Kitces.com - Advancing Knowledge in Financial Planning

Supplemental Saving In An HSA For Retiree Medical Expenses

January 20, 2016 07:01 am 27 Comments CATEGORY: Retirement Planning

The Health Savings Account (HSA) is unique in the landscape of tax-preferenced investment acounts, as it is the only type that enjoys both the benefit of tax-deductible contributions and tax-free distributions (for medical expenses). In fact, the unique treatment of the HSA has created a wrinkle in the traditional approach of funding retirement accounts: given the inevitability of medical expenses in retirement, arguably the best savings account for retirement (or at least for a portion of retirement expenses) is to use a health savings account for retirement over “just” an IRA alone.

In other words, for any retiree that is saving for both medical expenses in retirement and also all of their other retirement goals, using a combination of an IRA (for most retirement expenses) supplemented by an HSA as a "retirement health savings account" may be the most tax-preferenced way to save holistically for retirement. In fact, the health savings account tax treatment is so good that it can even be superior to funding a 401(k) plan with a small match (for those who haven't already started a health savings account for retirement)!

Notably, this doesn’t mean that retirees would exclusively fund a health savings account for retirement, as the accounts are both taxable and potentially subject to penalties if used for non-medical purposes. But for those who already have some retirement accounts, and/or have more than enough dollars overall to achieve their goals, the fact remains that contributing the maximum to an HSA every year has the potential for more beneficial tax treatment than any other type of tax-preferenced account! Which makes accumulating in an HSA so desirable that it may even be preferable to pay current medical expenses out of pocket, just to preserve (and keep contributing to) the HSA account balance to be used as a future health retirement account!

Is Financial Planning Software Preventing The Growth Of Real Financial Planning Advice?

January 18, 2016 07:01 am 38 Comments CATEGORY: Technology & Advisor FinTech

One of the not-so-secret “secrets” of financial planning is that relatively few advisors actually generate the bulk of their income by getting paid for financial planning advice. Instead, despite the growth of financial planning in recent decades, the reality is still that most advisors get paid for financial planning through the subsequent products that are sold for implementation, or the subsequent assets they gather or retain through financial planning as a value-add.

And while arguably this is still not a bad way to build a business model around financial planning, the fact that financial planning remains rooted primarily in product sales and asset gathering has influenced – perhaps more than most advisors realized – the way that our financial planning software is built.

In fact, with its focus on investment accumulation (for retirement and college) and insurance-related scenarios, most financial planning software may be little more than a product sales and asset gathering tool shrouded in financial planning terms. Areas that are highly relevant for financial advice but not for product sales – from tax strategies to debt management to cash flow and budgeting – remain remarkably absent from most financial planning software tools available today.

Given that financial planning is a complex, intangible service that may be beneficial for clients but is hard for them to conceptualize, having tools to illustrate financial planning strategies, help clients adjust their behavior, and show the value of the advice we’ve delivered is essential. Yet in a world where most financial planning software remains so product-centric, have we progressed to the point where the financial planning software is not facilitating real advice, but limiting its growth?

Weekend Reading for Financial Planners (Jan 16-17)

January 15, 2016 02:31 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 mega asset manager Invesco has bought "robo-advisor-for-advisors" platform Jemstep, in yet another example of an investment company acquiring a robo technology platform to use as a distribution channel for advisors.

From there, we have a number of technical financial planning articles, including: a look at why most retirees really go broke (hint: despite our focus on Monte Carlo analysis, it's not actually from market volatility, but spending shocks instead); how to proactively use the Roth recharacterization rules for various Roth conversion strategies; a discussion of recent research examining why corporate bonds don't seem to provide the risk premium over government bonds that would be expected given their default risk; and a look at the ongoing rise in various "values-based investing" approaches from SRI and ESG to impact investing (to the point that even regulators and the IRS are making it easier to pursue such strategies).

We also have a few practice management articles this week, from the ongoing decline of client referrals (as affluent clients seem to be increasingly concerned about the "social risk" of making a referral), to a reminder of the importance of updating your LLC operating agreement for your advisory firm (or more importantly, creating one if your LLC doesn't have one already!), the liability issues involved if an advisory firm employee makes a trading mistake, and some reminders of what not to do as you complete the annual Form ADV update process in the coming weeks.

We wrap up with three interesting articles, all focused on the topic of personal productivity: the first is a look at why you might consider getting a personal assistant to help you be more productive in business (even if you have to pay for it out of your own pocket); the second is a reminder of how helpful it can be to create a structured weekly routine for yourself (where client meetings are only scheduled on certain days of the week); and the last is a powerful reminder of the difference between just being "busy" (even if you're very efficient at getting things done!), and truly being productive.

And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including a discussion of the Invesco acquisition of robo-advisor Jemstep, social media platform Snapchat is rumored to be working on its own robo-advisor offering, BBVA Compass is announced as the first financial services firm to be linked up to FutureAdvisor since Blackrock acquired it, and Wealthfront announced its own Portfolio Review service to analyze fees and performance of a prospect's outside portfolios in an effort to try to amplify its own lead generation.

Enjoy the reading!

Getting Funding To Launch An RIA And The Startup Costs Of Becoming A Financial Advisor

January 14, 2016 09:01 am 6 Comments CATEGORY: Practice Management

The Bureau of Labor Statistics projects that employment opportunities for personal financial advisors will grow by 30% in the coming decade, and Cerulli projects that nearly 1/3rd of existing advisors will retire over that same time period as well - creating a tremendous opportunity for those who are interesting in becoming a financial advisor.

In this week’s #OfficeHours with @MichaelKitces – a new video series we’ve launched where I will take reader questions, both emailed and live, every Tuesday at 1PM EST via the Periscope social media platform – we look at how much it costs to start an advisory firm, what it takes to survive in the early years, and why it is so difficult to get funding for your new advisory business venture.

Yet ultimately, it turns out that the simple reality is it's actually remarkably inexpensive to become a financial advisor - at least compared to the startup costs for most other industries. The real blocking point for getting started is not the cost to establish the business, but the "income gap" that is created as you leave another job and haven't yet gotten clients in your new firm. Or viewed another way, it's the difficulty in paying your personal bills while getting started as a financial advisor that is the real challenge, not the startup costs for creating the business itself.

You can see me discuss all of this and more in our #OfficeHours video posted in today’s article, along with details on how to sign up to watch the next broadcast live, and participate for yourself!

Should Equity Return Assumptions In Retirement Projections Be Reduced For Today’s High Shiller CAPE Valuation?

January 13, 2016 07:01 am 49 Comments CATEGORY: Retirement Planning

The sustainability of retirement cash flows from a portfolio depends in no small part on the returns generated by that portfolio – in particular, the real returns, given the pernicious impact of inflation over a multi-decade retirement.

In today’s high-valuation environment, many retirement projections are being done with reduced long-term return assumptions… with the caveat that while many advisors agree on the need to project lower returns, there is little agreement on how much lower it should be.

A look at the available market data suggests that realistically, it would be appropriate to reduce equity return assumptions by about 100bps (or 1 percentage point) over the next 30 years, to reflect the current valuation environment. Ironically, the reduction is not greater, because 30 years is such a long time that even if returns are bad for a period of time, there are enough subsequent years to recover as well.

In point of fact, though, it turns out that market valuation is even more predictive of 15-year returns, and that today’s high P/E ratios imply that between now and 2030, market returns could be reduced by as much as 400bps. On the other hand, because market valuations (and the associated returns) tend to move in cycles, this also implies that in the 2030s and 2040s, market returns could be as much as 400bps above the long-term average as well.

Ultimately, then, the ideal way to adjust return assumptions in a retirement plan in today’s environment may not be to reduce long-term returns at all, but instead to do projections with a “regime-based” approach to return assumptions. This would entail projecting a period of much lower returns, followed by a subsequent period of higher returns, in a manner that more accurately reflects the impact of market valuation on returns – and better accounts for the sequence-of-return risk along the way as well!

Life Settlements – Selling A Life Insurance Policy That’s No Longer Wanted For More Than Its Cash Value

January 12, 2016 07:01 am 9 Comments CATEGORY: Insurance

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The classic view of life insurance is that it is purchased as long as needed or desired, and then lapsed (or if there's any cash value, surrendered) when it is no longer necessary. Term insurance policies are usually expected to lapse, and in practice even "permanent" insurance often ends out being surrendered before it is ever paid out as a death claim.

Technically, though, there is a third option to the "keep versus lapse" decision of life insurance: to sell the policy to a third party in a transaction called a "life settlement" to an (institutional) investor who might be willing to pay more than just the policy's cash value (or the $0 value that might be available if the coverage just lapses on its own). After all, in the hands of an investor, a life insurance policy is simply an "investment" that has ongoing cash flow requirements (premiums) but will eventually mature as a (much larger) death benefit later. So as long as the time horizon is "reasonable", the policy can actually have a remarkably appealing implied rate of return to an investor, for which the current policyowner can be paid!

In this guest post, Lingke Wang - co-founder of Ovid Life, a technology firm aiming to create a centralized transparent marketplace for life settlements transactions - provides a "Financial Advisor's Guide To Life Settlements" with a detailed review of the life settlement industry, what a life settlement provider is and how life settlements operate, and the mechanics of how an investor evaluates a prospective life settlement contract purchase (which is important to understand for any policyowner who might be selling their life insurance policy!).

Ironically, the biggest caveat of engaging in a life settlement is the reality that any life settlement policy worth selling to an investor is worth even more in the long run for the policyowner to just keep themselves, where the internal rate of return will be even more appealing (since the investor has both transaction costs to acquire the policy, and does not enjoy the death benefit tax free as the original policyowner would). Nonetheless, that appealing internal rate of return for keeping a permanent life insurance policy only applies by continuing to maintain the policy, including ongoing premiums. So for a policyowner who simply doesn't want to - or can't afford to - keep the policy in the first place, a life settlement may still be a more appealing exit than just letting the policy lapse away!