Nerd's Eye View blog

The Problem With S Corporations For Independent Brokers And Insurance Agents

February 13, 2017 07:01 am 38 Comments CATEGORY: Practice Management

Using an S corporation to reduce self-employment taxes – by splitting the income into a “reasonable compensation” salary and S corp dividends – is a popular strategy that financial advisors recommend to clients in a wide range of businesses. And in point of fact, it’s actually a viable strategy for financial advisors to use for their own advisory firms.

However, the recent Tax Court case of Fleischer v. Commissioner (TC Memo 2016-238) serves as a reminder that while advisory fees can be paid to an S corporation and partially passed through as a dividend to reduce taxation, the strategy does not work for insurance and investment commissions. In Fleischer’s case, the Tax Court invalidated his efforts to assign and transfer both his LPL investment commissions and MassMutual insurance commissions into his S corporation, finding instead that he should have claimed them as personal income on his Schedule C (and paid self-employment taxes on all of it).

The fundamental challenge is that, in order for a corporation to legitimately claim income, it has to actually control the contractual engagement to earn in the income. Which in the case of insurance and investment commissions, is generally impossible, because securities and state insurance laws require that commissions be paid directly to the individual. The only way an entity can legitimately receive the income is if the entity itself is registered as a broker-dealer or an insurance agency (and then contracts directly for the commission income), which alas may be common for an RIA but is usually not feasible for a broker-dealer or insurance agency due to regulatory and compliance costs.

Nonetheless, as the Fleischer case indicates, the fact that establishing a bona fide broker-dealer or insurance agency isn’t economically feasible in most cases doesn’t change the underlying requirement of the tax law – which is that if an individual earns income personally (including investment or insurance/annuity commissions), that person must report the income for tax purposes, and can’t simply transfer it into a business account and issue a 1099-MISC to the S corporation and expect it to be honored by the IRS!

Weekend Reading for Financial Planners (Feb 11-12)

February 10, 2017 02:48 pm 4 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with the latest of the fast-moving news on the DoL fiduciary rule, with the Texas judge who was forum-shopped in expectation of a favorable ruling by fiduciary foes coming out with an 81-page ruling that slammed the door on every industry objection to the Department of Labor's fiduciary rulemaking process, and now the latest rumor that DoL may still soon be issuing a proposal to delay the applicability date of the rule (though notably, the delay proposal itself would have to go out for public comment before it can occur).

From there, we have several technical planning articles, including: when/whether it makes sense to do after-tax contributions to a 401(k) plan; how life insurance is increasingly being issued online without a need for medical records and blood and urine samples (and at a lower cost); a retirement income comparison of the lifetime tenure payment of a reverse mortgage to an immediate annuity; and the role of QTIP trusts for "small" estates that want asset protection while still preserving a step-up in basis at the death of the spouse.

There are also a couple of practice management articles this week, from tips to prevent hackers or thieves perpetrating wire fraud on your clients, to a look at the key trends of the advisory industry (and busting a lot of myths along the way), a discussion of the key performance indicators that advisory firms should track to monitor their success, and tips on how to position yourself to grow clients when the next bear market comes along (by preparing a proactive communication plan).

We wrap up with three interesting articles: the first is a fascinating look at all the objections we as advisors tend to raise about marketing, despite the challenge that we truly believed in the value of what we provided, we should want to tell everyone about what we do; the second points out that it's time to reimagine how advisory firm offices are physically laid out, as clients want to feel more engaged in the process (and not just feel like they're sitting in a stately meeting room); and the last is an interesting "open letter" from a Millennial to advisors, reminding them that ultimately the problem isn't that young people don't want to work with an advisor, but simply that the availability of the internet and smartphones means they're acutely aware of what they can already do easily online, and as a result will demand (and be willing to pay for) advisors provide real value above and beyond what technology can already provide.

Enjoy the "light" reading!

The Real Blocking Point In Growing Financial Planning: Lack Of Awareness

February 9, 2017 11:16 am 6 Comments CATEGORY: Planning Profession

With the total number of financial advisors continuing to decline year after year, the industry is increasingly focusing on what it takes to attract and retain new financial advisors, with a strong focus on career track opportunities and how to improve retention. However, new research from the CFP Board reveals that the real blocking point to growing the ranks of financial planners is simply that too few young people even know that financial planning exists in the first place! In other words, our struggles to grow are first and foremost a simple issue of awareness... or lack thereof!

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we chat with Kevin Keller, CEO of the CFP Board, at the Center for Financial Planning's new Academic Research Colloquium, about the challenges of financial planning awareness, new initiatives from the CFP Board, and what individual financial planners can do to help.

Because despite the fact that financial planning is a very lucrative career - especially when compared to the median household income in the US - the research shows that most young people are skipping financial planning as a prospective college major because they simply don't know that the opportunity exists! As a result, even generalized public awareness campaigning, such as the CFP Board's "DJ ad", have actually been successful at attracting people to download the "Guide to Certification" and check out financial planning as a career.

Fortunately, the needle is beginning to move, as is evidenced by the 1,000 people from baccalaureate programs that sat for the exam this past year (up from 700 the years before). But there is still room for progress. Accordingly, in 2017, the CFP Board will be launching a new "I'm a CFP Pro" initiative - with the aim of increasing both gender and racial diversity by telling the stories of CFP professionals who are women and people of color - in addition to continuing to grow their Women's Initiative (WIN) and women-to-women mentoring program. Also being launched this year is a new Massive Open Online Course (MOOC) offered through Coursera in partnership with the University of Illinois, and a new certificate program with the Columbia University to help train advisors who want to be financial planning educators the necessary skillsets to actually teach the material.

The bottom line, though, is simply to recognize that the biggest problem in bringing new people into the financial planning industry is that many don't realize the profession exists in the first place. So if you want to have a role in advancing the profession, go back and speak to your alma mater or alumni association and just tell them about what you do as a successful financial planner, and help spread the word. Or alternatively, if you're connected to the TV industry at all, help us figure out how to launch a new television show that features financial planning or a central character who is a (good) financial planner!

Interpreting Monte Carlo Analyses and the Wrong Side of Maybe Fallacy

February 8, 2017 07:02 am 26 Comments CATEGORY: Retirement Planning

Monte Carlo analysis has become a common standard amongst financial advisors for evaluating the health of a prospective retiree's spending plan in retirement. And while the framework itself may be a rigorous way to look at a wide range of potential outcomes, there's one big problem: it's difficult to know how to interpret the results, and what to do with a scenario like a "95% probability of success". Who wants to risk being part of the other 5%?

In this guest post, Derek Tharp – our new Research Associate at Kitces.com, and a Ph.D. candidate in the financial planning program at Kansas State University – delves into behavioral biases and challenges that influence our ability to interpret the results of a Monte Carlo analysis, and in particular the so-called "wrong-side-of-maybe" fallacy.

The wrong side of maybe fallacy refers to our tendency to interpret a projection as "wrong" if the outcome is inconsistent with the most likely outcome forecasted, and can quickly interfere with the proper interpretation and understanding of probabilistic forecasts. Because unfortunately, we have a tendency to try and evaluate the accuracy of a forecast based on a single outcome - if there's a 95% probability of success, and it turns out to be a failure, the forecast must have been "wrong" - even though in reality, the accuracy of probabilistic forecasts can only be evaluated over a series of multiple outcomes (i.e., to see if a 95% probability of success is really success in 19 out of 20 attempts, on average).

Of course, when working with retirees, the reality is that they do only get one shot at retirement. Which means it's unlikely that advisors are going to encounter retirees who are sympathetic to the nuances of proper probabilistic interpretation if their retirement is turning out poorly! Furthermore, the wrong side of maybe fallacy isn't the only psychological barrier to properly interpreting Monte Carlo analysis. Behavioral research suggests that when clients are asked to express their comfort level with a particular Monte Carlo probability of success, rather than giving a response that answers the question at hand, they may be substituting in an expression of their intensity of feelings regarding failure instead. In other words, a retiree's indication of their comfort with a 90% probability of success may actually be an expression of how much they dislike the idea of 10% outcome (e.g., running out of money in retirement) rather than their actual willingness to tolerate the 10% risk of it occurring.

Fortunately, there are steps advisors can take to help retirees avoid misinterpretation of Monte Carlo analysis. From re-evaluating terminology – such as framing Monte Carlo analysis in terms of probability of "adjustment and excess" rather than "success and failure" – to emphasizing the importance of ongoing planning, and using "squishy" language to guard against clients being overly critical in their interpretation of an advisor's advice. Ultimately, if advisors want to help retirees make better decisions when evaluating Monte Carlo analyses, the cognitive and behavioral biases which may interfere with proper interpretation should not be ignored!

#FASuccess Ep 006: Eleanor Blayney On Improving Gender Diversity in the Financial Services Industry

February 7, 2017 07:00 am 2 Comments CATEGORY: Financial Advisor Success Podcast

Welcome back for the sixth episode of the Financial Advisor Success podcast!

This week’s guest is Eleanor Blayney, one of the founding partners of Sullivan, Bruyette, Speros, & Blayney – now known as SBSB – an early leader in the world of independent RIAs that quickly grew to a billion dollars under management in the early 2000s before it was sold to Harris Bank. Eleanor is also an author, and currently the CFP Board’s Consumer Advocate.

On this episode, I talk with Eleanor Blayney about the challenges of growing an independent RIA as a woman in a male-dominated industry, starting with how she first learned of the world of financial advice by reading about it in MONEY and Washingtonian magazines, and then cold called well-known advisors in the DC area until she found her way to her first job… and followed a path that ultimately led to her to becoming a partner at the firm despite not bringing her own book of clients.

From there, Eleanor talks about how SBSB grew its first billion of AUM so rapidly, by providing a combination of financial planning, investment management, and tax preparation services and forming a niche specialization advising on stock options for tech companies during the 1990s tech boom, and what it was like to sell the firm and transition into her current role as an author and industry advocate.

And be certain to listen to the end, where Eleanor weighs in on the controversial question of whether women should be considered a “niche” in financial services, and her advice on how to survive as a woman in a male-dominated industry (and what male advisors could do to be more supportive of industry diversity!).

So whether you’re a woman trying to find your own path in the world of financial planning, or simply an advisory firm owner looking for inspiration on how to carve a path to a billion dollar firm, I hope you enjoy this latest episode of the Financial Advisor Success podcast with Eleanor Blayney!

The Latest In Financial Advisor #FinTech (February 2017)

February 6, 2017 07:01 am 1 Comment CATEGORY: Technology & Advisor FinTech

Welcome to the February issue of the latest news in Financial Advisor #FinTech – where we look at the big news, announcements, and underlying trends and developments that are emerging in the world of technology solutions for financial advisors and wealth management!

This month's edition kicks off with a look at the emerging fight over consumer financial data, as J.P. Morgan and Wells Fargo announce a deal with Intuit (Mint.com) to facilitate direct data feeds through an API that will reduce the bank's server loads and enhance security over clients entering passwords into third-party applications, and former Intuit CEO Bill Harris calls the partnership "baloney" and suggests the big banks are simply trying to force data aggregations to rely on a bank-provided authorization token that allows the banks to control the flow of data and potentially even force third parties to pay for it. In the meantime, President Trump's Executive Order to begin dismantling Dodd-Frank threatens the not-well-known "Section 1033" that ensures consumers retain rights to their financial data, raising the question of whether banks will soon become even more restrictive against account aggregation solutions... and in response, the tech companies are now forming a new Consumer Financial Data Rights industry group to lobby for consumers' rights to their financial data (and the right of FinTech providers to collect it for them).

From there, the latest highlights also include:

TD Ameritrade launches a new iRebal Model Portfolio Marketplace that could become a major TAMP disruptor.
Betterment raises fees by 67% on its most affluent clients, and pivots to offering human financial advisors.
Wealthfront tries to expand from being "just" a robo-advisor to a full-fledged robo-planner, and in the process may show up the shortcomings of today's financial planning software providers.
Starburst Labs, maker of Wealthbox CRM, raises a $6.25M Series A round.
Grendel CRM makes a bid to become a central investment advisor dashboard with a deep TD Ameritrade Veo integration.
RightCapital financial planning software startup lands its first enterprise deal.

You can view analysis of these announcements, and more trends in advisor technology, in this month's column, including new integrations from Tamarac, a new Addepar partnership with Morgan Stanley, the SEC adding "electronic investment advice" (of both the "robo" and "digital" varieties) to its exam priorities for 2017, the launch of a new $50M Northwestern Mutual FinTech Venture fund, and a new tech tool to facilitate better client data gathering meetings called Asset Map.

I hope you're continuing to find this new column on financial advisor technology to be helpful! Please share your comments at the end and let me know what you think!

*And for #AdvisorTech companies who want to submit their tech announcements for consideration in future issues, please submit to [email protected]!

DoL Fiduciary NOT Yet Delayed By President Trump After All…

February 4, 2017 09:30 am 96 Comments CATEGORY: Regulation & Compliance

Given the party-lines debate that has revolved around the Department of Labor's fiduciary rule for the past year - ever since President Obama put the full force and backing of the White House behind the final rule - it was widely believed that once President Trump won the presidential election, it would just be a matter of time before he issued an Executive Order to delay the rollout of the regulation this April. And yesterday morning, the White House circulated a draft version of the coming Executive Order, to be signed that afternoon, that would impose a 180-day delay to the rule.

Except as it turns out, the final version of the Memorandum that President Trump signed did not actually include a provision to delay the fiduciary rule after all, despite wide media reporting to the contrary! Instead, the Secretary of Labor was merely directed to conduct a new "economic and legal analysis" to assess whether the fiduciary rule and its looming applicability date is causing harm to investors by limiting access, triggering dislocations in the retirement services industry, or likely to cause increased litigation and increased costs for consumers. And if that is the case, then the Department of Labor would undertake yet another proposed rulemaking process, with a Notice and Comment period, before proceeding. A direct Executive Order from the President to delay, though, is off the table (though notably, many had pointed out it wouldn't have been legally permissible to delay that way in the first place).

Given barely 2 months until the applicability date, it's still unclear whether the new economic analysis requirement and subsequent rulemaking process will be able to successfully delay the rule, especially since President Trump's Labor Secretary nominee Andrew Puzder hasn't yet been confirmed, and is now reportedly being delayed indefinitely due to ongoing questions about his ethics and financial disclosures paperwork. Nonetheless, a delay is still possible - and indeed, President Trump's Memorandum effectively directs the DoL to try to find some way to do so - whether by inviting a stay in one of the lawsuits, going through a "hasty" rulemaking process to at least get some delay in the applicability date on the table (and then expand into further rule changes thereafter), or getting Congress to intervene (and overcoming a Senate Democrats filibuster).

But for the time being, the fact remains that it's still "game on" for the Department of Labor's fiduciary rule. The President's Executive-Order-that-wasn't may still ultimately facilitate a delay in the rule, and/or start the process of making changes to the fiduciary rule's long-term provisions after the rule takes effect (but before any real enforcement and legal exposure kicks in). But that remains to be seen in the steps that acting Labor Secretary Ed Hugler does or doesn't take in the coming days and weeks to quickly push the required economic analysis and the start of a new rulemaking process! At a minimum, though, it's looking increasingly likely that the DoL fiduciary rule will be here to stay in some form... the only question is exactly what provisions last in the truly-final version, and when it will truly take full effect!

Weekend Reading for Financial Planners (Feb 4-5)

February 3, 2017 02:53 pm 1 Comment CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with the big news that President Trump has just issued a Memorandum to the incoming (but not yet confirmed) Secretary of Labor in an attempt to delay to the DoL fiduciary rule, with guidance to "consider whether to rescind or revise" it... though it still remains unclear whether the rule can actually be stopped without taking effect for at least some period of time, given the requirements for Notice and Comment periods before a new-new rule could be issued. Also in the news this week was the announcement that the original robo-advisor Betterment is raising fees substantially (by 67%) on its larger accounts over $100,000, and rolling out a series of human advisor service models (at even higher price points), as the robo-advisor definitively pivots away from its "pure" robo roots; and an announcement from TD Ameritrade that its new Veo One platform is live, along with a new iRebal Model Marketplace that could substantially shake up the landscape of current "robo" and TAMP providers.

From there, we have a few technical planning articles, including a new retirement study from Wade Pfau comparing the equity risk premium to annuity risk pooling as a means to fund retirement, another new retirement study from the UK finding that the "U-shaped" retirement spending path (where retirees spend more on active lifestyle in their early years, and more on medical/long-term care expenses in their later years) isn't substantiated by the actual data on retirees (which shows that real retirement spending just flat-out declines every year throughout retirement), and a look at a new approach to helping parents plan for college expenses by determining an amount that the child is "pre-approved" to spend on college before even beginning the process (which avoids awkward situations where the family tries to figure out how to afford an unaffordable college after already being accepted, when it's hard to back out).

There are also a couple of practice management articles this week, from a look at why just delivering great service isn't enough to get client referrals and good client satisfaction (and why your "great" service has to be articulated in a client service standard), to a discussion of all the ways that advisors lose out on prospects before ever having a chance to meet with them, and an exploration of the different ways advisory firms are beginning to shift towards a younger generation of clientele (from forming full-family teams, to cultivating "intrapreneurs" that create a firm-within-a-firm to serve younger clientele).

We wrap up with three interesting articles: the first is a fascinating look at what exactly causes us to procrastinate, and what the behavioral research says are the best techniques to overcome it; the second provides tips on how to be (and remain) productive in what is often an unproductive work/office environment; and the last is a great reminder of how the path of success can actually be the very thing that causes us to lose focus on what made us successful, and how to take a pause and re-set what your focus should be (and what you want it to be), both in your work and in your life.

Enjoy the "light" reading!

Betterment Raises Fees And Pivots To Platform Offering Human Advisors

February 2, 2017 07:42 am 8 Comments CATEGORY: Technology & Advisor FinTech

Since they first emerged nearly five years ago, the widespread belief has been that robo-advisors will ultimately cause fee compression amongst human financial advisors, as the process of implementing a diversified asset-allocated portfolio becomes increasingly commoditized. However, it turns out that in the pricing game of chicken between robos and human advisors, it's actually the robo-advisors that are turning first.

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we discuss this week's blockbuster announcement from Betterment that they will no longer be "just" a robo-business, are instead are pivoting to offer human financial advisors, and are raising their fees in the process!

Specifically, while Betterment will still maintain a 25bps advisory fee for its core digital business, the company announced that for accounts over $100,000, fees are being increased from 15bps to 25bps (a whopping 66% price increase for large accounts paying the "old" rates!), and large accounts will also have the opportunity to use Betterment Plus (offering an annual meeting with a CFP professional) for 40bps, or Betterment Premium (offering year-round access to a team of CFP professionals) for 50bps, or can be referred to the new Betterment Advisor Network (at whatever rate the outside advisor charges, plus the 25bps Betterment for Advisors platform fee).

The announcement that Betterment is pivoting to increase their fees and add new human advisory services is the most direct acknowledgement yet of the sheer unsustainability of the original robo-advisor model. Instead, Betterment has shifted to mimic its more successful competitors, including Personal Capital, Vanguard Personal Advisor Services, and the recently announced Schwab Intelligent Advisory - none of which are actually robos at all, but rather tech-augmented human advisor platforms.

Ultimately, though, Betterment's shift to offer a layer of human advice still isn't necessarily about staking a competitive position against (other) human advisors. Instead, it's a shift to become a platform business that compete with the likes of Schwab, Fidelity, and TD Ameritrade. After all, if the scaled human advice is merely offered "at cost", then Betterment effectively earns 25bps of fees regardless of where clients go - whether it's Betterment Digital, Plus, Premium, or the Advisor Network. It's no longer about getting the clients, per se, but simply being the platform where the clients go for whatever solution they choose.

Yet, there is still a question of whether Betterment will actually be able to compete in this space at all. After all, the irony is that now the "robo-advisor" is actually the higher priced offering, as the new Betterment Premium service is almost double the cost of the competing Schwab and Vanguard alternatives, with 5X to 10X the minimums! Which means Betterment faces a challenging uphill marketing challenge, for which the quintessential robo-advisor differentiator - low cost - is no longer in their favor!

The bottom line, though, is simply to recognize what a profound shift Betterment has made, and one that I think marks the ultimate demise of the pure B2C robo-advisor. For better or worse, Betterment is now trying to reinvent a modern version of the old-school investment platform – akin to Schwab, Fidelity, and TD Ameritrade – serving both consumers and advisors, but doing so with what it hopes will be recognized as superior technology. Which means the "robo" technology is still here to stay... though ironically for Betterment, the challenge remains what it has always been - whether they can market themselves and attract assets fast enough to hit critical mass, or succumb to the challenge of the financial services industry's brutally high client acquisition costs!

Behavioral Biases And The Hierarchy Of Retirement Needs

February 1, 2017 07:01 am 17 Comments CATEGORY: Retirement Planning

A growing base of research shows that even though money itself is fungible, the way we think about our various money assets is not; instead, we tend to “mentally account” for money into various buckets of current income, current assets, and (assets for) future income. The fact that we tend to categorize our income and assets into various buckets helps to explain the popularity of so-called “bucketing strategies” for retirement income, whether segmented by time (short, intermediate, and long-term needs) or type of spending (essential vs discretionary needs).

However, the research also suggests that the way we mentally account for income and assets also has an intrinsic hierarchy of priorities – first, we need to cover our current income needs, then our current assets, and finally our savings towards future income needs (ideally, with some potential for further upside and the possibility that our future income could continue to improve over time).

The significance of this “hierarchy of retirement needs” is that it helps to explain why some types of retirement income strategies like annuitization are very unpopular (despite the fact that retirees routinely state their biggest fear is outliving their retirement assets and annuitization can guarantee that will never happen), while others are used far more often even if their current guarantees are inferior to available alternatives (e.g., most guaranteed living benefit riders on today’s variable annuities).

However, perhaps the biggest caveat to the hierarchy of retirement needs is that if retirees must satisfy a desire for current income, and future income, and have liquid current assets available, they may actually feel compelled to save more for retirement than they actually need (even if there is no desire to leave a legacy behind). After all, it “should” be sufficient to just save for future and current income, without a separately holding of liquid assets; nonetheless, recent research finds that the amount of “cash on hand” (or at least, liquid bank holdings) a person has is directly (and positively) related to their self-reported well-being and life satisfaction, even if they didn’t have a financial need for it. Nonetheless, if the need for future income cannot be achieved until the need for current assets has been mentally satisfied first, retirees may continue to feel constrained by not having enough – even if they do – and/or to choose retirement income solutions that are mechanically inferior but psychologically more satisfying to our hierarchy of retirement needs!