Weekend Reading for Financial Planners (May 8-9)

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.

First Look At The New SECURE Act 2.0  Coming Later In 2021? (Jeff Levine, Twitter) - This week, the House Ways and Means Committee unanimously passed a new round of retirement legislation, dubbed the "Securing A Strong Retirement Act" (HR 2954), which is being viewed as a follow-up to the SECURE Act of 2019, and thus has become colloquially known as 'SECURE 2.0'. Key provisions include: the RMD age would be pushed back (again) from age 72 to age 75, implemented gradually over the next decade (age 73 starting in 2022, age 74 starting in 2028, and age 75 starting in 2030); a change to the statute of limitations on missed RMDs to start the clock once a tax return is filed (regardless of whether Form 5329 was filed), and the penalty for a missed RMD would be reduced from 50% to 25% (and down to 10% for 'timely corrected' missed RMDs without the current need to request a special waiver of the penalty); catch-up contributions for IRAs would become indexed for inflation, with the introduction of an 'extra' catch-up contribution for employer retirement plans for those aged 62-64 (boosting catch-up contributions from $6,500 to $10,000 in 401(k) plans and from $3,000 to $5,000 for SIMPLE RIAs); going forward, all catch-up contributions would be required to be made to Roth-style accounts (and new Roth-style SEP and SIMPLE accounts would be created to help support this); rules for variable insurance contracts are made more flexible to allow ETFs to be offered amongst the variable sub-account options; Qualified Charitable Contributions would be altered to index the $100,000 annual limit for inflation, and allow a once-in-a-lifetime QCD of up to $50,000 to a split-interest entity (e.g., a CRT or charitable gift annuity) but only if the entity is solely funded via a QCD (which means it may still not be cost-effective for CRTs given setup costs); "Qualified Student Loan Payments" where 401(k) matching contributions are made for those who pay down student loans would be formalized in the Internal Revenue Code (rather than the current reliance on private letter rulings); and a new "Office of Retirement Savings Lost and Found" (yes, seriously) will be formed to help retirement plan participants track down lost retirement accounts. Notably, at this stage SECURE 2.0 has 'only' passed the House Ways and Means Committee, and hasn't even been put to a vote in the House, nor is there a companion bill yet passed in the Senate, which means it may be many months until the legislation is finalized and passed. In fact, the SECURE Act itself was initially passed by the House in the spring of 2019, but took until December of that year to actually be signed into law. Nonetheless, with the substantial bi-partisan support it already has, the prevailing view is that SECURE 2.0 is just a matter of time, and while it's always possible the law will be modified before it is finalized, it appears likely to pass in a substantively similar form to what Ways and Means has managed to unanimously pass with bipartisan support.

New York Court Shoots Down State's Annuity Best Interest Rule (Emile Hallez, Investment News) - In 2018, the New York Department of Financial Services issued Insurance Regulation 187, which similar to the original-and-now-defunct Department of Labor fiduciary rule from 2015 would have required a uniform standard of care that required insurance agents and brokers to act in clients' best interests when recommending insurance and annuity products. The insurance product manufacturing and distribution industry, led by NAIFA, sued New York later that year to overturn the rule, which was upheld by the New York State Supreme Court in 2019, but this week was reversed on appeal by the New York Supreme Court Appellate Division, on the grounds that the principles-based best-interests standard was 'too vague' and gave the state too much latitude to find violations, noting that the New York's rule "fails to provide sufficient concrete, practical guidance for producers to know whether their conduct, on a day-to-day basis, comports with the amendment’s corresponding requirements for making recommendations and compiling and evaluating the relevant suitability information of the consumer". Which on the one hand highlights the wide latitude that regulators do have in enforcing principles-based fiduciary rules... but on the other hand, also fails to acknowledge that best-interests standards typically are principles-based precisely because the marketplace is too dynamic for an overly specific rules-based approach (which creates incentives for companies to push or work around the lines that are drawn). Ultimately, though, New York state still has the option to appeal its own appellate loss... or alternatively, to go back to the drawing board and issue a new rule, which industry observers suggest could end out being even more restrictive and rules-based in its approach, so stay tuned for what will likely be more news on this issue later in 2021?

RIA Digital Assets Council Launches Certificate In Blockchain & Bitcoin (Nicole Casperson, Investment News) - As the buzz around cryptocurrencies and blockchain continues to grow, this week Ric Edelman's "RIA Digital Assets Council" (RIADAC) announced the launch of a new certificate program on the topic. Structured as a series of 10 online learning modules, and covering a range from cryptocurrency as a (new) asset class, blockchain as a distributed ledger technology, portfolio construction and investment issues, regulation and tax issues, and compliance-related concerns, the new certificate program is eligible for 13 hours of CE credit, at a cost of $549. Notably, the advisor industry at large is still 'tepid' at best with respect to investing clients into cryptocurrencies, with a recent Grayscale white paper finding that only 10% of financial advisors even currently recommend cryptocurrencies to any of their clients, and the FPA's recent Trends In Investing study finding that only 1% of advisors are currently using cryptocurrency with clients. Nonetheless, with the Grayscale paper also finding that 44% of advisors "expect" to be working more with cryptocurrencies in the next five years, and Edelman making the case that blockchain-related "tokenization" will be adopted even more widely in the coming years, RIADAC is positioning itself to be able to fill the educational void on the topic.

IRS To Fix Its Confusing Tax 'Error' On New 10-Year Rule For Inherited Retirement Plans (Lynnley Browning, Financial Planning) - Last month, the IRS surprised many retirement planning commentators by updating its IRS Publication 590 (on the taxation of individual retirement accounts) and stating that those who inherit a retirement account under the new 10-year rule would be required to take annual RMDs from the account over that 10-year time window. The announcement came as a shock, given that the new 10-year rule under the SECURE Act was anticipated to be treated similarly to the preceding 5-year rule for non-designated beneficiaries, which merely required that the entire account be liquidated by the end of the 5th year after death (but not necessarily requiring withdrawals in each or any of those 5 years in particular). But now, the IRS has announced that it is reversing course and that its statement that 10-year beneficiaries would be required to withdraw RMDs in each of those 10 years was an "error", and that an updated version of Publication 590 will include examples that reaffirm that the new 10-year rule merely means that the entire account must be liquidated by the end of the 10th year after death (but not with any timing regarding when withdrawals occur across that 10-year window). Fortunately, the correction was announced relatively quickly - hopefully averting any 'early' withdrawals of 10-year beneficiaries who did not need to take funds out of their retirement account this year. Though notably, because there are no rollovers from inherited retirement accounts (as there are with traditional retirement accounts before death), those who have already taken withdrawals may not be able to put the funds back at this point.

It's Good To Have Options: DIY vs ETF vs RILA (David Blanchett, Advisor Perspectives) - While options are used for a wide range of purposes from hedging to sheer speculation, at the most basic level options simply allow investors to "reshape" the distribution of future returns by either buying into, or hedging out of, various parts of the upside or downside spectrum of outcomes. From a retirement planning perspective, this approach can be especially appealing given how sequence of return risk can adversely impact retirement income sustainability; if options make it possible to carve out the 'worst' parts of the (downside) return outcomes, it's possible that retirees could spend more even if their returns aren't higher, simply by ameliorating sequence-of-return risk. The practical question, though, is how to actually construct such options-based portfolios, for which Blanchett analyzes three choices: a "DIY" approach where the advisor directly purchases options to hedge their clients, "packaged" solutions via ETFs that use options strategies, and Registered Index-Linked Annuities (RILAs) which package the options strategy within an annuity wrapper. In theory, there would be no difference between the three - given that they're all ostensibly doing some combination of buying bonds, selling out-of-the-money call options, and using the option proceeds plus bond interest to buy (at-the-money) call options to produce the upside participation rate. In practice, though, Blanchett finds that annuity products may actually have better pricing than DIY (or packaged ETF) options, both because RILAs typically have specific product terms (e.g., 6 years) which allows the strategy to be implemented with longer-duration bonds that produce more interest yield (and thus have more money in play to generate higher participation rates), and also because insurance and annuity companies have at least some ability to 'leverage' their balance sheets with a more diversified (albeit still conservative) portfolio to generate more than 'just' the government bond yield that would likely be obtained in the DIY or ETF scenarios. And thus far, annuity companies have actually been pricing their RILA products at a lower product cost than ETFs (e.g., the Allianz Index Advantage Variable Annuity has an annual expense ratio of 25bps, compared to 74bps for the similar Allianz Buffered Outcome ETF). Or stated more simply: while annuities have long been criticized for their surrender charges and the associated illiquidity, the irony is that when it comes to hedging sequence of return risk, a commitment to a less liquid annuity can actually generate a more favorable options profile to secure retirement income (where any surrender charges are a moot point because the product is intended as a buy-and-hold retirement income strategy over the intended term anyway).

Affluent Americans Rush To Retire In New 'Life-Is-Short' Mindset (Alexandre Tanzi and Michael Sasso, Bloomberg) - A recent study found that about 2.7 million Americans aged 55 or older are contemplating retirement years earlier than they'd originally planned, a result of both the boom in real estate values and stock prices that is resulting in 'unanticipated affluence' for a segment of upper-income individuals in the "K-shaped" recovery after the pandemic. In fact, a November study from Pew Research found a surge in the number of Baby Boomers reporting they are retired (up 1.2M compared to the historical annual average), and a New York Federal Reserve survey found that the number of people expecting to work beyond age 67 fell to a record low of 32.9% last month. The shift in retirement preferences appears to be accelerated, though, by the pandemic itself, with the combination of the health scare and what has been for many less-fulfilling work in a virtual environment resulting in many either deciding to voluntarily retire early or for those who were laid off in the pandemic to 'choose' not to return to work after all. And even amongst those who had planned to keep working, the preparation of a transition back to an 'office' environment is persuading more to retire (especially if their return to work may also involve a return to work travel). From a planning perspective, the boom in retirement transitions is bullish for the advisor business itself, where the transition to retirement is often a 'money-in-motion' event that triggers the first use of (or switching of) financial advisors, representing a significant business opportunity. In addition, a wave of early retirements has a number of other important planning implications, from the timing of taking pensions early (or not) to the timing of Social Security, and how to bridge health insurance for those who retire before Medicare eligibility. From the broader economic perspective, though, the potential wave of retirements is raising concerns of an experienced-talent shortage in a wide range of industries.

New Frontiers in Wealth Management — How Advice Firms Can Ensure Long-Term Survival In A Changing World (Matthew Jackson and Bob Veres, Dialektic/Inside Information) - A new white paper from industry commentator Bob Veres and consultant Matthew Jackson interviewed a wide range of leaders in the advisory firms to create a compendium of perspectives on the future of the advice business. As they frame it, the industry is in the midst of a major transition, crossing the Adaptive Valley from incremental success within the established paradigm (“Peak 1”) to new levels of achievement within a new, long-term differentiating and sustainable paradigm (“Peak 2”). With the caveat that in going from Peak 1 to Peak 2, "sometimes we must, at least initially, move away from apparent success and headlong into seeming failure to achieve outcomes few understand are even possible. This is the essence of the so-called ‘Adaptive Valley,’ which separates local hills from true summits of higher fitness." The key distinction, though, is that the nature of building a Peak 1 business is fundamentally different from one on Peak 2. As Peak 1 innovation is about taking a successful idea and refining it incrementally (the Fast Follower), while Peak 2 innovators "do not seek to reform or improve existing businesses, but replace them with new ones, built from 1st principles". Which in turn means that "just" trying to iterate improvement from Peak 1 doesn't necessarily mean a firm will ever find its way to Peak 2. Instead, "you must make a conscious decision to leave behind safety and familiarity, and endure a potentially long journey through the 'Adaptive Valley'. Not only is the valley an uncomfortable place to be, but while you are in it, you may be temporarily at a disadvantage relative to your peers". This includes investing in the business in areas where many underspend, like staffing and marketing, and taking an earnings hit in the short-to-medium term. A key element of this is installing a "Managing CEO" who controls the non-advice side of the business (operations, marketing, and technology, and ultimately the client experience and the orchestration layer) and is in charge of creating processes, managing human assets, and using data to improve the client and staff experience. Often this means the Founder (the “Visionary CEO”) making what might be an uncomfortable move to relinquish control to that role. Another key element in scaling Peak 2 is evolving from serving as a ‘non-generic advisor’ centered on geographic proximity to creating true differentiation through developing a specialized niche and tailoring client experiences (and pricing models to serve that segment). This shift will also necessitate creating entirely new technology ecosystems from scratch (rather than fixing legacy systems that continue to lag behind). Though notably, while the journey from Peak 1 to Peak 2 is difficult, Veres and Jackson also suggest that as dominant incumbents leverage their scale to commoditize Peak 1 paradigm offerings, most advisors’ ability to differentiate and avoid the race-to-zero will become increasingly challenging, which will force the hand of advisors in deciding if they are going to ride out Peak 1 as a lifestyle advisor (otherwise too challenged to grow), or make the necessary investments as a growth-oriented advisor to begin the journey to Peak 2.

Exploring The Benefits Of Professional Management For RIAs: A Deeper Look Into Chief Executive Officers (Matt Sonnen, PFI Advisors) - It's common in independent advisory firms for multiple advisors to band together as partners in order to both share resources and expenses of the business, and also to divvy of the leadership responsibilities of the business, with one focusing on investments and/or planning, another on operations and compliance, and a third on being the 'Chief Executive Officer' responsible for leading and scaling the organization itself. The caveat, though, is that in a growing advisor enterprise, "C-suite" responsibilities are substantial and time-consuming, especially when stacked on top of managing client relationships and doing business development. In some cases, this squeeze on the founders' time eventually leads them to walk away from client responsibilities to focus full time on managing the business itself. For others, though, the alternative is to hire a CEO who becomes responsible for managing the enterprise itself. In fact, the whole point of a CEO is to keep a long-term focus on the needs of the enterprise as it will grow and evolve over time, not necessarily being focused on the day-to-day dynamics of client issues, but instead on the 30,000-foot view of the broader trends in the advice business and what it takes to succeed. Accordingly, Sonnen highlights a number of key areas where dedicated CEOs can (uniquely) focus, including clearly establishing the vision of the organization, and being able to take the time to ensure that every team member understands and is bought into the vision; setting the culture and values of the organization, and ensuring those run through the entire organization as well; being able to stay focused on the future by not being immersed in the day-to-day of the business (via delegation and empowering their team); creating the processes and systems necessary to build and scale the organization; establishing a network of advisors and mentors to be able to keep perspective on the growth and trends in the industry (to spot the Next Big Thing); and building and developing the brand of the organization so the firm is known in the marketplace. In turn, CEOs get to focus on moving the most important top-level "dials" in the organization, including Assets Under Management (or Revenue more generally), Profit Margins, Profitability from individual clients, Client Acquisition and Retention, and Time Spent on each Client. Which CEOs drive by being especially focused on how they manage their own time, and finding the balance between being in touch not too much (resulting in micromanagement), but enough to set the vision, guide the team, and keep them aligned.

Multiple Expansion Drives 70%+ Returns for RIA Stocks Over Last Year (Zachary Milam, Mercer Capital) - The typical advisory firm only finds out what it's worth when it gets a formal business valuation, and/or when the business is put up for sale and receives an offer for what it's worth. In the meantime, advisory firms can keep approximate track of their value with 'rules of thumb' like 2X revenue or 7X profits, which provides a proxy for how the firm is doing as its revenue and profits rise and fall over time. But what gets missed in applying rule-of-thumb valuation multiples to current revenue and profitability metrics is that sometimes, the supply and demand for advisory firms can change the multiples themselves. A case-in-point example is over the past year, where a growing hunger for advisory businesses, as measured by the subset of advisory firms (or companies supporting them) that are publicly traded and have multiples that can be observed, shows that the valuation multiples for the financial advisor business continue to be on the rise. In fact, the median valuation multiple (as a multiple of EBITDA earnings) actually expanded by 70% for advisory-related businesses with over $100B of AUM, and more-than-doubled for firms below $100B, as even though market volatility itself did take a toll on many firms, the forward-looking outlook for advisory firms is as strong as it ever was. Especially when recognizing that, due to the speed and sharpness of the market recovery, firms' forward-looking run-rates are in many cases significantly better than their trailing revenue or profitability metrics would suggest. Of course, the reality is that Mercer's research is focused on publicly traded (and more investment-management-centric) RIAs... but that also helps to make the point that when it's even a bull market in investment-centric RIAs, the financial-planning-oriented RIA (that is even more popular in the marketplace) is also likely to see support and even further increases in valuation multiples from here?

Google's Plan For The Future Of Work (Daisuke Wakabayashi, New York Times) - Just 5 years after its founding and meteoric growth, Google moved into a sprawling campus known as the "Googleplex", with "airy, open offices and whimsical common spaces" that became known as "what an innovative workplace was supposed to look like". But now as the pandemic reshapes office and work life, Google too is looking to the future of the workplace, and how to accommodate a significant number of employees who spent the past year working from home and don't want to return to the office. What's emerging are a number of new types of workspaces, including "Team pods" (combinations of chairs, desks, whiteboards, and storage units on casters that can be wheeled into various arrangements, rather than fixed rows of desks or cubicles), "Campfires" (circular spaces centered around a 360-degree camera to intermingle in-person and virtual team members all meeting in a circle), and "Camp Charleston" (an outdoor fenced-in mix of grass and wooden deck flooring to facilitate outdoor work). More generally, the significance of the shift is that Google historically built its office space in the vision of keeping people at work and "on campus" as much as possible (with all the amenities they could offer to keep workers there), while the virtual environment turns that entire goal upside down. Instead, the new philosophy is to focus on three emerging trends: work happens anywhere and not just in the office; what employees need from a workplace is constantly changing; and workplaces need to be more than just desks, meeting rooms, and amenities. In turn, "hot desks" (that can be swapped from one employee to another) and movable privacy walls help to flexibly create (or eliminate) divisions between team members when needed (or not). Ultimately, it remains to be seen how everyone will adapt to an emerging new world of 'hybrid work' that includes from-home and in-office environments, but just as Google has led the vision of what 'modern' offices should look like over the past 20 years, all eyes are on how Google is restructuring the hybrid office space of the future.

Get Ready For The New Workplace Perks (Charlotte Middlehurst, Financial Times) - In the "old" pre-pandemic environment, workplace perks were all about keeping workers in the workplace, from free food and beer to ping-pong tables and on-site gyms. In the post-pandemic era, though, when employees are increasingly likely to work from home (and eat from home, and exercise from home), and may only visit the office more occasionally as needed, workplace perks are going through an entire rethinking of what even is a perk anymore (and that in the end, the 'old' approach may have really just been a band-aid for what was simply an unhealthy long-hours culture in many companies). In fact, "flexibility" is itself becoming one of the leading perks - including the flexibility to work from home or the office in the post-pandemic world. More generally, there is an emerging recognition that the best perks are flexible, and don't take a one-size-fits-all approach to what team members want. Instead, Cary Cooper, author of "Flexible Work", suggests that companies begin to pivot more towards an approach that aligns work and psychological health with a more individualized "health-attuned" rewards culture. On the other hand, some perks - like company-provided food - are still seeing strong demand, if only because even many work-from-home employees don't necessarily want to cook-from-home (or go grocery shopping). Which is now leading to a wave of new startups like Juno and Thanks Ben that are developing more customized packages for employers who want more 'non-traditional' perks (from meditative gong baths to employee house cleaning).

Suburban Homes And Retail Are The Budding New Office Hotspot (Konrad Putzier, Wall Street Journal) - While demand for traditional centralized office space continues to wane in the post-pandemic environment, real estate companies are betting that most workers still won't want to work entirely from their homes, and instead are anticipating that more convenient nearby office spaces may become the new normal. Accordingly, there is a growing demand for 'small' office spaces in local towns, often built in former retail spaces that have been devastated by the pandemic, as a form of co-working 2.0 flexible work environment. The idea of the new approach is not necessarily to eliminate centralized corporate offices entirely, but instead to allow them to be downscaled while providing a second workspace for employees who don't want to entirely work from home, either. In addition, big apartment companies are also looking at adding flexible furnished office space to (or near) their apartments, for those who rent and may feel especially constrained trying to work from home in a smaller apartment and need a second space for work (without commuting all the way to the traditional office). And companies like Codi are helping homeowners who may have flexible spaces for work in their homes to rent out their spare rooms or garages as alternative work or meeting spaces (a form of "Airbnb for flexible work space"). The key point, though, is simply that while a full-time return to the office may not be in the cards for a lot of businesses, many people don't necessarily want a 100% work-from-home environment, either... so the game is on to figure out what the future of 'hybrid' work will look like instead?

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 Craig Iskowitz's "Wealth Management Today" blog, as well as Gavin Spitzner's "Wealth Management Weekly" blog.

Gavin Spitzner contributed this week's article recap on the New Frontiers in Wealth Management.