Nerd's Eye View blog

The Untenable State Of State Estate Taxes – Recouple, Repeal, Or Enact Gift Taxes

January 15, 2014 07:01 am 6 Comments CATEGORY: Estate Planning

The past decade has been a tumultuous one for the world of state estate taxes. What had been a rather stable structure for decades, with the Federal credit for state estate taxes paid that allowed states to create a "sponge tax" to absorb the maximum Federal credit, was brought to an end with the Economic Growth and Tax Relief Reconciliation Act of 2001, and in the years that followed the system was phased out and replaced with a state estate tax deduction instead. As a result, states faced the possibility that their estate tax revenue would drop to zero, which is in fact what happened for all states by 2005 that did not "decouple" from the Federal system to create their own state estate tax, often with their own exemptions.

Yet the reality is that for the remainder of that decade, states had continued to rely upon the Federal $1,000,000 gift tax exemption threshold to effectively "backstop" their state estate tax systems; after all, without any gift tax system, the estate tax doesn't really work, as people simply gift the money away before they die to avoid paying the tax at death. In turn, a new wave of state estate tax "disruption" occurred at the end of 2010 when the fiscal cliff legislation "reunified" the Federal gift and estate tax systems, bringing up the Federal gift tax exemption from $1,000,000 to an inflation-indexed $5M+ level, removing in the process the Federal gift tax support structure for the states that still had a gift tax.

As a result, in today's environment the states remaining with a state estate tax find themselves in an untenable position; most have an estate tax but no gift tax, which just invites citizens to either give away the money before they pass away, or relocate and change their residency to another state to another the tax (which causes the state loses income, property, and other tax revenue as well!). To fix the problem, states are increasingly compelled to come up with a solution: either enact gift taxes themselves to backstop the system (and then hire auditors to oversee and enforce the system); repeal the estate tax; or "recouple" the state back to the Federal system, to once again rely on the Federal tax structure and the IRS to backstop the states. Ultimately, it remains to be seen which path the states will pursue, but the likelihood for legislation is increasing - some states are considering proposals already - which means the time window is quickly closing for anyone who actually wishes to take advantage of the state estate tax "loophole" that still exists today!

News Highlight: CFP Board Reduces Length Of CFP Exam From 10 Hours To A 6-Hour Single-Day Test

January 14, 2014 07:01 am 28 Comments CATEGORY: Planning Profession

Last week, the CFP Board issued a press release announcing that it was transitioning from a paper-based test to a computer-based testing process, in an effort to improve the ease and efficiency of the test-taking experience for CFP certification candidates. The move to computer-based testing will allow the CFP Board to issue preliminary results immediately, offer official results in just 1-2 weeks (down from 5 weeks with the paper-based exam), and dramatically expand the breadth of available testing locations.

Yet in a surprising and dramatic change that was explained as little more than a side "benefit" to the computer-based exam process, the CFP Board also announced that the length of the CFP exam going forward would be chopped by a whopping 40%, from 285 exam questions down to only 170, while the duration of the exam itself is reduced from a 10-hour day-and-a-half exam into a 6-hour single-day exam.

While the CFP Board maintains that this is not a change in how hard the CFP exam really is - i.e., the difficulty of the exam isn't meant to be increased nor decreased by the change, because the (fewer) questions themselves will still be targeted for similar difficulty - the question arises nonetheless why the CFP Board would implement such a change, if the goal wasn't to at least create the perception that the exam will be easier and therefore more appealing to take? Which in turn raises the question - did the CFP Board just lower the standards of the CFP exam and try to make it easier to grow the ranks of CFP certificants?

Why Most Financial Planners Will Soon Be Forced To Lower Their Minimums

January 13, 2014 07:01 am 16 Comments CATEGORY: Practice Management

The growth of financial planning has been an incredible success story of the past 40 years, as the broader financial services industry slowly but steadily continues its shift away from the pure sale of products and towards the direction of personalized financial advice. Over the 25 years since the first CFP certificant was minted in 1973, nearly 10% of financial advisors obtained the designation, and the pace has accelerated as the CFP certification has continued to grow while the total number of advisors has been stagnant, now reaching what may be the “tipping point” of nearly 25% of all financial advisors.

Yet at the same time, the growth of CFP certificants – especially in the past decade – has not only outstripped the growth of all financial advisors; it has also dramatically outpaced the growth in the number of affluent households that financial planners typically serve. The end result: we are rapidly approaching the point where there are so many CFP certificants that there aren’t enough available half-million, millionaire, or wealthier clients available for them to serve.

As a result, financial planning may soon undergo a shift towards serving a wider base of clientele. The change will be driven not merely out of a desire to become a recognized profession that serves a wider base of the public, but instead out of sheer business necessity as financial planning firms of the future find they must lower their minimums and seek out a new “blue ocean” of prospective clients rather than continue to fight in a highly competitive space where just being a comprehensive financial planner is no longer the differentiator it once was!

Weekend Reading for Financial Planners (Jan 11-12)

January 10, 2014 01:01 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's reading kicks off with a big announcement from the CFP Board that it will be converting the CFP exam to be computer-based and in the process permanently reducing the length of the exam from 10 hours down to only 6 (and cutting the number of questions by 40% to match it). There's also a striking article reporting on the volume of Roth conversions that occurred in 2010 - the first year it was possible to convert without income limits - as the IRS found conversions increased nearly 1,000% over the 2009 numbers, and were especially concentrated amongst high-income investors (though ironically, they may have benefitted the least from the decision to convert!).

From there, we have a couple of practice management articles this week, including a roundtable interview in the Journal of Financial Planning about technology trends for advisors and the rise of the "robo-advisor", a review of the new financial planning software WealthTrace, and an announcement by financial planning software inStream that it is abandoning its free model and converting to an ongoing subscription model (and rolling out a lot of interesting features as well).

We also have a number of investment-related articles, from a discussion of William Bernstein's new book "Deep Risk" about the unique kinds of long-term risks that can permanently impair client portfolios, to a great summary by Reformed Broker Josh Brown about the current state of affairs in markets (we're somewhat overvalued, but with the animal spirits stirring, there's no reason why the party has to stop anytime soon), to a prediction that the "surprise" event of the year could be a default by Puerto Rico that sends ripples (or shockwaves?) through the municipal bond market as risk is repriced. There's also an article looking at how many elderly variable annuity holders are now having the surprising problem that they can't keep holding their annuity in deferred status and instead must convert it to a stream of income... unfortunately forfeiting what may be a substantial death benefit in the process.

We wrap up with three interesting articles: the first discusses how advisory firms can overcome the "success paradox" where the key things that helped the firm grow to where it is may be the exact factors blocking it from growing further (and the primary issue: usually the bottleneck around leadership at the top); some suggestions from industry commentator Bob Veres about what the top issues are likely to be for advisors in 2014; and a striking internal research study from "robo-advisor" Betterment, that has begun to calculate the behavior gap on its aggregate tens of thousands of customers and found that, through its systems, the average behavior gap is a mere 0.31%/year, barely 1/5th of the behavior gap reported for the typical investor in similar research studies (and raising the question of whether "client behavior gap" is something all advisors and robo-advisors might be expected to start tracking and reporting on in the future?). Enjoy the reading!

Investing Around Human Capital – Is Your Client’s Career A Stock Or A Bond?

January 8, 2014 07:01 am 10 Comments CATEGORY: Human Capital

Effective investment management requires proper diversification of assets to manage risk and maximize the likelihood of funding client goals. However, the traditional approach for doing so focuses on a client’s investment portfolio alone, or perhaps their personal residence as well, but often ignores their greatest asset: their ability to continue earning income through the fruits of their labor, also known as their “human capital.”

Just as with financial capital, the value of human capital may rise and fall over time. However, the reality is that human capital for some clients is far more volatile than others. Careers like working for the government, or being a tenured professor, produce human capital that exhibits “bond-like” risk and return characteristics, while more corporate and/or entrepreneurial positions are more stock-like (including the fact that they may be outright correlated to the economic cycle and stock market returns).

Accordingly, effective diversification of the client’s entire household balance sheet may entail using financial capital to counterbalance against the risks of human capital; in other words, those with stock-like careers should own more bonds, while those with bond-like careers can afford to own more stocks. Similarly, decisions about savings should recognize that sometimes, investing in human capital can actually produce a greater Return On Investment than saving (even better than buying stocks in a Roth IRA for the long run!). So the next time you’re working through financial planning decisions with your client, remember to consider whether their career and human capital behave more like a stock, or a bond!

4 Tips To Better Structure Your Financial Advisory Firm For Gen X Clients

January 7, 2014 07:01 am 1 Comment CATEGORY: Client Trust & Communication

While the bulk of financial services has been focused on the baby boomer generation - as the saying goes, they're "where the money is" - an increasing acknowledgement is growing that at some point, financial planners have to expand their horizons to the Generations X and Y that follow. Not just because eventually, Gen X and Gen Y will inherit the remaining wealth of the baby boomers, but also because - in the case of Gen X at least - they're beginning to reach their peak earnings years, and build some serious wealth of their own.

In this guest post, Ted Jenkin of oXYGen Financial, an advisory firm that is squarely focused already on serving Gen X and Gen Y - and is doing so successfully - shares some of his own tips about how to serve Gen X effectively. From reframing away from retirement planning to "exit planning", to recognizing the importance of coaching outside of purely financial matters, to trying to bundle services not just for pricing but for efficiency from the client's perspective, Ted provides insight on how working with Gen X is different than generations past.

So whether you're looking to work more with Gen X clients, or perhaps figure out why you've had limited success trying to work with them already, hopefully this article will be helpful to you in considering how you might need to shift your services to serve Gen X clients more effectively. Alternatively, if you're just thinking about working with Gen X at some point in the future, this article should provide a roadmap of some of the services you'll need to consider - and expertise you must develop - along the way.

Top 3 Issues Financial Planners Will Face in 2014: Fiduciary Regulation, Demographics Pressures, And Robots Vs Cyborgs (Vs Humans)

January 6, 2014 07:01 am 4 Comments CATEGORY: Planning Profession

As we begin 2014, a number of issues loom that may have broad impact for advisors in the coming year. Perhaps most significant is the fact that we may finally see some activity on the regulatory front; the next fiduciary proposal from the Department of Labor is targeted for August of 2014, and while the SEC may be taking a back seat on the fiduciary issue and waiting for the DOL to act, the regulator has committed itself to step up oversight (i.e., examinations) of investment advisers, and may even take up the recent SEC Advisory Panel's recommendation to begin levying "User Fees" on RIAs to help fund increased oversight. On the other hand, the CFP Board may also face its own turmoil this way in its ability to oversee CFP certificants, as the challenging Camarda case plays out.

In the meantime, the slow-motion trainwreck that is the advisory industry's demographics problem will continue to play out; the latest Moss Adams study showed that employee advisors are now outnumbering owner advisors, yet the number of advisors available to hire who have capacity for new clients continues to dwindle. While the anticipated mass exodus of retiring advisors has been more like a trickle so far - for a number of reasons - the veteran advisors who remain still cannot solve the capacity of growing firms that need to hire younger advisors to take the lead. In the coming year, the problem is going to become a lot more noticeable.

The third key trend for 2014 will be the continued rise of the "robo-advisor" but with a more nuanced look; while the robo-advisors seem to have exploded onto the scene in 2013, the reality is that by numbers, most of them are still quite tiny (especially relative to the venture capital they raised), and none appear to actually be economically viable and even running at a breakeven pace yet (much less making the return-on-equity profits their funders expect). In the coming year, we'll begin to see which robo-advisors will outpace the others and pull ahead, and many will aim to refine their models; some may even decide that it's more constructive to be a partner with advisors than a competitor, given the reality that most robo-advisors are actually more in competition with online brokerage tools like Schwab and E-Trade than human advisors. At the same time, it may be the heavily technology-enabled advisors - the "cyborg advisors" - who really begin to shine, blending the best of technology and human skills that pulls ahead of both the robo-advisors and the humans.

And in the meantime, the potential for a bear market will continue to loom in the coming year. Whether 2014 turns out to be the next stock bear market - or a rapid unfolding of the long-anticipated bond bear market - remains to be seen. But if 2014 is the next big one, expect the decline to ripple across the industry, as advisors who have rapidly grown their AUM businesses receive a stark reminder of the importance of profit margins to protect against the inevitable revenue declines that come from time to time, as many advisory firms are now so large that they cannot simply grow their way through a bear market with new clients!

Weekend Reading for Financial Planners (Jan 4-5)

January 3, 2014 01:23 pm 2 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's reading kicks off with the latest announcement from FINRA, that they are putting a heightened scrutiny on IRA rollovers, just as the Department of Labor is anticipated later this year to issue its own fiduciary rule on IRA rollovers, and raising the question of whether FINRA is trying to accommodate and prepare for the DOL rule or reassert its own jurisdiction on the issue. There's also an interesting article covering a recent survey from Spectrem Group that suggests prospective clients may have their own views about what "wealth management" means that differs from how advisors view the issue.

From there, we have a couple of practice management articles this week, including a look at how advisors may generate the most clients from client referrals but the best clients come overwhelmingly from Centers of Influence; a story of how one young advisor climbed the ladder from intern to CEO of an independent RIA and what it takes to climb the ladder; and a look at some of the differences in what Gen X/Y clients expect from their advisors versus baby boomer clients (hint: the Gen X/Y clients laughed out loud at the thought of having a 90-minute meeting).

From there, we have several more technical financial planning articles this week as well: a challenging article that questions whether commodities futures funds are really living up to their promise of high ("stock-like") returns with low correlations; a discussion of whether we may already be in another housing bubble, this time driven not by consumers but by private and institutional investors, as affordability hits new all-time lows; a look at whether client fears that their children won't be able to get into any college may be completely overblown; and a discussion of how the file-and-suspend Social Security claiming strategy, typically used for married couples, may actually be an effective approach for singles as well as a form of "delayed benefits insurance."

We wrap up with three interesting articles: the first is a discussion from an advisor who blogs about the benefits that he/she finds, beyond just the opportunity to develop business, from helping to clarify thinking to a mechanism for accountability; the second is an interesting discussion for technology innovation commentator Vivek Wadwha about how the United States may be poised for a new renaissance driven by real integration of the digital world into all industries that could spur a new wave of economic growth; and the last is an interesting discussion of how financial plans might be made more engaging for clients by inviting them to find images of their goals that they identify with, and then using those images to help them better visualize, connect with, and stay accountable to pursuing their goals. Enjoy the reading!

Mailbag: Home Office Vs Outside Office Space And Credibility As A Startup Financial Planner

January 2, 2014 07:01 am 8 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 will occasionally post a new "MailBag" article, presenting the question or comment (on a strictly anonymous basis!) and my response, in the hopes that the discussion may be useful food for thought.

In this week's MailBag, we look at a question about whether it's important and necessary to have a physical office space when you're starting your financial planning practice, or if it's just a waste of money. Can any advisor really establish trust and credibility with clients with only a digital presence, or is that limited to just younger advisors serving younger clientele?

Understanding The Two 5-Year Rules For Roth IRA Contributions And Conversions

January 1, 2014 07:01 am 93 Comments CATEGORY: Taxes

While Roth IRAs are very popular as a retirement savings vehicle due to their tax-free growth treatment, they also have several unique rules associated with them to ensure that their favorable tax status is not abused. In particular, there are two different 5-year rules associated with Roth accounts to prevent them from being taken advantage of; the first 5-year rule applies to Roth contributions and determines whether earnings will be tax-free, while the second 5-year rule applies to Roth conversions and determines whether conversion principal will be penalty-free.

Each of the 5-year rules are measured from the beginning of the tax year for which they apply, which means in reality tax-free earnings or penalty-free conversion principal may be accessible in less than 5 years in certain circumstances. And because the Roth rules aggregate all accounts together for the purposes of determining the tax treatment of various distributions, it's necessary to track the various 5-year rules and the amounts they're associated with, regardless of whether they are held separately or mingled together into a single account.

Ultimately, being able to effectively navigate the various Roth 5-year rules creates several planning opportunities as well. For some, taking advantage of the Roth conversion 5-year rule is a way for those well under age 59 1/2 to tap their IRA funds "early" without an early withdrawal penalty. For others, the reality is that the Roth conversion 5-year rule is a moot point anyway, because they already meet another exception to the early withdrawal penalty (e.g., already being over age 59 1/2). However, in all cases, the 5-year rule for contributions must be met before any Roth earnings can actually be tapped tax-free; fortunately, though, because any first-time contribution or conversion can start the clock, clients who are concerned about the 5-year rule can make a contribution to a Roth (or to a traditional IRA and then convert it) to start the time window now, and ensure they'll never need to worry about it in the future!