Weekend Reading for Financial Planners (Feb 11-12)

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 February 11th/12th:

Dallas Court Upholds DoL Fiduciary Rule (Sarah Lynch, Reuters) - On Wednesday, Texas District Court Judge Barbara Lynn issued an 81-page ruling that meticulously dissected and disagreed with every legal objection raised by the fiduciary rule's opponents, led by high-profile attorney Eugene Scalia representing the U.S. Chamber of Commerce, the Financial Services Institute, the Insured Retirement Institute, and SIFMA. The ruling came just hours after the Trump-controlled Department of Labor requested a stay on the case and for the judge to hold off regarding the ruling, which the Judge denied. At this point, Judge Lynn's ruling is now the third court to uphold the Department of Labor's fiduciary rule and the process it engaged in to create the rule, and the string of court victories for the rule - especially in this case, which was widely viewed as having been "forum-shopped" for a likely-to-be-favorable judge, who still ruled against fiduciary opponents - is expected to make it increasingly difficult for the rule to be rescinded at this point. Especially since this week, Senator Elizabeth Warren also issued a letter to Acting Secretary of Labor Edward Hugler, pointing out that major financial services firms, including Vanguard, TIAA-CREF, and Blackrock, have indicated that the fiduciary rule is a positive, should move forward, and does not need to be delayed. Nonetheless, the rumor today is that the Department of Labor is issuing a new proposal to delay the fiduciary rule by 180 days - with the caveat that the proposal to delay will itself have to go through a public comment period, which means a delay is still not assured - though even if a delay occurs, it is looking increasingly bleak for fiduciary opponents to fully rescind the rule, and that at best it may simply be revised to lighten some of the most stringent sections (e.g., the class action lawsuit provision).

Should You Make After-Tax Contributions To A 401(k)? (Christine Benz, Morningstar) - Beyond the standard 401(k) contribution limit of $18,000 (or $24,000 for those age 50 or older making catch-up contributions), some 401(k) plans allow additional after-tax contributions on top (up to the aggregate IRS limit of $54,000 for all contributions into the 401(k) account). Notably, the ability to make those additional after-tax contributions isn't new; however, a recent change in how rollovers of those after-tax contributions are treated for Roth conversion purposes makes it more appealing to do so. Specifically, the rules now permit after-tax dollars in a 401(k) to be converted to a Roth IRA (while any remaining pre-tax dollars are simply rolled over to a traditional IRA), and since the after-tax dollars aren't taxable, it's effectively a tax-free Roth conversion. Or viewed another way, putting after-tax dollars into a 401(k) is now a form of "deferred-Roth" contribution, in anticipation of the subsequent nontaxable Roth conversion later. Bear in mind, though, that if the 401(k) plan actually allows Roth 401(k) contributions, those should still be maxxed out first, because the growth on those contributions are tax-free immediately (whereas the growth on after-tax contributions inside the 401(k) plan is merely tax-deferred, and will only be tax-free on later growth after the funds are rolled out in a Roth conversion). In addition, it's important to bear in mind that once after-tax contributions are made to a 401(k) plan, they are subject to the liquidity constraints of the plan, which may include limitations on withdrawals and the timing of any rollovers, which makes the after-tax 401(k) contribution strategy most appealing for higher-income individuals who already have ample other liquidity and emergency savings. And of course, it's important to verify that the 401(k) plan even allows after-tax contributions in the first place, as not all of them do (though the plan might be amended to allow for it in the future).

Life Insurers Draw on Data, Not Blood (Leslie Scism, Wall Street Journal) - In the past, obtaining even just a sizable term life insurance policy would require a month to go through the process of submitting an application, providing blood and urine samples, and allowing time for underwriters to review medical records; now, a number of cutting edge insurers like Haven Life (a subsidiary of Mass Mutual) are accepting applications online, drawing on data from prescription-drug databases, motor-vehicle records, and other sources including property deeds and liens, and even professional licenses, and issuing the final life insurance policy in a matter of 20 minutes or less. Not surprisingly, there are still some restrictions in place - the electronic-system solutions are generally only for those age 45 or younger, policies are typically capped at a $1M death benefit, and if substantial health issues surface during the online questionnaire process, the application may still be reverted to the "standard" full underwriting process. Nonetheless, many are able to quickly and easily get a substantial life insurance policy issued, and the ease in accessing life insurance is important, as sales of individual life insurance policies are down more than 40% since the 1980s, and almost 30% of U.S. households have no life insurance at all. And what's notable about the emergence of new online players is that the policies are less expensive, unlike the past where limited-underwriting insurance was typically more expensive, as the insurers are finding that the other available data is comparably effective for underwriting, but they can sell the policies for cheaper because direct feeds of online data are cheaper than the cost for an underwriter to scrutinize individual medical records, and there's no need to pay a commission to an insurance agent. In fact, some companies like Covr are specifically exploring how to work with fee-only financial advisors to quickly and easily facilitate their clients' purchase of needed life insurance online.

Reverse Mortgages Or Immediate Annuities To Enhance Lifetime Retirement Security? (Mark Warshawsky, Journal of Financial Planning) - One of the unique features of a reverse mortgage is that it offers a "tenure" payment option, that offers monthly cash flow payments for life, akin to the payments from a lifetime immediate annuity (at least, as long as the retiree remains in the home for life). Yet the two income streams are not the same – immediate annuity payments are partially taxable, while reverse mortgage payments are not, but only because immediate annuities represent growth of assets, while the reverse mortgage is technically an accruing and negatively amortizing debt. In addition, immediate annuity payments are determined based primarily on available bond returns (which the annuity company purchases to back the payments), while reverse mortgage tenure payments are determined using a discount rate calculation based on both expected rates, a lender's margin, and the requisite ongoing mortgage insurance premium. And immediate annuity payments are determined based on projected life expectancy (and pooled mortality assumptions), while tenure payments are calculated assuming the borrower(s) will live to age 100. Given these dissimilarities, the question then arises: for those who need lifetime income, and have both equity in a home and retirement assets, which is the better source to tap? Warshawsky generally finds that an annuity solution will favor those who are older (e.g., age 75+) and favors males in particular (given the shorter average life expectancy for men, that produces higher annuity payments); conversely, the HECM reverse mortgage tenure payment is at least slightly more favorable to younger females, and is substantially more favorable for "younger" retired couples (e.g., those in their 60s or early 70s). Notably, because short-term interest rates tend to be more sensitive than long-term interest rates, and reverse mortgages are based on short-term rates (while annuities are generally tied to longer-term rates), the income pricing on reverse mortgages is more volatile; for instance, interest rates last summer favored the reverse mortgage, while the dip in interest rates in the fall caused the scales to tilt in favor of the annuity. Which means indirectly, the slope of the yield curve may also be a factor in weighing the relative appeal of reverse mortgages to immediate annuities, with a flatter yield curve favoring reverse mortgages, and a steeper yield curve favoring annuities.

Using QTIP Trusts In Smaller Estates And Revenue Procedure 2016-49 (Bruce Steiner, Leimberg Information Services) - With a Federal estate tax exemption of $5.49M, but several states still using an estate tax exemption of only $1M or $2M, an estate planning challenge emerges for "moderate" estates with a few million dollars: with higher exemptions, plus the availability of portability, a bypass trust is often no longer necessary for Federal estate tax purposes, but may still be necessary for state estate tax planning given lower exemptions (and usually no state portability)... except using the bypass trust for state purposes causes the assets to lose their step-up in basis at death, which means the family could lose almost as much in future capital gains taxes as it might save in state estate taxes! In addition, for more moderate estates, leaving "everything" to the bypass trust (for state estate tax purposes) opens up the possibility that the spouse can claim their elective share (a "mandatory" allocation of the state under state law, to prevent spouses from being disinherited), which could disrupt estate planning (and asset protection) planning. The alternative is to leave the assets to a QTIP trust for the surviving spouse, which achieves the asset protection goals and the future step-up in basis (though it doesn't shelter the assets for state estate tax purposes), but in the past it was unclear whether an estate could set up such a trust and make the QTIP election if it was below the Federal estate tax exemption in the first place. But now, Revenue Procedure 2016-49 has clarified that it is permissible to leave an entire estate to a QTIP trust, preserving step-up in basis at the second death and asset protection, and still make the QTIP election (even if the estate tax return is filed just to claim portability and the QTIP election). Alternatively, the estate plan could also establish a "Clayton QTIP" trust, where the trust would otherwise qualify as a QTIP or bypass trust, but the executor decides after death whether to make the QTIP election for some, all, or none of the trust, based on the Federal and state estate tax laws as they exist at that time.

RIAs Need To Prioritize Wire Fraud Prevention Education And Procedures (RIA In A Box) - Cybersecurity and the protection of client data (and client assets) is a rising concern for both state and Federal regulators, and "wire fraud" in particular – where an RIA improperly wires client assets to a third-party thief posing as the client – continues to be a major issue. A key challenge in combating wire fraud in particular, is that it's not just a matter of whether the advisor's computers and data are secure; instead, the most common approach of thieves is to hack a client's email account, search through their email history to get information about the advisor-client relationship, then use the hacked email account to send an email to the advisor (directly from the client's email address) to request the transfer. The thieves try to increase their success but introducing some kind of unusual 'urgency', such as "It's an emergency, I'm in the hospital and can't be reached because I'm traveling out of the country", with the hopes that a desperate-to-please-the-client attitude in the advisory firm means someone in operations might make the transfer quickly and not realize it was fake until too late. Which means the primary threat is not about the security of the advisor's servers and client data, per se, but the ability of employees to be unwittingly persuaded to comply with a fraudulent transfer request. Accordingly, advisory firms should: 1) educate clients on best practices in keeping their own accounts secure; 2) establish policies and procedures to mitigate wire fraud risk (i.e., a hard-and-fast rule that all wire requests must be verbally confirmed with an outbound call to the client at a previously designed phone number, ideally with a "secret word" to help authenticate the client); 3) educate the client on the wire transfer procedures and why they're in place for client protection (so that if the client really does need an urgent wire transfer, they'll understand the protocol and why it's in place); 4) regularly train staff members on what to watch out for; and 5) test the wire fraud policies and procedures (e.g., by actually sending a fake wire transfer request email to staff, and see if they properly comply with the established protocol).

Key Business Trends In The Advisory Business (Mark Tibergien & Kim Dellarocca, Advisor Perspectives) - There are many often-repeated beliefs about trends in the advisory industry, but in their recent book "The Enduring Advisory Firm", Tibergien and Dellarocca point out that many of them are actually false. For instance, since the rise of the robo-advisor, the industry "buzz" has been all about fee compression and advisory firms cutting their fees, yet in practice, the typical advisory firm fee schedule has been remarkably steady in the past 6 years, and in fact the top-performing advisory firms have actually been increasing advisory fees in recent years; to the extent advisory fees are declining at all, it appears to be amongst the subset of firms that have most directly tied their value proposition to investment performance (or that otherwise have been delivering especially low returns in recent years). Another common trend-that's-a-myth is the idea that younger advisors/employees lack a work ethic, whereas the reality seems to be that younger advisors are often simply more efficient at what they do, and what bosses interpret as being "unwilling to put in the time" is simply confusion because the younger advisors prefer to be judged on their output (and the fact that they are getting done what they were asked to do). Other notable trends-that-aren't include: the belief that robos will make it difficult to compete, when in reality they're increasingly looking like just another form of technology that advances the advisor value proposition (along with the advent of the RIA custody model, self-directed platforms, the emergence of ETFs and index mutual funds, rebalancing software, and account aggregation tools); and that the big opportunity in serving younger clients is to capture the looming $40 trillion wealth transfer that will occur between the generations in the coming years (when in reality, that wealth will often be dissipated in fractions across multiple family members, and many of the wealthiest boomers, such as Bill Gates and Warren Buffet, have already committed to donate huge swaths of wealth outright to charity). Notwithstanding these challenges, though, there are several issues that advisory firms do need to bear in mind, including: fees may not be compressing, but margins are; growth of new clients is slowing for mature advisory firms; the industry is still fighting its tarnished reputation; compliance and regulation will control an increasing share of an advisory firm's financial statements; and industry consolidation is inevitable.

5 Sink-Or-Swim Metrics For RIAs In 2017 (Angie Herbers, Investment Advisor) - While there are many potential causes that might be blamed for the decline in profit margins at advisory firms in recent years, Herbers suggests that ultimately, the cause is usually the failure of the firm to efficiently integrate the flood of new technology into the business, despite the ironic fact that the independent advisory industry has grown, the available technology (and its potential for cost savings) is now better than ever. And in these challenging times, Herbers suggests that it's more important than ever to track the Key Performance Indicators (KPIs) of the advisory firm, including: 1) the Lead Ratio (how many prospective leads who ever contact the firm are actually moving forward to meet, and is there a potential problem in the process?); 2) the Close Ratio (what percentage of prospect meetings are actually turning into new clients, and is there anything that can/should be done to improve the result, from a better sales process, to better qualifying the leads in the first place?); 3) the Client Turnover Ratio (what percentage of clients are sticking around every year, and is there anything that can be done to plug the leaks?); 4) Gross Profit Margins (which is gross revenues minus the cost of all employees, divided back into gross revenues – if the number is declining year after year, it means you may be hiring more quickly than you should be); and 5) the Technology Ratio (total tech expenses for the year, from software to hardware to data and employees/consultants), which should at the least be holding steady, and ideally should be rising as the firm reinvests (hopefully leading to a subsequent improvement in Gross Profit Margins in future years!).

Crash Course: How To Increase AUM In A Market Drop (John Bowen, Financial Planning) - At some point in the future, markets will decline, as "eventually" they always do, and Bowen points out that now (while the markets are still positive) is a good time to come up with a gameplan for the next inevitable downturn. Of course, the market itself, and its prospective drop, can't necessary be controlled, but Bowen notes that what can be controlled is whether and how quickly and effectively the advisory firm communicates with clients about the event; in fact, Bowen's research finds that the volume of communication itself is a key indicator of the financial success of the advisor (including client retention through market volatility). The caveat, though, is that the communication must be meaningful – which means not just talking about and pitching more investment strategies, but focusing on the financial issues of concern to the clients themselves. Which means the client communication has to be direct. Bowen suggests that the starting plan should be calling your top 20% of clients directly (as well as any you know will need additional hand-holding), and even consider scheduling extra in-person visits with those clients; from there, you can work down the list to smaller clients, and/or those who are less sensitive to market fluctuations anyway. In terms of the discussion itself, you should be prepared to address what's been happening in the markets, but remember your clients usually just want to hear from you and be reassured that the sky isn't falling (so don't get more detailed and technical than is really necessary), so helping them (re-)focus that they're still on track for their long-term goals is most important. Notably, an added benefit of all this additional communication is that not all advisors do it successfully – which means if you do, and your client has multiple advisors, the market volatility and the failure of the client's other advisors to engage in proactive communication means an opportunity for you to grow your business in the process!

No More Excuses For Not Marketing Your Firm For Growth (Stephanie Bogan, Investment News) - As an advisory firm grows, it often shifts from a proactive marketing approach (necessary to get the first few clients on board) to a more passive one that relies on client referrals and market tailwinds. Yet Bogan points out that if the advisor truly believes in the value of what he/she does, why not continue to be proactive and "feverishly spread the message" of what the firm does for its clients? In most cases, the concern is that there's "no time" to market (even though being buried in reactive work for clients clearly isn't a good solution either), or that the advisor isn't certain where to start in the marketing process (even though that didn't stop them from starting the business), but Bogan suggests that ultimately, those are just excuses for the real issue: a mindset that is full of fear (of stepping out of one's comfort zone, and/or of being rejected). In some cases, the challenge is simply that the advisor doesn't want to come across as a "slick salesperson", but in the end, if the advisor is truly confident in the value they provide, that authenticity and confidence will show through, and telling others what you do (and can do for them) won't sound like a sales pitch, but simply a genuine explanation of value.

Time For Financial Advisers To Reimagine Their Offices (Joe Duran, Investment News) - In most advisory firms, the structure and layout of the advisory firm office is based on "the way it's always been done", and/or around what's convenient for the advisor, but rarely from the perspective of what's truly best and most relevant for the client. For instance, Duran notes that at the Apple store, the main space feels open and inviting, with lots of gadgets to explore, while the typical advisory firm's waiting area is dull and staid. And once it's time to meet, the meeting room layout itself is often structured with the advisor at the head of the table, which affirms the advisor's "power" but can feel belittling to clients, compared to a more neutral or informal setting like sitting around a round table that might be more comfortable for the client themselves. Similarly, most advisors deliver a financial plan by creating it all in advance, and then providing the "big reveal" of the results, which may make the advisor feel good, but is very disengaging for clients who may not feel like they were part of the process, unless they actually have an opportunity to interact with the plan (which means putting it up on the big screen in the conference room so the client can engage directly!). And in the end, the reality is that not all clients even want or need to meet in the office at all anymore, which means it's possible to "untether" the advisor from the office altogether, and work with clients virtually (by adopting video conferencing and other web-based tools). The fundamental point: other professional services industries like medicine are shifting from provider-centric into more client-centric approaches, right down to how the office space is laid out and how they engage with clients, and the more it succeeds in other industries, the more clients are going to demand a similar level of engagement and service from financial advisors, too. Be ready.

An Open Letter To Advisory Firms Losing The Millennial Marketing Battle (Alex Nye, Financial Services Marketing) - In this article, Millennial Alex Nye talks through all the ways that the advisory industry fails to understand and relate to him and his Millennial peers. For instance, why do Millennials pay $50 for a nice bottle of wine and $100 on dinner, but not $80 for cable? The answer is that the internet makes substitutions easily available; cable isn't appealing, because there are cheaper alternatives online, while good wine and food are not. More generally, the availability of the internet means price and value are more constantly scrutinized; the issue is not that "advisors aren't valuable", but that Millennials are most easily able to recognize that a low-cost passive ETF is cheap, easy, and readily available, and so they demand that advisors provide some real value on top and beyond. It doesn't help that the Millennial generation is also the most distrustful of the financial services industry in the first place, with a mere 11% of Millennials saying they trust Wall Street to do the right thing most of the time, which means they're especially cynical and will be especially scrutinizing to determine if the advisor is someone they can truly trust. And ultimately, recognize that Millennials are the largest and most diverse generation in history – which means they have the widest variance of needs and wants as well, and as a result success with this generation will eventually mean going beyond just working with "Millennials" as a group and, instead, focusing on particular niches where you can craft a value proposition that is truly relevant and able to stand out.

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.