Kitces.com - Advancing Knowledge in Financial Planning

How The IDGT Strategy Turns Business Stock Into A Bond For Estate Tax Purposes

October 12, 2016 07:01 am 14 Comments CATEGORY: Estate Planning

For high-net-worth individuals who built their wealth through entrepreneurship and creating a business with substantial value, a significant challenge is not only that the business will someday be subject to estate taxes, but that the continued growth and success of the business just compounds the problem further.

Accordingly, an increasingly popular strategy in recent years to manage this issue is the Intentionally Defective Grantor Trust (IDGT), a unique type of trust structure where the income of the trust is still the grantor’s for income tax purposes, but the assets of the trust are excluded from his/her estate for estate tax purposes. In other words, the trust is “effective” for estate taxes, but “defective” for income taxes.

The benefit of this arrangement is that the value of the trust, and any growth thereon, are excluded from the grantor’s estate. But the fact that the trust is “defective” for income tax purposes is also a good thing, as it means the grantor can pay all of the IDGT’s income tax bills (without being deemed a gift), and can sell the family business to the IDGT in exchange for an interest-only installment note, without triggering capital gains taxes (since the grantor is effectively just selling the business to themselves).

Which means in essence, establishing an IDGT and then selling the grantor’s business to it, in exchange for a promissory note, means the grantor has transmuted his/her assets from a potentially high-return high-growth family business into a low-yield bond (given today’s low Applicable Federal Rates that are used to determine the interest rate for the installment note sale).

And in the long run, this can produce a substantial estate tax savings, to the extent that the business inside the IDGT outgrows the relatively low hurdle rate associated with the installment note. In fact, the strategy can be further leveraged by obtaining valuation discounts on the sale of the family business as well, though notably a recent proposed Treasury Regulation would crack down on such discounts, potentially as early as 2017. Nonetheless, even without a potential valuation discount, the opportunity for estate tax savings in using an IDGT is significant in the long run, simply for the ability of a successful family business to outearn and outgrow today’s ultra-low interest rate environment!

Creating Advisory Firm Processes And Workflows – Tips and Best Practices

October 10, 2016 07:00 am 8 Comments CATEGORY: Practice Management

When you first get started as a financial advisor, the reality is that there is a lot of time, and not a lot of clients. Which is good, because you're the only one available to get anything and everything done!

As the business grows, though, and especially once other staff members are added to the picture, the situation gets more complicated. Suddenly the things that need to get done involve multiple people, who have to coordinate. And there's a greater risk that tasks start to slip through the cracks, because there's a lot to do for existing clients, and prospective new clients, and running the business itself. It's time to begin introducing some process and structure to the business.

In this guest post, Teresa Riccobuono of Simply Organized (a professional organizer who consults with financial advisors about how to get more organized by creating systems and process!) shares some of her own tips and best practices about why creating processes and workflows are important, and how to go about actually getting started at it. Whether it's creating processes in the business itself, or processes for yourself to better manage your time, or processes that can turn into habits that make you more productive... the reality is that as any advisory firm grows, it becomes more and more necessary to systematize what you do, to ensure that your clients get the consistent high-quality service they expect!

So whether you're an advisor who has just hired your first staff member or two (or already have them and are struggling with the coordination to ensure that everything gets done by the right people at the right time), or you're looking for ways to improve your own time management and personal productivity by introducing a little more structure to your daily routine, I hope that you find this guest post from Teresa to be helpful!

Weekend Reading for Financial Planners (Oct 8-9)

October 7, 2016 02:53 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the huge news that Merrill Lynch is fully pivoting its retirement advisors to become level fee fiduciaries, eschewing commission-based retirement accounts entirely by April of 2017, and redirecting self-directed investors who still wish to trade to its Merrill Edge online brokerage platform or a new "robo" platform called Merrill Edge Guided Investing (though notably Merrill Lynch taxable brokerage accounts may still remain commission-based and are not subject to the new fiduciary rules). Also in the news this week was a decision from the DC Court of Appeals that has made a final ruling in favor of the CFP Board over the Camardas, which should end the ongoing lawsuit once and for all... and with the CFP Board's recent change to require mandatory arbitration, will likely be the last dispute any CFP certificant ever has with the organization that sees the inside of a courtroom.

From there, we have a few practice management articles specifically on the topic of hiring and retention, including: tips for hiring and retaining Millennial advisors; how to find the "right" team members by focusing first on cultural fit and passion (as long as the minimum technical skills are there); the importance of managing expectations for new employees to retain them going forward; and how "client-centric" firms aiming for high retention may be too client-centric, driving away their best employees (and ultimately damaging the firm's retention) in the process.

We also have several more technical articles, from a look at how to set "retirement guardrails" to determine when retirees may be spending too much (due to higher spending or poor market returns), to a discussion of how the community property rules interact with retirement accounts (and how a spouse's community property interest doesn't automatically ensure he/she can do a spousal rollover after death!), and an overview of how to use the IRS' Data Retrieval Tool (DRT) now that the 2017 FAFSA season is open.

We wrap up with three interesting articles: the first is a call-to-action for younger planners that despite being the "next generation" of financial planners, the time to lead is now (allowing for more time to build a foundation and enjoy the fruits of their labor!); the second is a look at the idea of practicing "radical generosity", giving especially deep and thoughtful gifts to clients, prospects, and referral sources, as a way to enhance the relationship; and the last is a look at how despite all the ongoing technological progress, the next 20 years may actually be far less disruptive than the past decades have been, as even "innovative" technology in recent years has actually been more incremental than truly revolutionary, and could actually drive consumers even more towards health care, education, and financial advising sectors, that remain uniquely human in their needs.

Enjoy the "light" reading!

The Problem With Trying To Be The Lowest Cost Financial Advisor

October 6, 2016 08:02 am 1 Comment CATEGORY: Practice Management

In an increasingly competitive environment for financial advisors, from the rise of robo-advisors and Vanguard Personal Advisor Services, there are more pressures than ever on us to justify our cost to clients. Leading many financial advisors to question whether it's time to cut AUM fees - or even abandon the AUM model altogether.

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, I look at when and whether it ever makes sense to cut AUM fees in an effort to grow the business and bring in more clients.

Clearly, for advisors who are far more expensive than their competition, cutting fees to at least be "reasonably competitive" may be inevitable. But for those whose AUM fees are already reasonable, beware the strategy of trying to attract clients by being the lowest cost financial advisor. Because ultimately, that may attract the most cost-conscious and price-sensitive clients - who may come to you for being the lowest cost, but will just as quickly leave you for another advisors who is just a basis point or few lower... because that's the behavior of clients who seek out the lowest cost solutions!

More generally, though, the real challenge of trying to compete by being the lowest cost provider is that it sets the focus to competing on price, instead of competing on value instead. In fact, for financial advisors who find their prospective clients challenge their pricing, usually the biggest issue is not their pricing at all - it's a lack of differentiation, and the perception from clients that your services are no different than any other financial advisor... which means price is the only comparison left.

In other words, most "price" conversation are actually value and differentiation (or lack thereof) conversations. Which means the real solution is not to adjust your prices - or change your entire business model (e.g., from AUM fees to retainer fees) - but instead to try to improve your differentiation by focusing on a niche or specialization, such that clients will focus on your unique value instead of comparing you to others on price alone! Because for advisors who are truly differentiated with a unique value, clients don't often ask very many questions about price and cost in the first place - because there's nothing to compare you to anyway!

The Portfolio Size Effect And Using A Bond Tent To Navigate The Retirement Danger Zone

October 5, 2016 07:01 am 38 Comments CATEGORY: Retirement Planning

The final decade leading up to retirement, and the first decade of retirement itself, form a retirement danger zone, where the size of ongoing contributions and the benefits of continuing to work are dwarfed by the returns of the portfolio itself. As a result of this “portfolio size effect”, the portfolio becomes almost entirely dependent on getting a favorable sequence of returns to carry through.

And because the consequences of a bear market can be so severe when the portfolio’s value is at its peak, it becomes necessary to dampen down the volatility of the portfolio to navigate the danger – a strategy commonly implemented by many lifecycle and target date funds, which use a decreasing equity glidepath that drifts equity exposure lower each year.

Yet the reality is that the retirement danger zone is still limited – after the first decade, good returns will have already carried the retiree past the point of danger, and bad returns at least mean that good returns are likely coming soon, as valuation normalizes and the market cycle takes over. Which means while it’s necessary to be conservative to defend against the portfolio size effect, it’s not necessary to reduce equity exposure indefinitely.

Instead, the optimal glidepath for asset allocation appears to be a V-shaped equity exposure, that starts out high in the early working years, gets lower as retirement approaches, and then rebuilds again through the first half of retirement. Or viewed another way, the prospective retiree builds a reserve of bonds in the final decade leading up to retirement, and then spends down that bond reserve in the early years of retirement itself (allowing equity exposure to return to normal).

Ultimately, further research is necessary to determine the exact ideal shape of this “bond tent” (named for the shape of the bond allocation as it rises leading up to retirement and then falls thereafter). But the point remains that perhaps the best way to manage sequence of return risk in the years leading up to retirement and thereafter is simply to build up and then use a reserve of bonds to weather the storm.

The Latest In Financial Advisor #FinTech (September 2016)

October 3, 2016 07:01 am 3 Comments CATEGORY: Technology & Advisor FinTech

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

This month's edition kicks off with the launch of two new categories of financial advisor technology - AdvicePay, a payment processor to facilitate monthly, quarterly, or annual retainer billing directly from a client's credit card or bank account (without running afoul of RIA custody rules!), along with Snappy Kraken, a comprehensive automated digital marketing platform for advisors, both premiering at the #XYPN16 #FinTech competition in September.

Also in the news over the past month is: McKinsey Consulting buys PriceMetrix, a financial advisor data platform to do benchmarking of advisor fees (necessary to determine "reasonable compensation" in the future under DoL fiduciary!); the launch of a new risk tolerance profiling system called TrueProfile, and the news that the Financial Planning Association is participating in the venture (putting it in competition with companies like Riskalyze and FinaMetrica, which also sponsor FPA events!); RIA In A Box wins its second consecutive "Best In Show" award at the Fuse Orion hackathon (who says compliance tech solutions aren't exciting!?); a new hybrid Robo/TAMP solution named "RobustWealth" launches, aiming to compete with alternatives like Betterment for Advisors but with the capabilities of a full-fledged TAMP; Betterment rolls out a new "Tax Coordinated Portfolio" service, threatening to commoditize Asset Location in the same way it has with Tax-Loss Harvesting; the Balance Financial PFM solution for advisors shuts down (but may live on as a proprietary HD Vest solution); transactional "robo" platforms Motif and Robinhood pivot to an AUM-like fee-based wrap account subscription model, but at a cost that could be drastically higher than other robo-advisors for small Millennial accounts; and a new product called "Screenmeet" launches for advisors, aiming to compete with (more expensive and complex) alternatives like GoToMeeting and WebEx for advisors who just want to do a simple screen-share of a document while speaking to a client on the phone.

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]!