Nerd's Eye View blog

How To Do A Backdoor Roth IRA (Safely) And Avoid The IRA Aggregation Rule And Step Transaction Doctrine

August 12, 2015 07:01 am 92 Comments CATEGORY: Taxes

Since the income limits on Roth conversions were removed in 2010, higher-income individuals who are not eligible to make a Roth IRA contribution have been able to make an indirect “backdoor Roth contribution” instead, by simply contributing to a non-deductible IRA (which can always be done regardless of income) and converting it shortly thereafter.

However, in practice the IRA aggregation rule often limits the effectiveness of the strategy, because the presence of other pre-tax IRAs and the application of the “pro-rata” rule limits the ability to convert just a new non-deductible IRA. On the other hand, those with a 401(k) plan that allows funds to be rolled in to the plan can avoid the aggregation rule by siphoning off their pre-tax funds into a 401(k) plan, and then converting the now-just-after-tax IRA remainder.

Perhaps the greatest caveat to the backdoor Roth contribution strategy, though, is the so-called “step transaction doctrine”, which allows the Tax Court to recognize that even if the individual contribution-and-conversion steps are legal, doing them all together in an integrated transaction is still an impermissible Roth contribution for high-income individuals to which the 6% excess contribution penalty tax may apply. Fortunately, though, the step transaction doctrine can be navigated, by allowing time to pass between the contribution and subsequent conversion (although there is some debate about just how much time must pass!). But perhaps the easiest way to avoid the step transaction doctrine is also the simplest – if the goal is to demonstrate to the IRS and the Tax Court that there was not a deliberate intent to avoid the Roth IRA contribution limits, stop calling it a backdoor Roth contribution in the first place!

As Envestnet Buys Yodlee For $590M, Total PFM Acquisitions In Advisor #FinTech Crosses $1B!

August 11, 2015 10:15 am 19 Comments CATEGORY: Technology & Advisor FinTech

Yesterday, Envestnet ‘surprised’ the FinTech world by announcing that it was buying data/account aggregation company Yodlee for a whopping $590M, at a 70% premium to Yodlee’s valuation at its IPO less than 12 months ago. Yet looking at Envestnet’s apparent strategy of building a “Holy Grail” technology platform solution for advisors, that includes CRM, portfolio accounting, and financial planning software, it’s not entirely surprising that Envestnet decided they wanted to own the data that feeds the engine, too.

From the broader industry perspective, though, Envestnet’s acquisition of Yodlee may make some competitors nervous. There are relatively few data sources for quality account aggregation data in the first place, especially ones that include a holistic picture of household cash flows (and not just investment account/performance data). And with Envestnet now owning one of the top two players (the other is the Intuit API that powers Mint.com), and having its own financial planning software given the recent FinanceLogix acquisition, it raises the troubling question of whether competing financial planning software providers like MoneyGuidePro (which relies solely on the Yodlee solution) could someday be left in the lurch.

More broadly, though, the Yodlee acquisition marks a massive uptick in what has already been an incredibly hot technology category. Just under two years ago, I predicted that account aggregation and Personal Financial Management (PFM) solutions would become the hot new category of advisor technology, and earlier this year (before any major deals had yet been announced) that 2015 would be the year of Advisor FinTech. Now it’s not even the end of summer, there have been over $1B of account aggregation and PFM-related providers in just the past 6 months alone, and suddenly the biggest problem may be that there are almost no players left to acquire… unless someone new comes along soon?

Pricing Models For Financial Advisors And The Power Of “Free” Financial Planning

August 10, 2015 07:01 am 22 Comments CATEGORY: Practice Management

The conventional view in financial planning is that if something is “free” it’s not worth anything, and that therefore if we want consumers to really “value” financial planning, we need to charge for it. Yet the caveat, as expressed by author Chris Anderson in his book “Free: The Future of a Radical Price”, is that bundling “free” solutions with another paid product or service is an entirely legitimate business model, and in fact a surprisingly robust one.

In fact, not only can a business be very profitable by giving away an initial product or service for ‘free’ and get paid for a complementary or supporting solution – the classic “freemium” model – but by leading with something that’s free, the business may actually grow and gain even greater adoption in the process. Arguably, this suggests that not only has offering financial planning for ‘free’ over the past several decades been a good business model, but it may have even helped to gain adoption and acceptance of the value of financial planning in the first place!

On the other hand, the reality is that the ongoing advancements of technology are beginning to undermine the products and asset management services that have classically been the financial engine of the financial planning business model. From declining commission rates on products – to the decline of commission-based products altogether – and new threats to the pricing of asset management from robo-advisors, the question arises of whether the free-planning-plus-paid-financial-products-and-services model may be on its way out.

In the near term, this phenomenon appears to be shifting the landscape, as financial services products and asset managers (e.g., Schwab, Fidelity, and especially Vanguard) begin to deliver their solutions directly to consumers – packaged together with ‘free’ financial planning. But perhaps in the future, the business model will flip around altogether, and instead of giving away free financial planning and getting paid via financial products or AUM, advisors will give away financial products and asset management, and get paid for the financial planning instead, turning the financial planning “freemium” model around 180 degrees?

Weekend Reading for Financial Planners (Aug 8-9)

August 7, 2015 02:05 pm 20 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the announcement that Jeff and Kim Camarda have decided to appeal the unfavorable ruling they received in their case against the CFP Board, alleging that there are serious issues with the CFP Board's disciplinary process that still haven't come to light and that they believe they can ultimately prevail in court, even as the CFP Board insists that Judge Leon's ruling was appropriate and will be upheld.

From there, we have several technical articles this week, including: a Morningstar discussion of the recent Wells notice the SEC served to PIMCO alleged mispricing issues with certain non-agency mortgage-backed securities held within their BOND ETF; why affluent clients may wish to implement a GRAT sooner rather than later (if they're thinking about doing one at all); ongoing trends to watch in the long-term care insurance industry; how despite their early hype, adoption of QLACs in retirement accounts continues to be slow; and a discussion by Wade Pfau of how portfolios that combine stocks and immediate annuities (i.e., partial annuitization) may be superior for retirement income and wealth accumulation over just buying traditional stock-and-bond balanced portfolios.

We also have a few practice management articles, from a look at the latest industry trends research on the continued rapid growth of RIAs (which drove hiring of 31,000 non-clerical financial services jobs last year, and added a whopping 2 million clients in the aggregate), to a discussion of how despite recent growth of advisory firms there are concerns that profitability is slipping (which does not bode well for when the next real bear market occurs), and a look at how the ongoing evolution of the financial services industry (especially thanks to technology) will increasingly put pressure on advisors to add (more) value or be put out of business.

We wrap up with three interesting articles: the first looks at several new studies coming out suggesting that the "midlife crisis" phenomenon may not just be a "first-world problem" but that instead the "U-shaped curve" of happiness throughout life is something found across the globe, and even in other species; the second is a fascinating futurist look at whether small/solo law firms will survive in our increasingly technology-driven world, and the implications it raises for financial advisors who are following a similar path to the legal profession; and the last is a good reminder that for advisory-firm owners in particular, the ego that may have given you the courage (or stubborness!?) to go out and start your own firm and succeed in the first place may well be the same ego that is now limited your ability to continue to grow and succeed from here.

And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including a look at LPL Financial's recently revealed intent to offer a "robo" solution for its advisors, the announcement from Wealthbox CRM that it will be the first advisor CRM to integrate with popular business communication platform Slack, and a new service from Smarsh that will archive web-based Office 365 email and documents!

Enjoy the reading!

Why Bonds Funds Aren’t Necessarily A Losing Proposition In Rising Rate Environments

August 5, 2015 07:01 am 35 Comments CATEGORY: Investments

With interest rates hovering around multi-decade lows, investors have been increasingly concerned about the consequences to bonds when the “inevitable” shift happens and rates begin to rise. As the simple math of bonds makes clear, rising interest rates will drive down bond prices, potentially to the point of creating negative total returns for bonds.

To defend against this risk, an increasing number of advisors have been shifting to buying individual bonds in lieu of using bond funds. Given that bond funds tend to target a consistent maturity, in a rising rate environment the potential exists that bond funds will “lock in” bond price losses annually, while holding individual bonds until maturity allows for the investor to be assured that the bond will not face capital losses and will eventually mature at par value.

Yet the reality is that in an upward-sloping yield curve environment, rolling bonds to maintain a constant maturity is actually an enhancement to total return… enough that even if rates do rise, funds that roll bonds down the yield curve may still outperform the hold-to-maturity bond investor! And the steeper the yield curve becomes, the greater the benefit to sticking with bond funds after all.

Of course, the reality is that if rates spike “enough”, there is still risk that funds rolling their bonds will underperform just holding individual bonds until maturity. But on the other hand, trying to avoid rising rates by buying individual bonds is still at best a risk-return trade-off, as investors give up a “known” potential to roll down the yield curve for greater returns against just the potential that interest rates may, eventually, rise far enough and fast enough to offset the benefit!

MailBag: Intra-Plan And In-Service Roth Conversions Of A 401(k) Plan

August 4, 2015 07:01 am 22 Comments CATEGORY: MailBag

Many readers of this blog contact me directly with questions and comments. While often the responses are very specific to a particular circumstance, occasionally the subject matter is general enough that it might be of interest to others as well. Accordingly, I occasionally post a new "MailBag" article, presenting the question or comment (on a strictly anonymous basis, of course!) and my response, in the hopes that the discussion may be useful food for thought.

In this week's MailBag, we look at two questions related to the increasingly popular strategy of making after-tax contributions to a 401(k) plan and subsequently converting them to a Roth, either via an intra-plan conversion to a Roth 401(k), or using ongoing in-service distributions from the 401(k) to convert to a Roth IRA!

Sales Training And Business Development Skills For The Next Generation Of Financial Advisors

August 3, 2015 07:01 am 20 Comments CATEGORY: Personal/Career Development

The first generation of financial planners rarely started out as financial planners; most were initially insurance agents or stockbrokers in the business of selling a product, who later evolved their business to get paid for advice instead (after they already learned how to sell). By contrast, financial planners entering the profession today often come to the table to be paid for their advice from the start, and subsequently struggle due to their lack of business development experience and sales skills.

After all, the reality is that even if someone comes into financial services to be paid for their advice – not the products they sell – it is still necessary to learn how to sell in order to convince potential clients to pay for that advice. Yet unfortunately, relatively little exists in the way of sales training for financial advisors who actually want to be paid for their advice – historically (and still), most “sales training” was/is available from the product firms who train their “advisors” how to sell their products.

Nonetheless, even if they must pursue it on their own, whether by reading, hiring a sales coach, or experience from the "school of hard knocks", it’s crucial for today’s new advisors to recognize that selling - and developing their sales technique - is an essential skill for success. From being ready to “ask for the business” and “go for the close”, to crafting a sales process, managing a sales pipeline, and monitoring business development metrics – in the end, it doesn’t matter how great your advice actually is if you can’t convince anyone to pay you for that advice in the first place!

Weekend Reading for Financial Planners (Aug 1-2)

July 31, 2015 02:26 pm 13 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the release of Judge Leon's opinion memorandum in the case of Camarda vs CFP Board, which reveals that the Judge's decision in favor of the CFP Board was based not on the merits of the case, but simply that the courts wouldn't intervene in the 'private internal affairs' of the CFP Board's disciplinary process... raising the concern that no CFP certificants may have any recourse in a court of law to hold the CFP Board accountable in situations where there is a future disciplinary dispute. Also in the news this week was the announcement that Schwab is aiming to significantly expand its branch office network and ramp up hiring of its own advisors, raising questions of whether it may increasingly find itself competing with the RIAs using its platform. And rounding out the news this week is an article by Knut Rostad offering suggestions of how the Department of Labor can improve its "BICE" rules to ensure the fiduciary standard is not undermined.

From there, we have a few technical planning articles this week, including a discussion of whether managed payout funds are better retirement income vehicles than immediate annuities (the results don't look good for those who top priority is retirement income!), a look at how most people with access to an Employee Stock Purchase Plan (ESPP) are underutilizing them and leaving "free" profits on the table, and some suggestions on how to modify the way Power of Attorney documents are used to cut down on the rising trend of elder financial abuse.

There are also a few practice management articles, from a reminder that the slow summer season is a good time to do strategic planning for your advisory business (or personal career!), to a look at the rise of "advisor blogging" as a means to market and grow an advisory firm, and a discussion of the issues that advisors should consider when it comes to compliant storage of digital client documents (from encrypting your computer, to the encryption capabilities of your cloud storage service, and how to ensure secure transmission of the data between the two!).

We wrap up with three interesting articles: the first is a good reminder that to really help clients, advisors need to focus on what really motivates them (i.e., clients aren't necessarily motivated by setting goals; instead, figure out what motivates them, and help them to direct that energy towards achieving their goals!); the second is a high-level look at how the entire financial services industry is in transition, driven by both top-down regulatory changes still being implemented since the financial crisis, plus the bottom-up impact of the rising Millennial generation and the increasing intrusion of Silicon Valley and the world of FinTech; and the last is a fascinating roundtable interview with "next generation" advisors, suggesting that the primary problem advisory firms have with retention of younger advisors is not that they're all looking for a handout, but that firms are simply failing to articulate clear goals for young advisors to pursue and then also failing to reward the young advisors with advancement when those goals are achieved.

Enjoy the reading!

One Insurance Agent’s Transition To Fee-Only RIA, In Just A Few Months…

July 30, 2015 07:01 am 47 Comments CATEGORY: Practice Management

Making a big change in your advisory business can be scary, and there's perhaps nothing more scary than breaking away from where you started your financial services career to go out on your own as an independent RIA. From wondering whether your clients will come with you, to facing the burdens of being the business owner responsible for everything, to just the transition process itself, there's a lot to deal with.

In this guest post, Daniel Wrenne - a former Northwestern Mutual agent turned fee-only independent RIA - shares the story of his own transition process, and the surprisingly fast 6-month timeline it took from when he first had the idea to go out on his own, until his independent RIA was approved by the state of Kentucky and his new business was launched. And Daniel shares everything he went through along the way, from the key software tools and technology he chose, to how many clients actually transitioned (fewer than he hoped, but all the best clients he really wanted!), and the niche he's chosen to pursue going forward, supporting by an inbound marketing strategy to grow his business in the future.

So if you're an existing insurance agent or broker thinking about breaking away to start your own independent RIA, this should be helpful to you as you consider what it may take to move forward from here, as well as recognizing the realistic challenge you're up against (Daniel notes that even in transitioning existing clients, he'll be waiting a full year before taking any salary out of the business for himself!).

How Has The 4% Rule Held Up Since The Tech Bubble And The 2008 Financial Crisis?

July 29, 2015 07:01 am 50 Comments CATEGORY: Retirement Planning

The 4% rule has been much maligned lately, as recent market woes of the past 15 years – from the tech crash of 2000 to the global financial crisis of 2008 – have pressured both market returns and the portfolios of retirees.

Yet a deeper look reveals that if a 2008 or even a 2000 retiree had been following the 4% rule since retirement, their portfolios would be no worse off than any of the other "terrible" historical market scenarios that created the 4% rule from retirement years like 1929, 1937, and 1966. To some extent, the portfolio of the modern retiree is buoyed by the (only) modest inflation that has been occurring in recent years, yet even after adjusting for inflation, today’s retirees are not doing any materially worse than other historical bad-market scenarios where the 4% rule worked.

Ultimately, this doesn’t necessarily mean that the coming years won’t turn out to be even worse or that the 4% rule is “sacred”, but it does emphasize just how bad the historical market returns were that created it and just how conservative the 4% rule actually is, and that recent market events like the financial crisis are not an example of the failings of the 4% rule but how robustly it succeeds!