Weekend Reading for Financial Planners (October 7-8)

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 October 7th/8th:

SEC Begins Working With DoL On Fiduciary Rule (Kenneth Corbin, Financial Planning) – This week, in testimony before the House Financial Services Committee, current SEC Chair Jay Clayton stated that the SEC has begun to work with the Department of Labor on a fiduciary rule proposal that would harmonize the standards of conduct for investment advisers and broker-dealers, after its process of collecting comments earlier this year. The next step here would be for the SEC to formalize an actual rule proposal, which is expected to be more “palatable” to the brokerage industry and Republican lawmakers. Of particular focus is the fact that a single advisor is currently subject to two different standards for different accounts belonging to the same brokerage client, given that the DoL’s fiduciary rule would apply to his/her IRA but the suitability rule would apply to any non-retirement investment accounts. On the other hand, fiduciary advocates have raised concerns that a new version of the fiduciary rule could now have its own negative or unintended consequences, while others are concerned about whether or how the SEC’s version of the rule could weaken the DoL’s fiduciary consumer protections. At this point, is it not clear whether the SEC will try to better regulate titles and keep brokers separate from investment advisers (which may be challenging for broker-dealers that don’t want to relinquish the “advisor” title),  or attempt to create a consolidated uniform fiduciary standard (which FINRA may lobby for to expand its jurisdiction to oversee RIAs). And while no timeline has been presented for the SEC’s rule proposal, ostensibly if the DoL’s fiduciary rule is ultimately delayed, an initial version of an SEC proposed rule will be released in 2018, in an effort to finalize an SEC rule before the DoL’s version would take effect in mid-2019.

FINRA Board Approves Expanding Data Public Sees On Brokers (Mason Braswell, Advisor Hub) – Last week, FINRA authorized a regulatory notice to solicit comments on a proposal that would expand the amount of information available to the public on BrokerCheck, with details on dual-registered broker/IARs that would be akin to the data the SEC makes available on RIAs through its Investment Adviser Public Disclosure (IAPD) website, and the ability to let firms include (response/defense) comments about arbitration awards that they made to customers. On the other hand, the proposal would also allow BrokerCheck to exclude information about deceased individuals, or those who have not been registered since 1999. Notably, though, while expanded data is generally considered positive, critics have noted that allowing firms to include defensive comments about arbitration awards on BrokerCheck, without allowing consumers to also state their side of the case, is too self-serving. Similarly, there are concerns that deleting data on deceased and unregistered brokers will make it easier for broker-dealers with a history of hiring problematic brokers to obscure their past behaviors. Ultimately, any final rule change that FINRA proposes, once the public comment period has been completed, will still have to be approved by the SEC, although in recent years the SEC has had a strong streak of approving virtually all FINRA proposals.

Uniform Fee Chart Gathers Steam As Merrill Lynch And Cetera Sign On (Tobias Salinger, Financial Planning) – Back in 2014, the North American Securities Administrators Association (NASAA) formed a working group to establish a model disclosure document for broker-dealers to explain the various fee and charges that may apply to clients, including representatives from FINRA, SIFMA, and FSI, along with major broker-dealers and wirehouses including LPL, Morgan Stanley, Prospera Financial, and Signator, which initially adopted the guidelines in 2015. And after two years of languishing, the uniform fee chart is now gaining momentum, with 9 firms agreeing to sign on earlier this year, and now 14 more, including major players like Merrill Lynch, Cetera, Voya, and Ladenburg Thalmann. Notably, the point of the fee disclosure is not to cover standard trading commissions and advisory fees, but all the other miscellaneous charges that can apply from broker-dealers, from annual account fees and minimum balance fees, to the fees charged for outbound ACAT transfers, estate settlement, or holding ADRs or limited partnerships. Of course, the reality is that the looming Department of Labor fiduciary rule, and the transparency requirements it imposes, were leading to a push for greater transparency already, including a series of disclosures that will be required under BICE (once it takes full effect). Nonetheless, with adoption accelerating amongst major broker-dealers, there is hope that the majority of broker-dealers will agree to make the uniform disclosures available on their websites within the next year.

How And Where Advisors Are Spending The Same Dollar Twice (Matt Lynch & Marty Miller, Investment Advisor) – While the increasingly sophisticated technology available to financial advisors holds great promise of efficiencies and cost savings, in practice there is often a substantial cost – both financial, and in time and focus – to adopt new tools, and it can take far longer than anticipated to achieve favorable results… if at all, as many advisory firms are struggling from the switches to their second or third iteration of a particular type of software, still trying to find the right fit. Notably, though, not all firms even approach the problem for the same purpose – for some, it’s about getting better technology to achieve growth, while for others it’s about efficiency and cost control, and still others it’s about adding new capabilities to better serve clients. And the distinctions matter, because recognizing why the firm is pursuing new technology can be crucial to the process of really vetting potential solutions properly. In fact, Lynch and Miller suggest that the most common reason for “failed” technology adoption efforts are a lack of clarity about what the firm was really trying to achieve, which led them to not vet potential software and partners properly in the first place. In fact, they suggest one that good mechanism to really consider whether a new tool is the “right” one is to imagine that you had to present the decision to your management committee or board of directors, where you had to make a clear case to justify what was going to be implemented, and why, and what the expected return on investment would be (and what would have to happen for those results to be achieved). At the same time, it’s important to recognize the need for team buy-in – not just because the whole team must adopt technology for it to yield results, but also because team members may even feel threatened by new technology if the perception is that it may replace them in their own jobs. And the final tip: beware buying all-in-one solutions, unless you truly plan to use all the components, or you’ll end out needing to buy separate tools as well (for what the all-in-one already does), which means you’ll be spending dollars twice to fulfill the same need!

Best Tax Moves For Advisory Businesses (Jeff Stimpson, Financial Advisor) – Most financial advisors are small business owners, which means they are able to avail themselves of a wide range of tax deductions and benefits available to businesses. The starting point is deducting ‘obvious’ business expenses, from software to desk chairs and other office equipment, business phone lines and office rent, along with advertising and liability insurance. In addition, deductions are available for qualified retirement plans, and paying out of pocket for health insurance (and/or making a Health Savings Account contribution), as well as “professional” expenses including fees for licensing, membership dues for business/professional organizations, and the cost of continuing education. In addition, as small businesses, most advisory firms can deduct their larger purchases as Section 179 expenses (rather than being forced to depreciation them over time). Financial advisors structures as S corporations may also be able to pay themselves a salary (for just a “reasonable” portion of the business income), and take the rest as S corporation dividend distributions not subject to FICA taxes (though this can be problematic when working under a broker-dealer).

Mark Tibergien Looks To The Future Of RIAs (Janet Levaux, Investment Advisor) –  Over the past 10 years, the number of financial advisors working as independent or hybrid RIAs has nearly doubled, with client assets growing by about 9%/year at those firms. Tibergien sees this shift in the context of a broader trend, where financial advisors are shifting from being professional salespeople to professional buyers (gatekeepers for their clients), from being product advocates to client advocates, and from a commission-based structure to fee-based compensation (and a concomitant shift from suitability to fiduciary standards). In essence, financial advisors are shifting from the brokerage business to the actual advice business, driven by multi-decade factors including the rise of financial planning designations (e.g., CFP and ChFC), the shift to the independent broker-dealer model (which facilitated a more entrepreneurial mindset amongst advisors) along with the unbundling of the broker-dealer model (to no longer selling proprietary products), and the overt promotion of the fiduciary standard by certain membership organizations (initially NAPFA and later the FPA). And as CEO of Pershing Advisor Solutions, Tibergien himself has witnessed this trend, with a particular focus on larger breakaway RIAs (their average new RIA last year was $750M of AUM, and the platform overall is up to $200B of AUM). And the trend is not only likely to continue, but accelerate, as the DoL fiduciary rule may be the “final shove” needed to push even more registered representatives of broker-dealers to become RIAs, and forcing broker-dealers to reinvent themselves as advisor support firms and not primary product distribution companies. Ultimately, Tibergien expects to see 10-12 large truly “national” RIA firms to emerge in the next 10 years, along with 50-60 “super-regional” firms, as industry consolidation continues, although Tibergien also anticipates that the talent shortage of young financial advisors will grow more acute as more Baby Boomer financial advisors retire.

Stay Up On Medicare Enrollment With Annual Reviews (Mary Beth Franklin, Investment News) – On October 15^th, the next Medicare Open Enrollment period will begin, which is a time for clients who have previously elected not to take Medicare (during their original enrollment period at age 65) to finally decide to enroll. In addition, the Open Enrollment Period is also when those already on Medicare Parts A and B can switch to a Medicare Advantage plan (or from Medicare Advantage back to Part B, though they may not be able to get a private Medigap policy), or switch from one Medicare Advantage plan to another if already enrolled in one, or switch Medicare Part D prescription drug plans. Which means it’s a good time to conduct an annual review of clients’ Medicare plans – at a minimum to evaluate if their Part D coverage aligns with their current prescription drug needs (e.g., whether current drugs are still covered, if their drug plan’s formulary is changing, etc.). For advisors that need further guidance, Franklin notes that the National Council on Aging offers a free online guide to Medicare Open Enrollment, along with tools to help Medicare beneficiaries compare plans.

An Exception That Could Delay RMDs From 401(k)s (Ed Slott, Financial Planning) – Under the special “still working” exception, individuals who have reached age 70 ½ are permitted to delay taking their Required Minimum Distributions (RMDs) from their current company’s employer retirement plan until if they actually retire if they are still working at the company. Notably, the exception only applies if they do not own more than 5% of the company (including the attribution of shares from other family members, including a spouse, child, or grandchild), although that determination is made once in the year he/she turns age 70 ½ (which means the RMDs can still be delayed even if the employee becomes a more-than-5%-owner in subsequent years). In addition, the exception applies only to the current employer’s 401(k) plan (not any other employer retirement plan account, nor to any of the individual IRAs), though it applies equally to traditional and Roth 401(k) plans as long as the employee is still working. On the other hand, it’s notable that there is actually still no official guidance from the IRS on what constitutes “still working” – in theory, even working one hour per year might be eligible, but at a minimum it’s important to recognize that the require is not to be working “full time” (e.g., 40 hours/week) to qualify. Once the still-working exception ends, the employee must take their first RMD for the year he/she retires – even if the retirement date is December 31^st of that year – although as with anyone who faces their first RMD, the first distribution is not actually due until April 1^st of the following year (though deferring means the first RMD will be due alongside a second RMD that would also normally be due in the second/subsequent year). And for those who plan to roll over after retiring (and after having delayed RMDs for the still-working exception), be certain to take the RMD from the plan first, and only then complete the rollover, as the RMD itself is not eligible for an IRA rollover.

Mnuchin Recommends Withdrawal Of Proposed 2704 Regs (Susan Lipp & David Lenok, Wealth Management) – Last summer, the Treasury proposed new regulations under IRC Section 2704 that would have severely limited the use of valuation discounts for any type of family limited partnership (FLP) or other family business transfer, where the family would retain control before and after the gift/bequest occurred. At the time, the proposal generated a substantial furor, with advocates (including the Treasury itself) suggesting that it was crucial to curtail FLP valuation abuses with “artificial” discounts, and critics claiming that the proposal was a substantial overreach of the Treasury’s authority that would create a number of adverse unintended consequences. Now, after nearly 30,000 formal comments submitted in response to the proposal, a new report entitled “Identifying and Reducing Tax Regulatory Burdens” led by Treasury Secretary Mnuchin has declared that the proposed 2704 regulations are “unworkable”, and as a result the Treasury would be withdrawing its proposed regulation shortly. Estate planning attorneys have expressed relief, as the withdrawal of the proposal both preserves the FLP as an estate planning strategy, and reduces potential estate planning complications that may have arisen if the proposals had gone through (though of course FLP discounts may be a moot point anyway if President Trump’s proposed repeal of the estate tax is adopted). Nonetheless, the imminent threat of the Section 2704 regulations is now gone, which will likely renew interest in FLP discounting strategies. Although it’s important to bear in mind that if/when the political pendulum swings the other way in 2020 or 2024, a Democratic administration may still re-propose the Section 2704 regulations, or a substantively similar alternative “loophole closer”.

Why We Hate Rich People (Brad Klontz, Journal of Financial Planning) – In late 2009, the New York Times ran an article about how the financial crisis didn’t “just” affect the average American homeowner; the affluent, too, were feeling substantial financial distress. And the response was nearly “vitriolic”, with readers both showing little empathy for the plight of the affluent, but outrage at the author for caring in the first place! Which in turn raises the question of why, exactly, such hatred was directed at the affluent in the first place – as notwithstanding the dialogue of the time, that “the one percent” had rigged the system and caused the collapse, it was obviously clear that not “all” rich people were connected or to blame, even as classic stereotypes of greedy rich people dominated. Accordingly, Klontz actually did a subject study to analyze more than 1,000 wealth individuals, to try to actually evaluate whether and to what extent the stereotypes of the wealthy really were accurate or not. The results, published in a paper titled “The Wealthy: A Financial Psychological Profile”, and a related literature review, found that feelings of resentment towards the wealthy stem from three psychological constructs: 1) money ambivalence and cognitive dissonance (paradoxically, those most likely to endorse anti-wealth beliefs were actually more likely to have money-worship scripts, suggesting the dislike stemmed at least in part from the implicit frustration of desiring wealth and struggling to achieve it); 2) the psychology of envy, which can further amplify the cognitive dissonance, especially in situations where the rich person had a similar prior background (potentially making us feel inferior for not achieving a similar result from similar circumstances); and 3) the Theory of Relative Deprivation, which recognizes that we assess our own well-being less based on the absolute level of our income or financial success, and more based on our relative results to others (such that the more acutely aware we are of the wealth of others, the more relatively inferior it can make us feel). Notably, though, Klontz also points out that the discomforts that some people experience due to disparities of income can lead us to put an effective ceiling on our own wealth to keep us in a “financial comfort zone” relative to our peers. In other words, not only can significant wealth gaps incur a dislike of those who are much wealthier than we are, but there’s a risk that in becoming wealthy and separating from our peers, we can even trigger a dislike of ourselves that leads us to self-sabotage our own financial success.

Why Rich New Yorkers Are Hiding Their Wealth And Privilege (Rachelle Bergstein, New York Post) – In researching her new book called “Uneasy Street: The Anxieties of Affluence”, author Rachel Sherman interviewed 50 New York-area parents of young children, who had household incomes from $250,000 to $10 million and assets as much as $50M. And what she found was that, even amongst the ultra-affluent, there is a strong tendency to rationalize one’s circumstances as being “in the middle”. For instance, one stay-at-home mom in a household with $2M/year of income viewed herself as “in the middle” because she still saw people around her with even more money. In another case, a 39-year-old mother with a $4.5M penthouse apartment petitioned the local post office to remove the letters “PH” from her official mailing address, because she didn’t want to appear “elite and snobby”. In essence, Sherman found that even the wealthy still struggle to find the socially acceptable balance between being wealthy and trying to convey that they are “morally worthy”. Similarly, Sherman found a strong tendency of the wealthy to underscore the hard work they put in to earn their wealth, as a means of distinguishing themselves from the stereotype of the undeserving, idle rich – even though, in some cases, the bulk of the assets really were inherited, or the “work” was not directly related to the wealth creation (e.g., one subject justified her upscale apartment by pointing out that she put a lot of elbow grease into painting the walls). In other cases, the wealthy rationalized their wealth to themselves through concomitant charitable endeavors, or by justifying their spending as necessary to help give their children the best possible lives, even as they also try to expose their children to a wide range of other individuals and circumstances to help them keep their own wealth in perspective. The fundamental point: notwithstanding the stereotypes of flaunting wealth and conspicuous consumption, many affluent individuals actually find their own wealth to be extremely disconcerting (even if they don’t necessarily take steps to change it).

The Effect Of Early Retirement On Kids (Reddit) – In this Reddit thread, Redditors share their experiences growing up in a “FIRE” (Financially Independent/Retired Early) household, and the impact it had on them, in a world where many fear that by retiring early it will leave a bad impression on their children (about not needing to work). Yet one person recounts how when his father retired early at age 45, he was able to take an active role in his kids’ educations, improved his personal health, and left a very positive impression on his son about how to work smart … though he also witnessed marital strife amongst his parents because his mother had not retired early (for unspecified reasons). And another shares a similar story of having a FIRE’d father (when he was in middle school) who was able to be very engaged in his child’s education and extracurriculars (with a positive outcome). In fact, notwithstanding the common fear that retiring early will set a “bad example” for children, a common theme amongst most children of parents who FIRE’d was that their parents still ended out staying active and engaged somehow (even if it was engaged with their wealth, such as by managing their real estate properties), and that consequently their parents still set positive examples for them.  In other words, at worst the “risk” of setting a bad work ethic example by retiring early is entirely in the hands of parents who retire early about whether they still find a way to set a good example. Though as one person stated it more simply: “I really wish my Dad had spent more time at work instead of with me when I was a kid… said no one, ever.”

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.