Weekend Reading for Financial Planners (Sept 4-5)

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.

The Social Security Trust Fund Is In Better Shape Than Expected. For Now.  (Ginger Szala, ThinkAdvisor) - This week, the latest Social Security Trustees Report was released, indicating that the Social Security trust fund is currently projected to be depleted by 2033, one year earlier than the 2034 depletion date projected last year; after that point, Social Security would "only" be able to pay 76% of scheduled benefits (where those future benefits are paid simply by using the then-dollars that come in from FICA/payroll taxes on workers in 2034 and beyond). In practice, though, some experts feared that with the economic slowdown of the pandemic, the Social Security trust fund depletion could have accelerated to be as soon as 2029, which means in practice the outcome is actually less dire than was feared (though it remains to be seen if the lingering effects of the pandemic may further impact the projections in next year's report, particularly given the recent increase in inflation that will increase Social Security's future payments more than typically projected via the annual Cost-Of-Living Adjustment, which may or may not be offset by the estimated-to-be-400,000 number of deaths of Social Security recipients due to COVID-19). Notably, though, the reality is that the Social Security trust fund has been projected to be depleted in approximately the 2033-2035 range for more than a decade, and the solutions to resolve the shortfall are well understood, with some prospective combination of reducing benefits by 21% immediately, 24% starting in 2034, or by 25% for all those who became eligible in 2021 or later (but grandfathering current recipients); increasing FICA taxes from the current 12.4% to either 15.76% today, or 16.6% in 2034; or a wide range of other projected solutions, including reducing the annual COLA, indexing the Social Security bend points (and/or creating a new, higher Social Security bend point), increasing the Social Security wage base (and/or eliminating altogether the cap on the amount of income subject to Social Security taxes), or increasing full retirement age beyond age 67, for which the Social Security trustees have laid out tables showing the relative impact of various trade-offs. Which ultimately means there isn't really a question of "what to do" about Social Security's shortfall, but simply a matter of what politicians will implement, between a 24% benefits cut, a 4.2% increase in payroll taxes, or some combination of the other options, between now and 2033?

Advisor Satisfaction By Generation (Catherine McBreen, Advisorpedia) - In recent years there has been a growing discussion of whether "next generation" clients - i.e., Gen X and Millennials - will engage financial advisors the way the Baby Boomer generation has, but, in practice, one study after another is showing that younger clients appear, if anything, to be more interested in working with a (human) financial advisor, and studies by McBreen at Spectrem Research similarly showed that satisfaction is fairly similar and high across the generations (at 'just' 87% for Gen X and a high of 92% for the WWII Silent Generation). However, when it comes to satisfaction with the nature of advisor-client communication, there is a more substantive difference, with 74% of the Silent Generation and 62% of Baby Boomers rating their advisor's responsiveness as "excellent", compared to only 50% of Gen X and a mere 33% of Millennials. In turn, it is perhaps not surprising that the research also shows that while younger clients may be 'satisfied enough' that they're not terminating their advisor relationships, their unhappiness about responsiveness means they are somewhat less likely to refer their advisor, at 53%-56% of Gen Xers and Millennials (compared to over 2/3rds of Baby Boomers and the Silent Generation). On the other hand, the research also indicates that Millennials are the most active referrers when they do refer, with 26% of Millennials referring their advisor 6+ times in the past year alone, compared to just 6% of Gen Xers, 5% of Baby Boomers, and 2% of the Silent Generation. In other words, younger generations have different/higher expectations around communication from their advisors, and are driven by that responsiveness (and not just 'satisfaction' in general) when deciding whether to refer... but when advisors do win over their younger clientele, they can quickly become an advisor's strongest source of referrals!

2021 Midyear 'Pulse Of The Industry' Shows Rapid Growth And Hiring (Lauren Tucker, Ensemble Practice) - With work and travel restrictions being lifted for at least the first half of 2021, the Ensemble Practice conducted a recent survey of larger (averaging >$1B of AUM) independent advisory firms to understand where they stood through the first half of 2021 (albeit before the rise of the Delta variant). Overall, the results show that advisory firms are experiencing a significant positive growth 'rebound' from 2020, with the median firm's AUM up 13.7% in just the first 6 months of 2021 alone, which was carried not only by the rise in markets but strong new client growth leading to an average 6% increase in the number of client relationships per advisor. In turn, the boom in revenue and client growth is leading to an uptick in hiring, with 63% of firms surveyed hiring for a new position (not just replacing an existing one), and 50% of firms having already increased their headcount this year. Notably, the study also found that while mergers and acquisitions continue to be popular as a growth strategy for larger firms, internal transitions of those firms are also becoming increasingly popular, with 33% of firms reporting an internal equity transition to partners and next-generation advisors, and 12% of firms having added entirely new partners in the first half of the year.

How A Client's Solo 401(k) Can Become A Mega Backdoor Roth IRA (Ginger Szala, ThinkAdvisor) - In recent years, the "solo 401(k)" plan has become an increasingly popular way to save more dollars for retirement, particularly with the rise of the "gig economy" where more and more workers are independent contractors setting up their own "employer" retirement plans, sometimes even as a side hustle on top of their "main job" that may have its own 401(k) plan. Because as long as the businesses are unrelated, an individual really can be a participant in two separate 401(k) plans. The caveat, though, is that salary deferrals are a per-individual limit across all plans - not just per plan - which means if they've already maxed out the $19,500 contribution limit (or $26,000 with catch-up contributions over age 50) in their main plan, it's not possible to add more to the separate solo 401(k). However, it is still possible to contribute after-tax dollars to a separate/second solo 401(k) plan... and then, if their plan has been designed to permit in-service distributions of those after-tax contributions, can convert those dollars to a Roth IRA entirely tax-free (given that they would all be after-tax dollars!), as a form of "mega backdoor" Roth IRA! Which, in the extreme, could permit as much as $58,000 per year in backdoor Roth contributions, as long as the individual earns at least that much in their independent/side business to be able to contribute 100% of those earnings to a solo 401(k) plan (and obviously, as long as they have the available free cash flow to be able to make such contributions!).

The Very Rich Are Eyeing PPLI To Avoid A Looming Biden Tax Increase (Ben Steverman, Financial Advisor) - Private Placement Life Insurance (PPLI) has long been a tax-shelter vehicle for ultra-high-net-worth clients, leveraging the tax-deferral build-up of cash value in a permanent life insurance policy but in a structure that accommodates more specific investment choices (for that particular HNW client) and without the sometimes-expensive commission structure that can overlay 'traditional' permanent life insurance. However, a change to life insurance reserve requirements under the Consolidated Appropriations Act in late 2020 now allows insurance companies to use lower interest rate assumptions (based on a new variable rate tied to current market rates) in determining whether a life insurance policy will become a taxable Modified Endowment Contract (MEC), which has the end result of allowing substantially higher cash value contributions into permanent life insurance without triggering MEC status. At the same time, the rise of a potentially significant increase in the taxation of both ordinary income and especially capital gains under President Biden's proposals is leading to growing interest in a wide range of 'tax shelters' for ultra-HNW clients. And the combination of the two is leading to a rapid increase in the number of HNW individuals now exploring PPLI as a tax shelter, with the new, more appealing tax-deferred cash value accumulation potential, coupled with a looming Biden tax increase. Of course, the reality is that surrendering a high-growth life insurance policy is itself still taxable, which means the value of high-growth PPLI, once implemented, can generally only be extracted partially via policy loans, or by holding the policy until death (though that option itself may still be appealing for those otherwise concerned that the Biden administration will eliminate the step-up in basis rules). And because of the complex rules involved in establishing PPLI, it's generally recommended only for those who can contribute at least $2M (and more commonly, $5M+) to the policy. Though some carriers like Lombard International are trying to give advisors themselves the option to 'keep control' (i.e., still manage) assets within the Private Placement Life Insurance policies, making it an appealing option for firms with ultra-HNW clients to explore.

Five Tax Planning Strategies For The Ultra-Wealthy (Allan Roth, Advisor Perspectives) - The Biden administration has proposed a number of potentially significant tax increases for affluent clients, including an increase in the top ordinary income tax bracket from 37% to 39.6% (in a world where IRAs may 'only' be able to stretch for 10 years), taxing long-term capital gains above a $1M threshold at those 39.6% ordinary income rates, eliminating the step-up in basis on gains in excess of $1M at death, reducing the estate tax exemption amount from $11.7M back to "just" $3.5M, and restricting some of the tax benefits associated with grantor trusts. However, because the Biden proposals have not been implemented - at least not "yet"? - a window remains for engaging in more proactive tax planning opportunities in advance of the potential legislation (albeit with the risk that it's at least possible, though unlikely, that some tax changes could be implemented retroactively). Potential strategies in the current environment include: establishing an intentionally defective grantor trust (IDGT) to shift higher growth assets out of the estate in exchange for a slower-growth installment note that remains (and as a grantor trust, it's 'permissible' to pay the income taxes from within the estate on the growth outside the estate, further amplifying the estate tax savings over time); leveraging family limited partnerships to obtain discounts on intra-family gift transfers; establishing a Grantor Retained Annuity Trust (GRAT), where assets placed into the trust are expected to be repaid from the trust plus a modest interest rate (but any growth in excess of that interest rate is shifted out of the estate to heirs); converting IRA dollars into Roth dollars at current tax rates (to avoid the potential for higher rates in the future); and engaging in capital gains harvesting where current gains are intentionally triggered (or even an entire business is sold!) at current Federal capital gains rates (which top out at 20% plus 3.8% Medicare surtaxes) to avoid the risk of 39.6% + 3.8% = 43.4% in the future.

Mystery No More: Portfolio Allocation, Income and Spending in Retirement (Katherine Roy & Kelly Hahn, J.P. Morgan Asset Management) - J.P. Morgan Asset Management leveraged the EBRI database of 23 million retirement accounts, and their own data on 62 million households, to study 31,000 people as they approached and entered retirement between 2013 and 2018, enabling them to present one of the most comprehensive views of households going through the retirement transition, and examining their investment management, income, and spending behaviors. The median estimated investable wealth was $300,000-$350,000, and about 30% had an annuity and/or pension. The most eye-opening data involved de-risking behavior, with 75% of people reducing equity exposure after rolling over their 401(k), with a median equity allocation decline of 17%. People with 80-100% in equities pre-rollover logically saw the biggest decreases (a whipsawing 42% swing going from perhaps an unhealthy overweight to unhealthy underweight!?), while those with 60-79.9% in equities decreased equities by an average of 18%. Looking at income and spending patterns, 84% of those subject to RMDs took only the required amount, though it's not entirely clear if that was because they were problematically using RMDs as a spending guidepost, or simply because they were affluent enough they didn't need the RMDs and thus simply took only what they must (as the data does indicate that those less wealthy took earlier withdrawals more often). At the same time, though, there is also evidence that spending patterns were more broadly correlated with available retirement income (where spending increased when income increased, e.g., with the onset of Social Security payments), suggesting the opportunity for planners to work with clients to support higher spending early in retirement when they really can afford to (and when they're more likely to have the opportunity to enjoy it!). And consistent with other recent research, clients with regular income from annuities or other means spend more than those without (looking at people with the same overall wealth levels). With those 10,000 boomers turning 65 every day and transitioning into life after full-time work, helping aging clients optimize when and how they leverage their assets to align their money with the behaviors that bring them the most joy and satisfaction while managing longevity risk is going to continue to be a driving force in the industry.

8 Financial Do's and Don'ts for the 7-Figure Retirement (Sheryl Rowling, Morningstar) - Relative to the average American, having a 7-figure retirement account is a 'nice problem to have', but the reality is that with more affluence often comes more challenges and complexity, and more decisions that have to be made in order to navigate the retirement transition. Accordingly, Rowling highlights a number of key decision points - and the related do's and don'ts - to consider in helping prospective retirees make the transition, including: it's important to be mindful of sequence of return risk, especially when retiring early (thanks to all of that wealth), as the longer the time horizon, the more risk there is with an untimely early retirement market decline; most pre-retirees have relatively stable tax planning because their income is consistently buoyed by annual wages, and consequently may underestimate the volatility of their taxable income in the early retirement years (and miss opportunities for tax planning to maximize tax-efficient retirement withdrawals); be mindful of the timing when starting Social Security retirement benefits, especially for those who otherwise have plenty to live on, expect a long life, and can afford to bridge the early retirement years from their portfolios in order to delay Social Security; beware locking in "expensive" payments and financial commitments... including not only the second/vacation/retirement home, but over-extending the "Bank of Mom and Dad" to adult children; and finally, remember that just because one has the financial affluence to be able to afford not working anymore, doesn't mean they will find a life without work (and for some, without purpose or a reason to wake up every morning) to be fulfilling, as in the end it's much better to be retiring towards something rather than just retiring away from our current life!

Hospitals And Insurers Didn't Want You To See These Prices. Here's Why. (Sarah Kliff & Josh Katz, New York Times) - This year, a new rule from the Federal government is requiring hospitals for the first time to begin publishing the complete list of prices they negotiate with private insurers, and while the insurers' trade association had actively fought the rule, repeated court losses mean that some hospitals are beginning to release data... and revealing that some hospitals charge patients "wildly different amounts" for the same basic services, and that some of the world's largest insurance companies are negotiating "surprisingly unfavorable rates for their patients", in some cases higher than they would have paid with no coverage at all! For instance, at the University of Mississippi Medical Center, a colonoscopy costs $1,463 with a Cigna plan, $2,144 with an Aetna plan, and just $782 for those who are uninsured and simply paying out of pocket, even as one of the proclaimed benefits of health insurance is that large insurers are supposed to be able to negotiate in bulk with providers to receive more favorable rates. Which is especially contentious over the past decade, as health insurance has increasingly shifted towards high-deductible plans where those unfavorably negotiated rates don't even adversely impact the insurer, just the individual paying for health insurance who has to bear the entire cost out of pocket themselves! The insurance industry maintains that the situations where cash-payers get better rates than insurer-negotiated rates are just an anomaly, but a broader study of 60 major hospitals that have released data shows at best, there is little pattern on how rates are negotiated, with some small health plans that ostensibly would have little leverage sometimes out-negotiating the five larger insurers that dominate the market, and, in some cases, a single insurer can have a half-dozen different prices even within the same facility, just depending on which plan was chosen at open enrollment (and whether it was bought as an individual or via an employer), such as an MRI at Aurora St. Luke's in Milwaukee that costs $1,093 on a United HMO plan but $4,029 on the same insurer's PPO plan for the same service from the same institution. In turn, a similar variance can exist across multiple hospitals within a similar region - such that patients might literally save thousands of dollars by driving just a few miles to another facility for a particular procedure... but without any way to determine what the relative costs of each will be. And notably, it's not only that patients often struggle to determine prices for services; in practice, even employers can often have difficulty getting pricing information from/regarding the plans they may be considering for their employees (and in some cases, hospital-insurer negotiated contracts outright include gag orders that prevent price disclosure!). Ultimately, it remains to be seen what will happen as more revelations about pricing come as the new disclosure requirements set in - and the Centers for Medicare and Medicaid Services has indicated it may start to levy increasing fines against hospitals that do not comply - although thus far, it's still the early days of gathering and delivering the data.

Wisdom I Wish I Knew 30 Years Ago (Barry Ritholtz, The Big Picture) - As the host of the Masters in Business podcast, Ritholtz notes that one of his favorite questions to ask guests is "What do you know today about your chosen field that you wish you knew when you were first starting out years ago?" And so as an experienced practitioner, Ritholtz has turned the question on himself to reflect on the 10 things he wishes that he understood himself when starting his career, including: keep "building your skillstack" even after you finish your formal education, whether by taking classes, reading, or other learning opportunities; sometimes the best way to learn is "addition by subtraction", getting more focused on fewer things and going deeper on them, instead of just trying to take in everything (which almost inevitably results in shallower less impactful learning); assemble a portfolio of talented people that you get to know and would do anything with or for (they could be colleagues, people you hire, people you work for, those you introduce, etc.), who will make you better simply by having them in your orbit; have some "trusted counsel" who can provide you unfiltered feedback when you need to hear it; remember that without failure, there is no growth, and that while we shy away from career situations where we might fail, they're often the ones that catapult us forward (even if we fail at that job or task in particular!); don't worry about your first few jobs (it's not about where you start your career, it's about where you grow to by the mid-career stage after the first decade!); and "we are our habits", so focus on building the habits that advance you forward (because when it's a habit, even just one tiny step at a time compounds when it's done every day/week/month of the year!).

Quinn's Commands To An 18-Year-Old (Richard Quinn, Humble Dollar) - Notwithstanding the challenges of student loan debt, the reality is that today's youngest generation is the best educated generation in history. Yet at the same time, Quinn notes that having a better education, and more potential, isn't necessarily a full substitute for experience, and accordingly imparts his own 60-years-of-greater-experience wisdom for what young people today should really be mindful of. Key tips include: a college education gives you what you put into it (i.e., getting the piece of paper that is a degree doesn't really mean much if you were just getting by); where you go to college may seem important, but after your first job, it will be meaningless, as your value in the future will be determine by the value you demonstrate to your first (and subsequent) employers; the system is always rigged by some people and for some people, making it harder for some folks to get ahead, but that's always been the case to varying degrees and there are always exceptions, so don't let it constrain you; seek what you've earned, not just what you feel entitled to; you will face obstacles, unfair treatment, and have to deal with less-than-honorable individuals, so the faster you learn how to just get over it and move on, the better; plan ahead, because the future is not as far away as you may think; and save first before you spend, as living within (or below) your means and avoiding accumulation of unnecessary stuff is something you'll be very thankful for later!

100 Tips For A Better Life (Ideopunk) - In this thread, Ideopunk provides a wide range of great tips for living a better life that anyone can apply, including: things you use for a significant fraction of your life (e.g., you're in your bed for 1/3rd of your life, and your office chair for 1/4th of your life) are worth investing in; if you have to ask "where is the good knife", it means you're buying bad ones as well, and should probably throw those out (and ditto for anything where you have a good X and a bad X to choose from!); establish clear rules about when to throw out old junk, as once you do, junk will quickly cease to be a problem; when buying things, remember how time and money trade off (if you're low on money, take time to find deals; if you're low on time, stop looking for deals and just buy something quickly for a 'reasonable' price and move on); learn keyboard shortcuts, their time savings really adds up over time!; done is better than perfect; discipline is superior to motivation (as the former can be trained, but the latter is fleeting); you can improve your communication skills with practice more effectively than your intelligence, so remember that even if you're not the smartest in the room, you will have a great advantage if you can communicate ideas clearly; if you try to learn methods from/about successful people, remember that the people who tried and failed it probably didn't make a video for you to get both sides of the story (so take it all with a grain of salt!); cultivate a reputation for being dependable, because good reputations are valuable and rare; don't forget how much our mood and wellbeing are influenced by the simple things: exercise, good sleep, light, and being in nature.

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 "Mystery No More: Portfolio Allocation, Income and Spending in Retirement".