Nerd's Eye View blog

How DoL Fiduciary Disrupts Trade Publications And Membership Associations

July 14, 2016 08:07 am 3 Comments CATEGORY: Planning Profession

The looming implementation of the Department of Labor's fiduciary rule has raised many questions about whether products like non-traded REITs, variable and indexed annuities, and actively managed mutual funds will still be able to survive and thrive when commissions are at least curtailed. And the shift raises significant challenges for the broker-dealer platforms that distribute those products. But as it turns out, broker-dealers aren't the only ones facing significant collateral damage from the coming product fallout.

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we look at how the contraction of commission-based products may also lead to a significant contract in financial services product advertising, which could have significant spillover effects into the industry trade publications and membership associations that are highly reliant on those advertising dollars to buy ad inventory and booth sponsorships.

Ironically, though, a contraction in financial services product advertising could actually be a boon for financial advisors, as a reduction in the advertising from financial services product manufacturers after our clients' money could leave more room for advertising from companies that actually create solutions for advisors themselves. There's more room for advisor FinTech firms and industry consultants to compete for advisors' attention when they're not being crowded out by large financial services product manufacturers.

But given that solution-providers for advisors tend to be much smaller companies, with less revenue and less advertising buying power, a contraction is still coming in industry advertising, which could have harsh consequences given the over-abundance of industry trade publications and conferences, all vying for advisors' limited attention.

In the long run, though, the reality is that financial services industry advertising may end out being larger than ever. After all, if financial services product manufacturers cannot compete by paying the best commissions, and have to compete by designing and offering the best product, there's even more pressure to market that product effectively. Which means more advertising, and more spending at conferences. But given the timeline for DoL fiduciary implementation, those dollars may not show up until 2018 and beyond. In the meantime, trade publications and membership associations may be facing a very tough 2017.

How Lapsing A Life Insurance Policy With A Loan Can Cause A Tax Bomb

July 13, 2016 07:01 am 25 Comments CATEGORY: Insurance

Life insurance serves a valuable social purpose, allowing families to protect themselves against the economic consequences of an untimely death of a breadwinner. In fact, life insurance is viewed as such a positive that Congress provides significant tax preferences for insurance policies, including tax-deferral on any growth in the cash value, and a tax-free death benefit for the beneficiaries.

Another popular tax feature of life insurance is the ability to access the policy’s cash value in the form of a tax-free loan. However, in reality the tax-free treatment of a life insurance policy loan is not actually a preference for life insurance under the tax code, but the simple recognition that ultimately a policy loan is just a personal loan between the life insurance company and the policyowner, for which the life insurance cash value is collateral. A credit card cash advance isn’t taxable, nor is a cash-out mortgage refinance, and a personal loan from a life insurance company isn’t, either.

However, while a life insurance loan isn’t taxable – nor is its subsequent repayment – the presence of a life insurance loan can distort the outcome if/when a life insurance policy is surrendered or otherwise lapses. Because the insurance company will require that the loan be repaid from the proceeds of the policy.

In the case of a life insurance death benefit, this isn’t necessarily problematic. The death benefit is already tax-free, and the loan is simply repaid from the tax-free death benefit, with the remainder paid to heirs.

When a life insurance policy is surrendered or otherwise lapses, though, the remaining cash value is again used to repay the loan… even though the taxable gain is calculated ignoring the presence of the loan. Which means in the extreme, it’s possible that a life insurance policy can lapse without any remaining net cash value, due to a loan repayment, yet still produce a significant income tax liability based on the policy’s gains. This “tax bomb” occurs because in the end, even if all of a policy’s cash value is used to repay a life insurance loan, it doesn’t change the fact that if the policy had a taxable gain, the taxes are still due on the gain itself!

Assessing Compatibility To Partner With Another Financial Advisor

July 11, 2016 07:01 am 1 Comment CATEGORY: Practice Management

Even the most successful individual financial advisors can eventually hit a wall, where it’s simply not possible to make themselves more productive by growing a team to support them. The biggest advisory businesses bring together multiple successful advisors, who can each contribute their own unique (and hopefully, complementary) skillset to make the business bigger than what any one of them could achieve alone.

The caveat, however, is that just because two advisors are individually successful doesn’t mean that they will be a successful partnership. At best, different skillsets result in partners taking on more specialized roles in the business, and needing to learn to communicate well with people who have a very different perspective. At worst, the partners have fundamentally different long-term goals that eventually create untenable conflicts that cause the partnership to fail.

In an effort to avoid failed partnerships before they begin, former advisors Tanya Rapacz and Lisette Smith formed Partnership Resource, a niche consulting business that specifically works with financial advisors forming and sustaining partnerships. And their latest offering is a “Partnership Compatibility Assessment” tool, built to help advisors figure out up front whether they have sufficient alignment in what motivates them personally to be able to build a successful business together.

Of course, in the long run, there’s more to a successful partnership than “just” an alignment of business objectives and an ability to communicate and work through conflict. But given the number of financial advisor partnerships that I’ve witnessed come together and fall apart over the years, I suspect that better assessment tools like this will go a long way towards heading off the most problematic partnerships before they even begin, to the betterment of all involved!

Weekend Reading for Financial Planners (July 9-10)

July 8, 2016 02:48 pm 1 Comment CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with a discussion of the Senior Safe Act, legislation currently winding through Congress that would make it easier for financial advisor to report suspected elder abuse amongst their clients without fear of litigation for breaching client privacy (but sadly, only when reporting to government agencies, and not family members). Also in the news this week is a lobbying effort by the Investment Adviser Association to allow clients of RIAs to automatically be deemed accredited investors, regardless of their actual income or net worth, and be allowed to rely on the RIA's recommendations (subject to fiduciary duty) as protection from overly risky investments.

From there, we have several advisor technology articles this week, including a review of social media management software Grapevine6, the Canadian portfolio management software platform Croesus (now looking to grow its adoption amongst RIAs in the US), a discussion of how technology vendors are trying to step up to help large advisory firms cope with the DoL fiduciary rule requirements, and a look at how the most successful advisors are disproportionately likely to be heavy adopters of technology (but affluent investors are still most likely to choose their advisors for more 'traditional' reasons like years of experience and expertise/capabilities).

We also have a few more technical articles this week, from a look at how the Medicare "Hold Harmless" provisions are projected to strike once again for 2017 (which will limit Medicare premium increases to just 0.2% for most, but spike Medicare premiums for higher-income individuals as much as 22%), to a discussion of the rules for holding foreign stocks and claiming the foreign tax credit, and an analysis of the rules for the Net Investment Income Tax (NIIT) as applied to non-grantor trusts (where the 3.8% surtax can kick in after just $12,400 of income).

We wrap up with three interesting articles: the first is a look at how many parents who take time out of the workforce to care for children, seeing that child care may have consumed most or all of their take-home pay already, may be grossly underestimating the long-time financial impact of staying home with children once accounting for how time out of the workforce can permanently change a worker's income and career trajectory; the second is an analysis of how income inequality may actually be driven less by the concentration of national income in the hands of capitalists or merely going to higher-skilled professions, and more a result of the barriers that many professions have erected in the name of consumer protection that may have (unwittingly or on purpose) limited competition and (artificially) inflated incomes; and the last is a look at Millennials, who are often lauded for having an "entrepreneurial mindset" but are actually forming new businesses at a significant lower rate than prior generations did at the same age, raising the question of whether competition from mega-firms and the overhang of student debt may be permanently impairing Millennial entrepreneurship, or if the reality is just that the Millennial entrepreneurship needs another decade to germinate before it really starts to blossom (given that in reality research shows the peak age for entrepreneurs to start a business is 40-something anyway, not as a 20-something).

Enjoy the "light" reading!

Should Advisors Reduce Their Management Fees On Fixed Income Allocations?

July 7, 2016 08:46 am 11 Comments CATEGORY: Investments

The ongoing decline in interest rates since the financial crisis have been a boon for those looking to refinance a mortgage or businesses looking to borrow, but an immense challenge for investors that rely on fixed income returns, from insurance companies to individual accumulators and retirees. And as bond returns grind lower, it has brought a renewed focus on costs (that eat up an ever-larger percentage of a smaller return), including the question of whether financial advisors should charge less for managing a bond portfolio compared to a stock portfolio.

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we look at the question of whether advisors really should be charging separate and different fees on the fixed income versus equity allocations in a portfolio, including and especially for those who also deliver extensive financial planning services as a part of their AUM fee as well.

Of course, given that the typical bond mutual fund is already less expensive than the average stock mutual fund, arguably the asset management industry has already spoken and suggested that the fees should not be the same. If only because today's low bond yields, plus the more limited volatility of bonds (at least compared to stocks), means there's just only so much opportunity to create active management value in bonds and outearn that fee in the first place.

On the other hand, the reality is that most advisors don't manage just all-bond or all-stock portfolios as a mutual fund does. Advisors typically manage blended portfolios of stocks and bonds, sometimes tactically managing amongst all those asset classes, and an increasingly large portion of the AUM fee is being allocated to financial planning services anyway... which are based on the amount of actual financial planning work to be done, and arguably remain the same regardless of how the portfolio happens to be invested.

And in fact, with the looming Department of Labor fiduciary rule taking effect in April of 2017, charging different fees for stock versus bond allocations may become a prohibited transaction anyway, at least in an IRA where the advisor has discretion over the portfolio's overall allocation in the first place. Which means that while advisors might charge less for conservative model portfolios compared to those that are more aggressive (and in theory have more active management opportunities), or begin to unbundle their planning and investment management fees altogether, but the question of whether to charge differently for bonds and stocks within the same portfolio may soon be a moot point anyway!

Why Most Retirees Will Never Draw Down Their Retirement Portfolio

July 6, 2016 07:01 am 81 Comments CATEGORY: Retirement Planning

In theory, the whole point of saving and investing for retirement is that upon reaching retirement, it’s time to spend down the money and enjoy it. In practice, a growing base of research finds that for most of their retirement, retirees are just continuing the growth of their pre-retirement portfolios, suggesting a “consumption gap” between what retirees could and should spend versus what they actually do.

However, the reality is that for a long-term retirement, where compounding inflation can double or even quadruple spending needs after 30 years, retirees actually should allow their portfolios to grow at least slightly for at least the first half of retirement. It’s a necessity just to cover later-years’ spending needs at their inflation-adjusted levels.

Furthermore, given uncertainty about the length of retirement, how high inflation will be, and whether portfolio returns will be favorable or not, often retirees spend even less in the early years just to defend against these risks – an approach now dubbed the “safe withdrawal rate”. Yet given that most of the time markets and inflation don’t actually spiral out of control, following a safe withdrawal rate approach just further increases the likelihood that retirement portfolios will continue to grow throughout retirement.

The end result is that while in theory a retirement portfolio is meant to be spent, in practice most retirees faced with an ever-open-ended potential of living many more years will feel compelled to keep extra assets available, just in case… and never actually reach the point of depleting the retirement portfolio at all! Which, notably, isn’t a sign of inefficient portfolio spending or a consumption gap, but merely the prudent reality of dealing with an uncertain future!

Proposed SEC Rule Would Make Business Continuity And Transition Plan A Fiduciary Obligation

July 4, 2016 07:01 am 3 Comments CATEGORY: Practice Management

While there are many risks to starting a business, one of the greatest is the potential for a low-probability but high-impact “business disruption”, from the unexpected death of a key employee, to a cyber-attack or a natural disaster like a hurricane.

Arguably, having a plan to contend with such business disruptions is simply good business, but the SEC has noted that, in the aftermath of events like Hurricanes Katrina and Sandy, not all RIA firms appear to be sufficiently prepared to contend with a significant business disruption.

Accordingly, the SEC has proposed a new Rule 206(4)-4, which would make it unlawful to provide advisory services to clients unless the RIA has a business continuity and transition plan (that is reviewed at least annually). In fact, the SEC has stated that it views having a business continuity plan as essential for an advisor to fulfill their fiduciary duty; or viewed another way, the firm that isn’t prepared for a business disruption isn’t prepared to fulfill its fiduciary duty to clients.

While still only a proposed rule at this point, the SEC’s effort to require a business continuity plan comes on the heels of a similar Model Rule put forth by NASAA last year for state-registered investment advisers, and seems likely to pass in some form.

For many SEC-registered RIAs, the new rule will simply be a ‘healthy’ nudge to enact continuity plans that should be a matter of good business anyway. Though in some cases, the greatest challenge will not be figuring out business continuity in the event of a disaster, but a transition plan in the event that the advisory firm owner unexpectedly dies – a requirement that necessitates either the orderly wind-down of the business, or establishing a buy/sell agreement now to ensure that another firm can step in to act if necessary. Could such a requirement finally spur interest from more advisory firm sellers in what up until now has been a marketplace dominated by buyers?

Weekend Reading for Financial Planners (July 2-3)

July 1, 2016 02:44 pm 1 Comment CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the announcement that after 18 months of development, June finally saw the launch of four states' Section 529A "ABLE" accounts, the new tax-free accounts for disabled beneficiaries that are expected to become popular as a supplement to (or in some cases, a cheaper alternative to) special needs trusts.

From there, we have a few technical articles this week, from a look at how various types of retirement spenddown strategies may be impacted if market returns stay persistently low (hint: even flexible spending strategies may be at risk), to a discussion of the rules on Medicare enrollment and the (potentially adverse) consequences of delaying past age 65, and a look at how to coordinate the rules for contributing to and withdrawing from a Health Savings Account (HSA) after reaching age 65 and Medicare eligibility.

We also have several practice management articles, including: why it's crucial for wealth management firms to evaluate their advisors more broadly than just new client assets and business development; strategies to prevent burnout from your advisory firm staff; how the best path to client loyalty is not about avoiding all mistakes but having a process to promptly and effectively fix mistakes when they inevitably occur; what to be aware of when it comes to the new prohibited transaction rules for the Department of Labor's fiduciary rule; and why success for advisors is not just about doing "what you love" but finding the activities you enjoy doing, are good at, and the ones that actually help to move the business forward.

We wrap up with three interesting articles: the first is a look at Schwab's recent announcement to revive its consumer marketing campaign on behalf of RIAs that use the Schwab platform, and whether it's a real business development opportunity for Schwab-based advisors or just a way to appease those advisors even as the Schwab retail offering increasingly competes with them; the second is a look at how the advisory business is shifting from one where firms simply create something of value and offer it to clients, to instead a world where advisors and (prospective) clients actually 'co-create' the value that is meaningful and personalized for the client; and the last is a look at what advisors should be thinking about if they're considering a coach, and the kind of mindset that is necessary to really get the most value out of a coaching relationship.

Also, be certain to check out the video at the end, an excerpt from a two-part series for advisors from Carl Richards of the Behavior Gap called "Your Manual For Scary Markets" on how to talk clients through times of market volatility and be an effective buffer between them and the "scary markets" that can arise from time to time.

Enjoy the "light" reading!

Why I’m Not Optimistic About Actively Managed ETFs For Financial Advisors

June 30, 2016 02:23 pm 4 Comments CATEGORY: Investments

Over the past decade, the rise of ETFs and the decline of the (actively managed) mutual fund has quickly created giant ETF behemoths like iShares, Vanguard, and State Street, while putting immense pressure on (actively managed) mutual fund companies, with US equity mutual funds in the aggregate experiencing cumulative net outflows since 2008. In turn, this has led a wide range of asset managers to try to adopt their own ETFs, seeking out ways to bring their active management process to a form of actively managed ETF (in a structure that limits their risk of being front-run on large trades).

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we look at this emerging trend of actively managed ETFs, and why I am very skeptical that active ETFs will ever gain much traction amongst financial advisors.

Ultimately, the key trend to recognize is that the shift of financial advisors from being commission-based to the AUM model over the past decade has shifted the entire financial advisor value proposition. The pressure is now on advisors themselves to show the value they're creating in the portfolio design and management process. Which means they can't just buy active mutual funds - or actively managed ETFs - that the client could have bought themselves in their own online brokerage account.

Instead, financial advisors have been adopting their own internal portfolio design and investment management processes, aided by the growth of the AUM model itself that allows independent advisory firms to be larger than ever before and more capable of having their own investment process. Yet given the limited size of even the largest advisory firms, it's still challenging for most advisors to manage individual stocks and bonds. ETFs became the perfect intermediate portfolio building block.

Which means in the end, the explosive growth of ETFs and their adoption by financial advisors over the past decade may be less about a shift from active to passive, and more about a form of disintermediation where financial advisors are eliminating third-party active managers and bringing the process in-house instead (or if they do outsource investment management, they go to a TAMP or SMA solution that is not available to consumers directly). Yet if this is the case - advisors are looking to bring active value that clients cannot access themselves - it suggests that the push of fund companies to offer actively managed ETFs in the hopes that they can share in the growth of the ETF marketplace may turn out to be nothing but a mirage.

Planning Opportunities For Non-Spouse Beneficiaries Of Inherited Retirement Accounts

June 29, 2016 07:01 am 28 Comments CATEGORY: Retirement Planning

To help mitigate the tax consequences of inheriting a potentially large pre-tax retirement account, the Internal Revenue Code permits spouses to roll an inherited retirement account over to his/her own IRA, and other “non-spouse” beneficiaries are permitted to at least “stretch” distributions out over their life expectancies as well.

However, the favorable rules for a so-called “stretch IRA” do not automatically apply to all inherited retirement accounts. In the case of an inherited employer retirement plan – such as an inherited 401(k) or inherited 403(b) account – the employer has the option to force non-spouse beneficiaries to use the far-less-favorable “5-year rule” instead, compelling the entire account to be liquidated by the end of the 5^th year after death.

Fortunately, though, since 2010 employer retirement plans are required to at least permit a non-spouse designated beneficiary to complete a trustee-to-trustee transfer to an inherited IRA, preserving the ability to complete a stretch. On the other hand, the transfer provisions are only available to the original beneficiary of the inherited employer retirement plan, and not any successor beneficiaries (who can continue the stretch if available, but only from the original account).

On the plus side, though, the rules permitting a transfer from an inherited employer retirement plan to an inherited IRA also allow the assets to be shifted to an inherited Roth IRA, effectively giving the beneficiary the option of doing a Roth conversion even after the death of the original account owner. This is a strategy uniquely available to beneficiaries of inherited employer retirement plans, as an inherited IRA may not be converted to a Roth. The caveat, however, is that just because it’s possible for a beneficiary to convert doesn’t mean it’s wise to do so; since an inherited Roth IRA (after conversion) still has required minimum distribution obligations, it will usually be preferable to convert any other type of pre-tax retirement account first!