions on Line 25; and whether the client takes the Itemized versus Standard Deduction on Line 40 and in Schedule A (especially given the looming changes to itemized deductions in 2018 and the increased standard deduction that will replace it for many clients who used to itemize in the past!).

DAPTs: The Vital Tax Planning Tool For HNW Clients That Few Advisors Know (Martin Shenkman, Financial Planning) - The Domestic Asset Protection Trust (DAPT) is an irrevocable trust that individuals can set up for themselves for both asset protection and tax planning purposes. At this point, only 17 states permit them (of which the most popular are DAPTs established in Delaware, Alaska, Nevada, and South Dakota), and for those who don't already live in the applicable state, it's necessary to create the trust itself in that state and have a (typically corporate/institutional) trustee in that state to lay claim to that state's favorable DAPT laws (and there is still some legal ambiguity under the Uniform Voidable Transfers Act about whether an individual in a non-DAPT state may lose protections by trying to establish a trust in a DAPT state, depending on their exact home state laws). Fortunately for advisors, DAPTs can be structured as "directed" trusts, where investment management of the trust itself is directed back to the original advisor, and the corporate trustee is only responsible for tax filings, managing distributions, etc. Notably, there are a number of legal technicalities to comply with in order to establish a DAPT, including signing a solvency affidavit to affirm that they have adequate resources after the transfer for all their future expenses (to avoid the risk that funds transferred into the DAPT are later deemed a fraudulent transfer), don't make the client themselves a beneficiary of the trust (instead give someone acting in a non-fiduciary capacity the power to appoint descendants of the grantor as beneficiaries), and give someone else the power to make distributions to the client (rather than having the client retain that power themselves). The ultimate benefit – not only can assets transferred into the DAPT enjoy additional asset protection, but if the remaining proprieties are respected, the assets can avoid being exposed to estate taxes in the future, too!

The 'Nightmare' Of Bitcoin Tax Planning (Roger Russell, Financial Planning) - Back in 2014, the IRS issued Notice 2014-21, declaring that cryptocurrencies like Bitcoin would be treated as property (not currency like cash that can be exchanged tax-free for other currency), such that any changes in value upon sale of the cryptocurrency would be treated as a taxable capital gain (or loss). In addition, the recent changes to IRC Section 1031 under the Tax Cuts and Jobs Act makes it clear that there's no way to do a "like-kind exchange" from one cryptocurrency to another (starting in 2018). As a result, Bitcoin and other cryptocurrency holders must be reporting their gains and losses on their upcoming tax returns for any sales that occurred in 2017 – which could be a significant hassle given how often many cryptocurrency investors trade or buy incrementally (creating a large number of individual tax lots to track). In addition, any cryptocurrency that is earned from mining activity must also be reported as income when received. And the IRS appears to be applying greater scrutiny in this area, with a recent report from Credit Karma indicating that only 0.04% of tax returns filed this year are reporting cryptocurrency transactions, while Coinbase alone (a popular cryptocurrency exchange) reports a whopping 11.7 million users by October of 2017 (though it's not clear what percentage of them are specifically U.S. taxpayers). In fact, the IRS recently subpoenaed Coinbase's records specifically to identify which cryptocurrency investors are U.S. taxpayers... which means for those who haven't been reporting their cryptocurrency gains yet, more scrutiny (and a potential audit!?) may be coming soon!

The Emperor Of Financial Planning Has No Clothes (Michael Ross, Investment News) - The Financial Planning Association was formed in the year 2000 by the merger of the IAFP (a financial trade organization at the time) and the ICFP (a professional organization), of which Ross was a member of both (and is now the president of the FPA South Florida chapter). Yet while financial planning has grown significantly in the nearly 18 years since the FPA merger, and increasingly is being recognized as a profession by the public, Ross suggests that the FPA has failed to live up to its vision of being a professional organization for CFP certificants. Instead, the organization still largely operates under a "big tent" trade organization approach, where both practitioners and the wholesalers and product manufacturers who serve them are all eligible for membership (unlike the American Medical Association, which limits its membership to actual doctors and doesn't allow pharmaceutical drug sales reps), while fewer than 25% of CFP certificants themselves are members (a number that has been nearly halved since the FPA first formed!). Yet ultimately, all bona fide professions need a professional membership organization, and as a result, Ross suggests that FPA needs to re-connect with its fundamental purpose. At the same time, the organization also still struggles to find a balance between its centralized national headquarters (in Denver), and the independent chapters that affiliate to it... for which Ross notes that the bulk of both FPA dues and decision-making power goes to Denver, and around which some suggest that FPA National is trying to further consolidate power with its "OneFPA" initiative, even though most members interact primarily at the local chapter level (as contrasted with the National Association of Estate Planning Councils, a bottom-up organization where most resources stay at the local level and only a small portion goes to a small national governing body). Ultimately, Ross suggests that the core problem is that the FPA is governed by an unelected board, which in turn appoints their own successors, rather than being democratically elected by the membership itself, potentially creating a self-perpetuating cycle as board members may be more likely to select successors who share their existing views.

A Path Forward For The CFP Board (Knut Rostad, Advisor Perspectives) - In the CFA Institute's recent research publication "From Trust To Loyalty", the organization found that clarity and transparency on fees and managing conflicts of interest rank very high with investors... so much, in fact, that fee transparency beat competitive returns as a primary concern when selecting an advisor! Yet in the context of financial planning, Rostad points out that the majority of CFP certificants work in brokerage firms where transparency and full disclosure are often hard at best, and sometimes impossible (as registered reps themselves don't always know the details of how their broker-dealers are making money behind the scenes!). Of course, the recent changes to the CFP Board's Standards of Conduct would require CFP certificants to be fiduciaries at all times – a positive step forward – but Rostad notes that the CFP Board's fiduciary requirements still reject significantly curtailing conflicts of interest, instead opting for a more disclosure-oriented approach, and then not even providing detailed guidance about how CFP professionals are expected to manage and mitigate their conflicts of interest (or even to disclose them most effectively). In fact, the CFP Board's final rules didn't even include the presumption that a CFP certificant would actually be delivering financial planning, nor does it require full disclosure to consumers that they're not actually receiving financial planning (and instead are receiving "non-financial-planning financial advice"). To be fair, the process of setting (and lifting) standards is a journey that must evolve over time, but Rostad notes that the CFP Board has provided little indication about where exactly the standards are anticipated to journey from here, even as practitioners wait for guidance to understand how they're even supposed to apply the CFP Board's latest changes in their actual business conduct with clients.

Why We Should All Be Moving Toward A Fiduciary Society (Bob Veres, Financial Planning) - With the SEC getting ready to queue up their own version of a new standard of care for all providers of financial advice, all eyes are on whether the SEC actually supports a bona fide fiduciary duty, or if the new proposal ends up being a more watered down version akin to today's suitability standard for brokers (which the brokerage industry and its representative associations SIFMA and FSI are actively lobbying for). The brokerage industry makes the case that both models should be preserved under the auspices of giving consumers a "choice" about how they want to be served... yet the reality is that one consumer study after another reveals that consumers don't even understand that there is a choice, because the brokerage industry uses the same "financial advisor" titles as those actually regulated as advisors, obfuscating any difference to choose from in the first place. In fact, given that the fiduciary has always been the foundation of relationships of trust – and the industry fought off the DoL fiduciary rule specifically by emphasizing that brokers and insurance agents are not in a position of trust and confidence with their clients! – Veres suggests that "choice" is the wrong framework to consider the issue in the first place. Or at a minimum, if the discussion is about choice, it should be trying to give consumers better clarity about what they're actually choosing between – an advisor or a salesperson – in the first place.

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.