Weekend Reading For Financial Planners (June 22-23)

Wealthy Americans Expect To Need $5.5M To Retire And Leave Legacy, See Advisors As Valued Partners: Survey

(Leo Almazora | InvestmentNews)

Given that there is no single definition of "wealth" or being "financially comfortable", these terms can mean different things to different groups of people. For instance, while an individual with few assets might feel like having $50,000 would make them financially comfortable, an individual with more assets (who might have significant spending needs, or who might be tempted to compare themselves to affluent peers) could 'require' a significantly higher number to feel "wealthy". And given that financial advisors often work with this latter group (though there are different fee models and pro bono options to serve the former group), they might find that many prospects come to them with lofty expectations of what it would take to feel financially comfortable.

According to a survey of Americans with at least $500,000 in investible assets sponsored by First Citizens Bank, these individuals expect to need an average of $3 million in assets to retire comfortably and $5.5 million to both retire and pass down wealth to heirs (94% of those surveyed indicated they expect to give to heirs either during their lives or as a legacy interest). And while the spending needs of those surveyed is unknown, these (high?) estimates suggest that a financial advisor could help them determine a (more?) accurate retirement nest egg target to meet their needs. Further, despite the interest in giving, only 50% of respondents said they are prepared to do so and have a written plan in place (2/3 of those surveyed indicated they have a will, and only 40% said they have an estate plan), indicating the potential value for an advisor to help them create an estate plan that reflects their wishes.

Notably, individuals surveyed who work with a financial advisor appear to recognize significant value from the relationship, with 89% of those surveyed crediting their financial advisor for helping them generate more wealth than they could have on their own, 66% indicating that an advisor helps them feel more prepared for the future, 58% saying their advisor reduces their stress, 45% noting their advisor saves them time, and 43% responding that their advisor allows them to focus on the important things in life.

Altogether, this survey indicates that financial advisors not only can help clients build wealth, but also work with them to create more accurate wealth targets (through financial planning analyses) and estate planning strategies (including getting the right documents in place for their needs!) that can help them reach their financial goals and provide them with greater peace of mind!

Advisors Are Bullish On ETFs, Bearish On Mutual Funds, FPA Study Says

(Karen DeMasters | Financial Advisor)

One of the biggest trends in the investment industry in recent years has been explosive growth in the variety, availability, and use of exchange-traded funds (ETFs). Not only because they are more tax efficient, have more flexible trading, and are typically less expensive than mutual funds – which has made them a popular way to implement passive investing strategies – but the use of 'passive' index ETFs can serve as a complement to more active strategies within the portfolio (e.g., through actively managed funds or individual securities).

According to the FPA's and Journal of Financial Planning's 2024 "Trends In Investing" study, which surveyed 208 financial advisors across a range of practice models, 89% of respondents indicated they use or recommend ETFs to clients (the most of any investment vehicle surveyed), and 60% said they expect to increase their use or recommendation of ETFs in the coming year (also topping the list). And while once-dominant mutual funds are still used or recommended by 68% of advisors surveyed, 30% of advisors indicated they plan to decrease their use of them during the next year (a greater percentage than any other investment vehicle).

Other notable trends identified in the report include upticks in advisors using or recommending individual stocks and bonds (with 53% and 50% of advisors using them, respectively), and expectations to increase their use over the next 12 months (with 27% planning to increase their use of individual bonds and 26% planning to increase their use of individual bonds). In addition, while a small percentage of advisors use cryptocurrencies, their ranks jumped in the past year, up to 5% of respondents from 3% last year (perhaps boosted by the introduction of 'spot' Bitcoin ETFs that make investing in cryptocurrencies simpler?). Altogether, just under 75% of advisors indicated they prefer using a blend of active and passive management strategies, with the remainder of advisors roughly evenly split between preferences for either active or passive management.

In sum, ETFs not only appear to hold a dominant position in the portfolios advisors recommend to clients, but could see their lead extend further into the future in part because even advisors who actively manage portfolios themselves appear to be using ETFs as the core 'passive' building block for their active ETF strategies, supplemented by individual stocks and bonds, as well as other investment vehicles!

Will An Ex-Fidelity Advisor's Reg BI Suit Catch The SEC's Eye On Asset Managers' Proprietary Products?

(Dinah Wisenberg Brin | ThinkAdvisor)

The Securities and Exchange Commission (SEC) and other regulators conduct regular exams of firms they supervise in an attempt to uncover potential violations of relevant regulations. Another way for regulators to find out about potential violations, though, is whistleblower complaints from within the firms themselves. And a recent complaint and lawsuit from a former Fidelity employee could both bring to light potential violations of Regulation Best Interest (Reg BI) (which requires brokers to act in their clients' best interests at the time that they're making an investment recommendation, by meeting 4 core obligations: disclosure, care, conflicts of interest, and compliance) and other rules by the asset management giant… and offer regulators insight into practices that might be emerging at other asset management firms as they have been trying to navigate Reg BI as well.

According to the lawsuit, the former employee (who spent 24 years at Fidelity) alleges that he was fired in retaliation for reporting that the firm improperly pressured him and other advisors to push clients away from lower-fee investments to the company's own higher-fee managed money products, including separately managed accounts. The pressure to push clients into "unsuitable or ill-advised, high fee generating financial investments" over the course of 5 years violated Reg BI and other laws, according to the complaint. Highlighting the fundamental conflict of interest that arises when a company that manufacturers its own proprietary products (e.g., mutual funds, ETFs, managed accounts, etc.) also employs financial advisors to sell/distribution those products while also giving financial advice.

While the results of the lawsuit remain to be seen (Fidelity has until July 5 to provide a legal response to the lawsuit), some legal experts suggest that if the case goes to trial, material exposed during the proceedings could further prompt an SEC investigation. And if an investigation resulted in a major fine, it could prompt more asset management firms to assess their practices, and how they distribute their own managed solutions or proprietary products through their own employee advisors, to ensure they are in line with Reg BI and other regulations.

Ultimately, the key point is that as the SEC has identified Reg BI as one of its top enforcement priorities for 2024, this lawsuit (if its allegations are found to have merit) could serve as a window into the problems that have resulted from Reg BI permitting such conflicts of interest to continue to exist (allowing asset managers that manufacture product to distribute those solutions while also providing advice as dual registrants). To the extent the SEC still believes that such 'hat-switching' is problematic, and chooses to enforce Reg BI more aggressively, such conflicted sales practices may still be curtailed through enforcement. Which means other asset managers may be particularly attuned to both the court (via the whistleblower suit) and regulatory (via SEC enforcement) outcome of the Fidelity complaint, as it could serve as a warning to firms that they too may be held accountable for the conflicts that result from using their own advisers to distribute their own products… either via regular regulatory examinations, or also by employees who speak up when they identify possibly problematic practices!

IRS To Crack Down On "Basis Shifting" Tax Avoidance By Business Partnerships

(Tracey Longo | Financial Advisor)

While some practices fall clearly on one side or the other, it can sometimes be challenging whether other actions could be considered as (legal) tax avoidance (i.e., an action taken to lessen tax liability and maximize after-tax income, such as taking advantage of certain deductions and credits) or (illegal) tax evasion (i.e., the failure to pay or a deliberate underpayment of taxes). With this in mind, the IRS frequently provides guidance to help taxpayers and tax professionals identify practices that are either blessed as tax avoidance or could be considered tax evasion.

Amidst a broader push by the Biden administration for more stringent enforcement of tax law, the Treasury Department this week issued guidance and announced proposed regulations regarding "basis shifting" transactions used by certain partnerships. Under this practice, partnerships use pass-through business structures to link entities for purposes of selling assets so that taxes are determined only after subtracting the assets' original basis from profits. According to the Treasury Department, the basis shifting transactions targeted in the new guidance can occur in 3 areas: transfers of partnership interests to related parties, distribution of property to a related party, and liquidation of a related partnership or partner. Treasury officials argued that by moving such assets from entity to entity on paper, hedge funds, wealthy investors, and other businesses are able to manipulate their basis and reduce their tax liabilities (i.e., by depreciating the same asset repeatedly) without any substantive economic consequence.

In sum, the Treasury Department appears to be on the lookout for strategies used by wealthy taxpayers, including basis shifting, which may have been commonly perceived by parties using them as tax avoidance, but might be considered tax evasion going forward, suggesting that certain clients and their tax advisors might consider whether other tax avoidance practices being used might soon come under the crosshairs soon as well?

Supreme Court Sides With IRS On Tax Of Shareholders' Life Insurance Policies

(Ronald Mann | SCOTUSblog)

For closely held corporations, establishing a buy-sell agreement is a common practice. Under this strategy, a corporation might purchase life insurance policies on the principal shareholders and, if one of the shareholders dies, uses the proceeds from the policy to purchase the shares from the individual's estate (so that the deceased's family can gain liquidity for the value of the shares and so that the business remains under the control of the remaining shareholders rather than also including the recipient of the deceased's shares). A key question, though, is whether the life insurance proceeds that come to the corporation after the shareholder's death increase the value of the corporation (given that the corporation now has the cash from the policy benefit) or whether the corporation has the same value (because the corporation had a liability under the buy-sell agreement to spend them to redeem the shares of the deceased shareholder).  

In a recent case, Connelly v. Internal Revenue Service, the U.S. Supreme Court decided unanimously that the former view applies, noting that "Because a fair-market value redemption has no effect on any shareholder's economic interest, no willing buyer would have treated [the] obligation to redeem…as a factor that reduced the value of those shares." Practically, the decision means that the deceased shareholder's shares were worth more than their value before he passed away due to the company's receipt of the life insurance proceeds, creating a potentially increased estate tax burden for his estate. Notably, though, the Supreme Court's decision explicitly highlighted that a cross-purchase buy-sell agreement (where the shareholders [rather than the corporation itself] agree to purchase each other's shares at death, funded by life insurance policies on each other) would have avoided the risk that the insurance proceeds would have increased the value of the deceased's shares (though cross-purchase agreements come with their own risks, including the inability of a shareholder to pay the premiums on the life insurance policies on the other[s]).

Altogether, this Supreme Court decision highlights the importance for business-owner clients of closely evaluating succession plans (and particularly those funded with life insurance proceeds) to ensure that they avoid undesirable tax consequences while still meeting the needs of all parties involved. Which can present an opportunity for a financial advisor to add value for a business owner client by evaluating the range of possible methods to do so (whether a cross-purchase agreement or otherwise) in order to find the option that best meets the client's needs!

How Financial Advisors Can Help Clients Avoid (Increasingly Punitive) Estimated Tax Penalties

(Laura Saunders | The Wall Street Journal)

The United States tax system is set up on a "pay-as-you-go" basis, which means that taxpayers are required to pay taxes throughout the year as income is earned, whether it be through withholding income (via employer payroll) or making estimated tax payments directly to the IRS. Individuals who don't pay timely taxes throughout the year may be assessed estimated tax penalties by the IRS, which are based on the amount of unpaid tax, accruing at the Federal short-term rate (in the first month of the quarter in which taxes were not paid) plus 3 percent.

Amidst the rising interest rate environment of the past few years (which has increased the penalty interest rate to 8%, up from 3% in 2021), total estimated tax penalty assessments soared to $7 billion in 2023 from $1.8 billion in 2022, and the average estimated tax penalty climbed to approximately $500 in 2023 from $150 the previous year. Which means that many taxpayers, including those who are self-employed or receive significant interest, dividend, or taxable gain income, could find themselves facing steeper penalties if they do not make the required payments on time.

Financial advisors have several ways to help clients avoid estimated tax penalties. To start, while many self-employed clients will recognize the need to make estimated payments, other clients, such as those who work for an employer and have taxes on their wages withheld but also have significant income from exercising stock options or large amounts of investment income, may not realize they too have an estimated tax obligation. Recently retired clients, who have "always" covered their estimated taxes via payroll withholding, and now need to make their own estimated tax payments for their portfolio income and retirement account distributions, also need to be educated on the estimated tax rules.

From there, the most straightforward way for advisors to help clients navigate their estimated tax liabilities is to leverage one of 2 'safe harbor' methods, by either: 1) paying 100% of the prior year's tax liability in equal installments [110% if the client's Adjusted Gross Income from the previous year was more than $150,000]; or 2) paying 90% of the current year's tax liability in equal installments. In addition, advisors can analyze the best method of paying the estimated tax liability; while a client can make payments before the 4 quarterly deadlines (April 15, June 15, September 15, and January 15), they could also increase their withholdings from employment income (which are treated as though they were paid ratably throughout the year) or, if the client is retired, taking an IRA distribution and withholding the entire amount for taxes (which can be particularly attractive because an IRA distribution can be taken at any time during the year and, like withholdings from employment income, count towards the estimated payment requirements throughout the year, retroactively applying even if the IRA distribution withholding occurs as late as December!).

Ultimately, the key point is that as penalties for missed estimated tax payments have become particularly acute in the elevated interest rate environment where late penalties accrue at 'current' interest rates, such that the value of getting them 'right' has increased. And with a variety of strategies available to calculate and make estimated tax payments, financial advisors can recommend a plan that meets each affected client's needs (and demonstrate their value in hard dollar terms!).

The Biggest Marketing Myth Of Them All

(Dan Solin | Advisor Perspectives)

During a discovery meeting with a prospect, a financial advisor might be tempted to do much of the talking, explaining their personal story, how their firm operates, and the services they offer to try to convince the prospect that they are the 'right' advisor for their needs. Nevertheless, while the prospect might come away from such a meeting with a better idea of what the firm has to offer in general, they might not feel as though the advisor understands their unique needs (or whether they have the tools to solve them).

With this in mind, Solin instead suggests that active listening (i.e., listening to better understand the prospect) is a better approach for advisors in discovery meetings, allowing them to uncover insights about the prospect's pain points, preferences, and objectives (and given that prospects might not be prepared to reveal these on their own, advisors can help clients 'open up' by asking questions that can help uncover the prospect's concerns. Further, active listening is not only a way to gather information about the client (to both assess their planning needs and whether they might be a good fit for the firm), but also shows that the advisor is genuinely interested in what the prospect has to say, which can foster a sense of trust and credibility (and differentiate an advisor from more impersonal digital advice tools!).

In the end, while it an advisor might feel good talking about themselves and what they have to offer, allowing the prospect to spend most of the time talking during a discovery meeting can both give them the positive feeling of sharing their own story and start to create a connection of trust for a relationship that could last for years or decades to come!

How To Not Lose A Prospect In Your First Meeting

(Ari Galper | Advisor Perspectives)

Discovery meetings between an advisor and a prospect typically include a significant amount of dialogue between the 2 sides, as the prospect shares their financial background and concerns, and the advisor discusses how they serve clients and might be able to meet the prospect's needs. Nevertheless, given that prospects will come to these meetings with varying levels of knowledge about the financial planning process (and perhaps personal finance issues in general), they might have a hard time understanding and retaining everything the advisor says, which could leave them unsure whether the advisor is the 'right' person for them.

With this in mind, Galper suggests that advisors use a visual "road map" that lays out the next steps in working with the advisor. Importantly, while an advisor might be tempted to put all of their services on this roadmap (in an effort to impress the prospect) or include every detail about their planning process, doing so could only reinforce a sense of being overwhelmed on the part of the prospect. Instead, a simple graphic that allows the prospect to see what it would look like to become a client can serve to build trust, as the prospect could have more confidence that they understand what the advisor has to offer and how they would benefit from the planning process.

In the end, while dialogue is an important part of a successful discovery meeting, using a (simple!) visual aid that allows the prospect to visually connect with what is being said and the client experience they would receive can create a more engaging, immersive experience (leveraging both audio and visual elements) that could increase the chances that the prospect decides to become a client!

Never Sell The Negative

(Kerry Johnson | Advisor Perspectives)

Often, a prospect will approach an advisor because they have a deep concern or are feeling an acute financial pain point. For instance, they might come into a meeting saying, "I don't want to run out of money in retirement". While a logical response from an advisor might be to say "I can help you avoid running out of money," Johnson suggests that addressing the client's negative mindset (i.e., "Moving Away" from the concern) in this way might not be as effective as reframing the issue more positively towards a goal that can be achieved (a "Moving Toward" mindset).

The first step towards building a "Moving Toward" mindset is for the advisor to listen to the prospect's "Moving Away" comments and empathize (as it is almost certainly a valid concern that will need to be addressed!). Next, the advisor can ask the prospect what they would like to happen (e.g., "How much monthly income do you think you will need in retirement") and then, after the client answers, paraphrase their response to ensure they feel understood. Finally, the advisor can offer a "trial close" to gain commitment by the prospect (e.g., "If we could focus on generating $4,000 per month throughout your retirement in a sustainable manner, would that be helpful?"). In this way, giving the prospect something to "Move Towards", they could become more motivated to take the next step with the advisor.

In sum, an advisor's ability to transform a prospect's pain point(s) into a positive, achievable goal could help the prospect better see the value that the advisor might be able to offer and potentially increase their motivation to become a client!

Why Buying A Car Is More Expensive Than Ever

(David Welch and Claire Ballentine | Bloomberg News)

While a home is often the most expensive purchase an individual will make, cars also are a major line item on an individual's cash flow statement. And while the current high cost of buying a home (due to elevated home prices and mortgage rates) makes headlines regularly, the cost of buying a car have increased significantly during the past few years as well.

Like housing, the increased cost of car purchases is a combination of higher sticker prices (which reached almost $49,000 for a new car at the end of 2023, up 30% compared to January 2019) and elevated interest rates (with an average rate of 9.6% for a new car and 14.3% for a used car). While consumers wait for interest rates to tick lower, car companies have largely recovered from the supply chain holdups associated with the COVID-19 pandemic that contributed to the sharp rise in prices and inventories of new cars are rising, which has slowed further price increases (with annualized inflation for new cars standing at 4.1% for June, down from the 4.7% figure in May; notably, prices for used cars actually fell 5.2% year over year) and could lead to price reductions on less in-demand models. For instance, demand for electric cars appears to have stalled somewhat, leading to record inventories (130 days in December, compared to 69 days for internal combustion vehicles) and price cuts.

Altogether, while new and used care price increases have moderated (or even declined in some cases), they remain significantly higher compared to the pre-pandemic period, with elevated interest rates driving up monthly payments further for those who finance. And given that car purchases are a major (if infrequent) expense for many clients, financial advisors could acclimate clients to the new cost and rate environment (particularly if they haven't bought a car in the last 4 years) and assess whether planning assumptions might need to be adjusted to account for these changes (whether in terms of how much a new car might cost or the interval between car purchases)!

The New Math Of Driving Your Car Until The Wheels Fall Off

(Joe Pinsker | The Wall Street Journal)

For some individuals, continuing to drive a car for as long as possible is a point of pride as their odometer ticks past 200,000 or even 300,000 miles. At the same time, the decision of whether to hold on to a car is a financial one as well, as vehicle owners weigh the costs of repairs on an aging car with the expenses involved in buying a new car. Notably, recent trends in car-related expenses and the durability of vehicles have been changing this calculus, and more owners appear to be choosing to extend the lives of their cars.

For example, the average age of U.S. vehicles on the road hit a record 12.5 years in 2023, the 6th straight year this figure increased, according to S&P Global Mobility, and the share of cars that are at least 10 years old has risen from 16.9% in 1977 to 44.2% in 2022. Part of the reason for this change (at least in the past few years) is the sharp rise in new and used car prices as well as increasing financing costs in the elevated interest rate environment, which potentially make extending the life of an older car more financially attractive than buying a new one. Another factor is the increased durability of cars manufactured during the past couple decades, allowing them to stay on the road longer than previous models. Further, a vehicle owner with a reliable, relatively low-maintenance car manufactured a decade ago might be hesitant to buy a new model that is not only pricier, but also has more built-in electronics that can malfunction and increase repair costs.

In the end, while a financial plan might assume that a client will buy a new car every 5 or 8 years, recent trends suggest that many car owners might find (perhaps with analytical help from their financial advisor!) it cost-effective to extend the lives of their cars longer, which could free up cash for other purposes. Though this interval between car purchases will also likely depend on individual client preferences, with some wanting a shiny new car every few years and others looking to join the 300,000-mile club!

Why Is Car Insurance So Expensive?

(Emily Flitter | The New York Times)

When one thinks about the costs of car ownership, the first things that come to mind might be the cost of buying the car itself, repair expenses, and regular fill-ups at the gas station. But recently, the cost of car insurance has become more salient for many drivers, with auto insurance prices increasing 22% in the 12 months ending in April and average 12-month premiums reaching $1,280 at the end of 2023.

A few of the reasons for this increase are an increase in the number of car insurance claims as more individuals hit the road as the pandemic receded, rising vehicle prices (which makes a 'totaled' car more expensive to replace), and increasing repair costs (due in part to the integration of technology throughout the vehicle). Another key reason, though, is the state-based regulatory environment for car insurers. State regulators review auto insurance companies' requests to increase premiums on customers to ensure they reflect increased expenses borne by the companies (e.g., payouts to customers) and are not just an effort to boost profits (states can also require insurance companies to return money to customers if claims are lower than expected, which occurred during the early months of the pandemic when fewer drivers were on the road). However, these state reviews can take time (sometimes several months), which means insurance companies can sometimes bear significant losses before they are able to charge higher rates.

This gap between companies' requests for higher rates during the past couple years (amidst an increased number of claims) and the delay until their approval appears to be playing a major role in the recent sharp rise in auto insurance costs, as the insurance companies attempt to make up for losses incurred between 2021 and 2023 (a total of $51 billion for the industry, according to AM Best) and states gradually approve the proposed premium hikes. Which suggests that consumers could potentially see car insurance costs continue to outpace the broader inflation rate until the balance between insurance companies' costs and the premiums they charge come back into balance (providing them with a profit margin, but one that isn't too excessive in the eyes of state regulators).

Ultimately, it appears that a 'perfect storm' of an increased number of car accidents, rising vehicle and repair prices, and delayed premium hikes to reflect them have contributed to the spike in car insurance premiums. Which could provide an opportunity for advisors to add value for their clients by reviewing their policies and determining whether their current policy strikes the 'right' balance between their coverage needs and premium costs!  

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

In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "Wealth Management Today" blog.