Executive Summary
Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with several stories on the initial aftermath of the DoL fiduciary rule becoming applicable on June 9th, including the growing number of annuity agents who are opting in to using the Best Interests Contract Exemption (instead of PTE 84-24), state insurance regulators considering whether to change the annuity suitability rules to a more fiduciary-like standard, and a look at the latest Schwab Independent Advisor survey that finds as DoL fiduciary shifts more advisors towards the AUM model and increases competition, that more advisors are feeling compelled to offer more services and spend more time with clients to justify their advisory fees (but without being able to charge more for the extra effort and offerings).
From there, we have a few technical articles this week, from Ed Slott discussing how HSAs can be used not just for ongoing health costs but as a supplemental tax-preferenced savings account for future retiree health care costs, the rise of 81-100 group trusts as a lower cost alternative for small business employer retirement plans (in a world where it's still difficult to offer a Multiple Employer Plan [MEP]), and a discussion of what Private Placement Life Insurance (PPLI) is and where it fits for certain ultra-high-net-worth clientele.
We also have several practice management articles, focusing on hiring and building our your advisory team, including: a roadmap on how to hire top talent (by first determining core values and core competencies, and using those to screen out candidates first); why it's better to look for "cultural add" than just "cultural fit" to improve diversity (and how hard that really is, given our tendencies to hire people like ourselves); and guidance from Julie Littlechild on how to establish a mentoring program to aid in the personal development of your team.
We wrap up with three interesting articles, all focused around homeownership, housing policy, and the country's growing challenges with affordable housing: the first looks at how the trend of Millennials to live in the urban core of cities (instead of the suburbs) is exacerbating the housing crisis, as there simply isn't as much room to build housing in already-densely-populated urban areas (and the high cost of land in urban centers tends to lead developers to build more expensive housing to generate a return on their own real estate investment, which just makes the problem worse); the second explores how the shift of the economy from manufacturing to knowledge workers is leading to a growing concentration of workers in urban areas (where "smart people" can meet and gather and form businesses together), which suggests the housing challenges created by urban concentration will just get worse (even as it provides an unexpected windfall for existing homeowners in major cities); and the last explores how the emerging affordable housing crisis is bringing newfound scrutiny on the popular mortgage interest deduction, which over the years has shifted to disproportionately become a tax subsidy for upper-income individuals (who can actually afford houses, and have mortgages that charge enough interest to exceed the standard deduction, and benefit the most from the deduction at their higher tax rates), and whether it's time to reform the program into at least an alternative 15% mortgage interest credit (which would reduce the benefit for upper-income individuals, and make it more accessible for lower-income individuals, even and including those who don't itemize their deductions at all).
Enjoy the "light" reading!
Weekend reading for June 17th/18th:
DOL Rule Forces Independent Advisors To Differentiate & Adapt (Christopher Robbins, Financial Advisor) - In the latest Schwab Independent Advisor Outlook study, a growing number of financial advisors report feeling compelled to do more for clients, without being able to increase their fees to pay for it. A whopping 44% of advisors state they have already begun to provide more services to clients without charging for them, and 40% of advisors are spending more time on each client without increasing fees. Notably, the study does not find that advisors are cutting their fees to compete with robo-advisors and the like; instead, advisory firms are responding to competitive pressures by trying to do more to justify their existing fees in the first place (at the risk of compromising their profit margins over time). In fact, the pressure to do more and offer a wider range of services for clients was the dominant theme of the study's future outlook as well, as advisors themselves are increasingly suggesting that the key to differentiation in the future - especially as DoL fiduciary forces more and more competitors into the AUM model - will be offering clients a broader range of services beyond just the portfolio, from tax planning, to philanthropic advice, and health-care planning. In the meantime, as the DoL fiduciary standard itself becomes universal, only 20% of the RIAs in Schwab's study stated that they anticipate trying to differentiate through a commitment to more stringent standards for advice. Nonetheless, 79% of advisors reported feeling confident about the future of the industry, and expect more opportunities in the next 10 years, particularly as financial planning itself continues to mature.
DoL Fiduciary Rule: When Advisers Actively Seek To Use BICE (Greg Iacurci, Investment News) - Notwithstanding the fact that opponents of the DoL fiduciary rule have consistently derided the Best Interests Contract Exemption (BICE) since it was first proposed by the Department of Labor, a fresh look at the advisor landscape finds that with the June 9th applicability date now passed, a "surprising" number of firms proactively embracing the BICE rules, especially amongst insurance and annuity agents. Insurance and annuity agents had widely been expected to rely on Prohibited Transaction Exemption (PTE) 84-24, which had been considered less onerous than BICE. However, the Department of Labor delayed the full BICE requirements to next January, and during the transition period, advisors must still adhere to the Impartial Conduct Standards (providing best interests advice, for reasonable compensation, while making no misleading statements to clients), but are not subject to the full series of disclosure requirements. With PTE 84-24, however, the full requirements for disclosing initial and recurring compensation - and an accompanying requirement that consumers acknowledge receipt of that information in writing - have become effective with the June 9th rollout date. Thus, firms appear to be pursuing the now-less-onerous BICE rules to sell annuities through the end of the year, instead of PTE 84-24... except for Independent Marketing Organizations (IMOs), which generally don't qualify as Financial Institutions and can't use BICE, and thus must rely on PTE 84-24 instead. Whether firms will stay with BICE, or revert back to PTE 84-24, after the January 2018 full rollout of the BICE rules, remains to be seen.
State Insurance Regulators Look To DoL Fiduciary Rule As They Mull Changes To Annuity Sales Standard (Mark Schoeff, Investment News) - The National Association of Insurance Commissioners (NAIC) has recently formed a committee to revisit its model regulations on suitability in annuity transactions (for the first time since 2010), and last week NAIC president Ted Nickel indicated that the NAIC is considering whether to update the annuity suitability rules to become a best-interests (i.e., fiduciary) standard instead. The interest for lifting the standard comes as the DoL fiduciary rule itself rolls out, which is already lifting the standard for annuities being sold in retirement accounts, raising interest with the NAIC to create uniformity in standards at the state level (both between state and DoL fiduciary regulation, and between DoL-fiduciary-impacted qualified and non-DoL-fiduciary non-qualified annuity products). Not surprisingly, the Insured Retirement Institute, which represents annuity products, has raised concerns about expanding the fiduciary scope to annuity sales, and the disclosure standards that may entail; yet the Consumer Federation of America emphasizes that disclosures and reducing conflicts of interest are at the heart of the fiduciary duty itself. For the time being, it's unclear whether the NAIC is really prepared to fully overhaul its suitability standard for annuities, or whether it may just try to partially lift the standard to more closely - but not fully - align with the Department of Labor's fiduciary rule. Stay tuned for further updates in the coming year.
Why Your Clients Need HSAs (Ed Slott, Financial Planning) - While the original purpose and intent of the Health Savings Account (HSA) was a tax-preferenced account that could be used to save for near-term medical needs (given that they must be paired with a high-deductible health plan that exposes consumers to larger near-term medical expenses), there is growing interest in using the HSA as a form of supplemental retirement savings account specifically to cover health care costs in retirement. The appeal stems from the fact that HSAs provide for not only a tax-deduction at the time of contribution, but also tax-deferred growth inside the account, and tax-free withdrawals when distributions occur (for eligible health care costs)... which means the longer funds can remain inside the account, the greater the time period to compound what eventually will be tax-free growth. The caveat, though, is that the individual must have enough financial wherewithal to contribute to (or even maximize) HSA contributions and also have the additional funds necessary to cover their own health care costs in the meantime (since the whole point is to not use the HSA funds to cover the cost of current or near-term health care deductibles). For those who can hold onto and grow their HSA accounts, at age 65 it's permissible to use HSA distributions to cover Medicare premiums (though not Medigap supplemental insurance), and at worst post-65 distributions for non-qualified expenses are merely taxable (but the 20% HSA-non-qualified-withdrawal penalty no longer applies). However, it's important to bear in mind that once enrolled in Medicare, the individual can no longer make new contributions to the HSA, as Medicare itself is not a high-deductible health plan (and remember that claiming Social Security benefits at age 65 or later will automatically enroll the individual in Medicare Part A, rendering him/her ineligible for HSA contributions from that point forward). And for those who may otherwise feel "behind" in their HSA contributions, remember that you can roll over funds from an IRA to an HSA for the annual contribution as a Qualified HSA Funding Distribution (but only once in your lifetime).
The Little-Known Alternative To Multiple Employer Plans Gaining Popularity With Advisory Firms (Greg Iacurci, Investment News) - Given the struggles (and sheer administrative costs and hassles) of small business employer retirement plans, there has been a recent growing interest in Multiple Employer Plans (MEPs) as a means for small employers to pool their buying power and achieve lower costs (potentially aided by a recent legislative proposal to ease the current restrictions on MEPs). However, another small business employer retirement plan alternative has recently emerged as well: an "81-100 group trust". The 81-100 trust is similar to MEPs, in that it provides a commingled pool of retirement dollars for multiple employers, who have access to a common (i.e., shared) investment lineup. For instance, Bukaty Financial has launched a solution called "FreedomTrust", which is now pooling together the $49M of AUM amongst 39 small business retirement plans. From the advisor's perspective, the appeal of an 81-100 trust is that the advisor can provide 3(38) fiduciary services (where the advisor offers discretionary investment management) in a more-efficient pooled manner; for instance, Bukaty offers their 81-100 trust, record-keeping, and its associated investment and fiduciary services, for an all-in cost of just 0.72% (compared to an average asset-weighted cost of 1.14% for a comparably-sized 401(k) plan). From the plan administrator's perspective, the appeal of the 81-100 trust is that, because it's ultimately treated as a "trust of trusts", each plan is still treated separately for compliance purposes, which helps to ensure that one employer plan that makes a mistake doesn't have adverse consequences for all employers in the shared plan (a common concern of open MEP plans).
My Own Private [Placement Life Insurance] Policy (Russ Alan Prince, Financial Advisor) - Private Placement Life Insurance, or "PPLI" for short, is an insurance policy that is created directly as a private placement for that individual insured. The significance of the arrangement is that with a private placement life insurance policy, the policyowner has more ability to dictate who will manage the cash value of the life insurance policy (which under the standard rules for life insurance, grows tax-deferred inside the policy). In the past, this often meant designating a hedge fund or private equity fund, but now a growing number of asset managers and RIAs are establishing their own customized PPLI (and also Private Placement Variable Annuity, or PPVA) policies. Notably, because PPLI (and PPVA) contracts are offered as private placements, the policyowner must be either a qualified purchaser (defined as someone with at least $5M in investable assets) or an accredited investor ($1M of net worth excluding the home, or an annual income of $200,000 for individuals or $300,000 for married couples). In addition, the policies themselves often have substantial funding requirements, just to be economically feasible to establish; for instance, CGS Financial has a minimum annual contribution of $1M per year in premiums to its PPLI policy, or $500,000 for its PPVA. For those that can afford the policies, though, there's a potential for substantial tax-deferred compounding growth; in fact, PPLI is more commonly used for investment (and tax) purposes, than for pure life insurance needs (for which traditional life insurance may be better), and are popular with large RIAs because they can still (get paid to) manage the cash value invested in the policy. In the meantime, while there are administrative setup costs, PPLI and PPVA policies do not pay commissions to an insurance agent (though there will be some consulting fee or basis point cost for the wrapper and underlying management itself).
A Roadmap For Hiring Top [Advisor] Talent (Kelli Cruz, Financial Planning) - As financial advisors, we are often on the lookout for the next great client, but Cruz suggests that it's equally important to always be on the lookout for the next great team member, too. And if you're uncertain of where to look, start by examining your existing team... where did they come from, how did they get to your firm, why did they come to the firm, and what are their (common) values? The latter two questions in particular are crucial, but it's difficult to train for values and attitude, and instead usually easier to just consider where the people with the right values and attitude came from, and look there for more. Beyond these dimensions, you should also consider the core competencies that are necessary for each/every role at the firm – both the individual role itself, and firm-wide competencies that are necessary. For instance, independent advisory firms that have a strong service mentality for clients might focus on the person's ability to follow-through on commitments, display enthusiasm, and exhibit an entrepreneurial attitude. Core requirements for individual job positions might include analytical skills (or not), organization and planning abilities, attention to detail, persistence, or strong communication and listening skills. The key point in the process is to recognize that these core competencies – individual and firm-wide – along with the core values, are not things that can be easily trained, and instead should be used as screening tools to weed out those who don't fit the standards (and can even be used to craft and hone interview questions designed to suss out who does and doesn't live up to the firm's standards). Third-party assessment tools like Kolbe, DISC, and StrengthsFinder, can also help flesh out the candidate's work style and intrinsic skill sets, which can then be further vetted with tools like a financial planning case study or mock client meeting.
Go For Culture Add, Not Culture Fit (Brad Feld, Feld Thoughts) - In recent years, it has become increasingly common to use "cultural fit" as a criterion for hiring, in recognition that employees who don't fit the cultural norms of the firm often struggle to succeed (or even get along with other employees). Yet the challenge is that by stringently hiring for cultural fit, there's a risk that the firm fails to ever add more diverse perspectives (or outright fails to add diversity altogether). Instead, Feld suggests that the goal should be "cultural add" – hiring people who are more diverse and thus can add to and extend the culture of the firm, rather than just reinforce the status quo. Thus, Feld began to advocate for the "Rooney Rule", after Pittsburgh Steelers chairman Dan Rooney, who established a requirement that NFL teams HAD TO interview at least one minority candidate for front-office job positions. The caveat, though, is that subsequent research has found that just adding one minority candidate into the finalist pool doesn't appear to have any material impact on the probability of hiring a minority; instead, it's necessary to have at least two such candidates in the pool. The reason appears to be that mixing in one candidate who is substantially different from the rest ends out just accentuating how different he/she is from the norm, making it even more challenging to move forward on the hire. Which means an effort to expand and "add" to a firm's culture may require as much or more of an effort in the hiring process than "just" hiring for cultural fit in the first place!
Help, I Have A Team! (Julie Littlechild, Absolute Engagement) - For many financial advisors, the business has grown to the point where it's necessary to have a team that supports the advisor. The bad news, though, is that most financial advisors have little or no experience on how to train and develop those team members and their skills over time, and most team development initiatives are informal at best (with only 60% of advisors even administering formal performance reviews, much less new-employee training or other initiatives). Littlechild suggests that one way to tackle the issue is to establish a formal mentoring program (either where you as the advisor mentor an employee directly, or even have someone else on the team be a mentor for newer employees). The starting point, though, is to identify the prospective gaps that are meant to be improved by the mentoring relationship, whether it's performance objectives (e.g., timeliness in completing work, success in meeting certain business goals), competency/development objectives (e.g., customer service skills, sales, time management, leadership, etc.), or personal development objectives (e.g., training courses, professional designations, or other personal improvement goals). When it's time to engage in the mentoring itself, there are a few ways to structure the relationship, including "the buddy" (typically used to help a new employee navigate the office and company), "the mentor" (a more classic mentor role, structured on a longer-term relationship), or "the sponsor" (whose objective is to actively support and promote the individual in their career advancement and development in the firm). If you're considering any version of these approaches, though, Littlechild suggests first discussing the option with team members themselves (either via survey, or a conversation), to explore their interest, and what kind(s) of mentoring they think would be most beneficial and positively impactful for them in the first place.
Why Millennials Are (Partly) To Blame For The Housing Shortage (Laura Kusisto, Wall Street Journal) - In most of the country's largest and most prosperous markets, it's easier to build new housing in the suburbs, but Millennials are increasingly seeking to live in the urban core of major cities (up 8.6% in Washington, DC, and 6.4% in Portland, OR, and Chicago), where housing construction options are more limited. As a result, as builders shift towards the trendier urban markets, they are producing less housing overall, and the higher cost of land in central cities also pushes developers to focus on more higher-end housing (further exacerbating local shortages for affordable housing options). And thus even as the new homes being built are getting more expensive (normally a sign of a strong housing market), fewer of them are being built than in past cycles, with housing construction more than 10 miles out from densely populated metropolitan areas down a whopping 50% from where it was in 2000. On the other hand, as Millennials get older, and eventually begin to get married and have children, there is some indication that they may be beginning to move to (and demand construction in) the suburbs. Nonetheless, the pressure is still on major cities to loosen land-use restrictions in core areas to try to accommodate the demand in the urban core, which is crucial to constructing a wider range of (more affordable) housing options.
How Homeownership Became The Engine Of American Inequality (Matthew Desmond, New York Times) - The average homeowner boasts a net worth of $195,400, a whopping 36 times that of the average renter (just $5,400). Yet rising home prices in metropolitan areas are making it increasingly difficult for many middle-income earners to be able to afford to buy a home at all, in what is being dubbed one of the nation's worst affordable-housing shortages in generations. As a result, while the standard of "affordable" housing is paying 30% or less of the family's income, slightly more than half of all poor renting families in the country spend at least 50% of their income on housing costs, and one-in-four spends more than 70%. And this gap is bringing newfound attention on the tax deduction for mortgage interest, which effectively provides a tax subsidy for homeownership, and while it became popular when it was expanded in the 1940s as a part of the G.I. Bill after World War II, has increasingly shifted to being only available to upper-income individuals (who can afford to buy houses, have large enough mortgage interest payments to exceed the standard deduction, and benefit from having the deduction applied against their higher tax rates). In fact, the mortgage interest deduction cumulatively resulted in $71B of tax subsidies for housing, along with another $63B for real estate tax deductions and the capital gains exclusion on the primary residence; and notably, those tax expenditures add up to more than the entire budgets of the Departments of Education, Justice, and Energy, combined (and half the GDP of Portugal or Chile). Nonetheless, the mortgage interest deduction has become a "sacred" tax deduction in policy circles, as hostile to change as making adjustments to Social Security and Medicare, in part for its popularity amongst those who use it, and also because some studies have estimated national housing prices could decline more than 10% if the mortgage interest deduction (and property tax deduction) were eliminated (even though doing so would help to reduce the renter-homeowner wealth gap and make more housing affordable). This fear is leading to alternative proposals, such as replacing the mortgage interest deduction with a 15% tax credit on interest paid up to $500,000 (which limits the magnitude of benefits for upper-income high-tax-bracket individuals, and allows lower-income individuals to benefit even if they don't itemize) that would still add up to a similar amount (and thus theoretically not reduce aggregate housing demand and adversely impact home prices or home ownership rates). Though ironically, President Trump's recent tax proposal to expand the standard deduction would only make the situation worse, reducing the relevance of the mortgage interest deduction for all but the most affluent homeowners, who own homes with mortgages large enough to pay interest in excess of the expanded deduction. Nonetheless, with an ongoing and worsening shortage of affordable housing, there is a growing recognition that "something" must be done to revisit and potentially reform the mortgage interest deduction rules.
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.
Love the attention on HSA’s. *Added benefit in the scenario of not using it for pre-retirement medical is the ability to take distributions tax-free on an ex-post facto basis. Couple a one-time distribution early in retirement of multiple years/decades of “banked” medical expenses with a big Roth conversion or resetting of the basis on taxable investments makes for some sweet tax savings! So much tax-efficient planning to be done with HSA’s.
Hello,
Nice Article, Excellent post I have ever read. It is providing an opportunity to boost my knowledge in financial planning.
Wonder why Medigap premiums are excluded when Medicare Advantage premiums are included.
The Medicare Advantage structure is still part of the Medicare system (and partially funded through it).
Medigap is ultimately an entirely private system policy that just happens to be designed to fill the gaps around Medicare.
– Michael