Weekend Reading For Financial Planners (August 15–16)

Author: Adam Van Deusen, CFP®

Team Kitces

Adam Van Deusen, CFP®, is a Financial Planning Nerd at Kitces.com, where he hosts the Financial Advisor Technician podcast, writes articles for the Nerd’s Eye View blog (including the popular Weekend Reading for Financial Advisors), and regularly speaks at industry events on a range of technical and practice management topics. He previously worked at a financial planning firm in the Washington, D.C. area and as a journalist covering the banking and insurance industries. Outside of work, he serves as a volunteer financial planner and class instructor for local and national non-profits.

Read more of Adam’s articles here.

Proposed IRS Regulations Clarify Employer Contributions, Employee Pre-Tax Funding Of "Trump Accounts", Restrict Ability Of Business Owners To Contribute To Own Kids' Accounts

(RSM)

The "One Big Beautiful Bill Act" (OBBBA), passed last year, introduced the Section 530A "Trump Accounts", a new type of 'starter' retirement account designed to be opened and funded on behalf of minor children so they can start accumulating tax-deferred retirement savings at an early age. Notably, while contributions to these accounts can be made not only by parents but also by employers, certain potential restrictions on these contributions have been unclear up to this point.

This week, the Treasury Department released proposed regulations that would answer some of these questions. To start, the proposed rule would clarify that the limit on employer contributions that are excludable from income (up to $2,500 per employee per year, indexed for inflation after 2027) would apply per employee (i.e., each employee could only exclude a total of $2,500 from income even if they have multiple children) and across all employers (i.e., if an individual has multiple jobs with employers who make contributions, they could still only exclude a total of $2,500 from their taxable income). Notably, the exclusion only applies to income tax, with employer contributions being subject to FICA (Federal Insurance Contributions Act) and FUTA (Federal Unemployment Tax Act) taxes.

In what could be a positive development for savers and employers alike, the proposed regulations also note that employers could have the option of allowing employees to make pre-tax salary reduction contributions (up to $2,500 per year) through a section 125 cafeteria plan to a dependent's Trump Account (which could provide employees access to a tax break without the employer making direct contributions themselves).

In bad news for certain business owners, under the proposed regulations, sole proprietors, partners, and 2%+ S-corp shareholders would not be able to make income-excludable employer contributions to their own or their dependents' Trump Accounts. Notably, business owners could still open one of these accounts for their child and fund it to the overall $5,000 annual limit, but any contributions wouldn't be excluded from income (they would still have the option of making contributions for their employees and their employees' dependents, though). Also, the proposed rule would not allow minor employees to make tax-free contributions to their own Trump Accounts.

While there has been significant discussion over the relative financial benefits of individual contributions to Trump Accounts compared to other savings vehicles, contributions made by employers or by the government (i.e., the pilot program to contribute $1,000 to accounts of those born in the years 2025 through 2028) could be particularly attractive to parents (who might not have the extra cash flow to make them themselves). Which presents an opportunity for financial advisors to offer value to their clients by ensuring they are aware of the funding opportunities available to them and helping them take advantage of available options (including considering their own Trump Account contributions in the context of their ability to save for their own retirement!).

Final Rule Will Eliminate BOI Reporting For U.S. Entities

(Martha Waggoner | The Tax Adviser)

In 2021, Congress passed the Corporate Transparency Act, which required many businesses transacting in the U.S. to file reports disclosing information about their "beneficial owners". Over time, however, there's been a whipsaw-like back-and-forth of developments affecting whether or not the new Beneficial Ownership Information (BOI) reporting requirements would be (or could be) enforced. The requirements were originally set to go into effect on January 1, 2024 (with a January 1, 2025 BOI reporting deadline for existing companies), but the requirements were subsequently paused and then reinstated by a dizzying series of decisions in various U.S. courts.

However, last February, the Treasury Department's Financial Crimes Enforcement Network (FinCEN) announced that it would not be issuing any fines or penalties in connection with the BOI reporting deadlines. And then, on March 2, the Treasury Department announced that it did not plan to enforce any penalties associated with the rule for U.S. citizens or companies, permanently.

This week, the Treasury Department said it is issuing a final rule that permanently removes the requirement for U.S. companies and U.S. persons to report beneficial ownership information to FinCEN under the Corporate Transparency Act. Under the final rule, U.S. persons who have obtained FinCEN IDs are exempted from having to update or correct information they originally provided to FinCEN. While foreign entities that are reporting companies (i.e., companies formed in a different country that have registered to do business in the U.S.) will still be required to report beneficial ownership information for foreign individuals, these companies won't have to report U.S. persons who help these companies register to do business in the U.S. Also, foreign pooled investment vehicles registered in the U.S. will be exempted from reporting the beneficial ownership information of a U.S. person in control of the investment vehicle.

The bottom line is that U.S. citizens and businesses will no longer face BOI requirements, at least for the time being. But with the Corporate Transparency Act still on the books, this almost certainly won't be the last time we hear about BOI reporting requirements – the only question is whether the final decision will be made by the courts, Congress, or a future presidential administration.

Advisors Optimistic About Financial Outlook, Client Growth: CFP Board Survey

(Leo Almazora | InvestmentNews)

Financial advisors have likely fielded a range of questions from clients this year on the market and broader economic outlook, from the impact of conflict in the Middle East and rising oil prices to the potential for a future market decline amidst multiple all-time highs in the U.S. equity market.

In its latest quarterly CFP Professionals Sentiment Index, which included responses from 423 CFP professionals, the CFP Board finds that advisors see their clients as having a more positive financial outlook compared to the previous quarter (with 50% seeing a generally positive outlook amongst clients, compared to 36% last quarter). For their part, advisors themselves also showed a more positive financial outlook (with 61% having a positive outlook, compared to 54% the previous quarter). Advisors also reported having an expanding client base (with 70% reporting an expanded headcount, the highest figure in at least two years).

In terms of qualitative client comments, several major themes emerged from respondents. First, while clients tend to be optimistic in the longer term, they have greater anxiety in the shorter term. This appears to be influenced by clients' focus on political and global affairs, with some clients rethinking certain investments based on political beliefs. Also, despite recent market highs, volatility experienced this year appears to be contributing to this anxiety (with some clients holding more cash in response). Clients also appear to be focused on inflation and affordability, with gas, housing, and food prices of particular concern (particularly for those close to retirement).

Altogether, this survey suggests that while both advisors and their clients alike appear to have positive long-run outlooks, an undercurrent of short-term concern amongst some clients provides advisors with the opportunity to provide support by putting market and current events into context and showing clients how their financial plan is built to weather different contingencies that might occur!

What Doubters Get Wrong About The 60/40 Portfolio

(Jason Kephart | Morningstar)

Stocks and bonds make up the core of many investors' portfolios, with the exact allocation to each depending on factors such as age and risk tolerance. While stocks have provided higher average returns over the long run, bonds can provide a steadying presence during equity market downturns, whether by gaining in value during these periods (e.g., as they did during the 2007–2008 financial crisis) or at least seeing a comparatively muted decline. However, increased correlations between stocks and bonds in recent years (particularly amidst the period of elevated inflation and rising interest rates experienced earlier this decade) have raised the question of whether a continued allocation to bonds (e.g., as part of a 60% stock, 40% bond portfolio) is appropriate.

Kephart argues that while the correlation between U.S. stocks and bonds remains high (0.54 for the past three years compared to 0.13 for the last 25 years), this stat doesn't tell the whole story. To start, while stronger correlations mean that stocks and bonds will lose money together more often (e.g., stocks and bonds lost money together in 28% of months during the past five years, compared to 14% of months over the past 25 years), it also means that bonds can have better returns when stocks are also performing well (e.g., over the past three years, both stocks and bonds rose in 50% of months, up from 40% over the past 25 years).

In addition, even when stocks and bonds have moved down at the same time, the drawdown for bonds has often been shallower than that of stocks. For example, over the past three years, while stocks fell nearly 5% on average during their worst months, bonds only declined by about 1.7%. Not only does this mean that a bond allocation can dampen what would otherwise be a sharper drawdown in equities (which could lead some individuals to exit the market altogether), but it can also offer a rebalancing opportunity by shifting some of the bond allocation to stocks to participate in a future equity market recovery.

In sum, while investors might hope for bonds to provide a positive return when equities decline, a bond allocation during more correlated periods could still be valuable for investors (though some advisors might also look at assets with a long track record of lower, or even negative, correlations to stocks to provide additional diversification benefits?).

How Advisors Are Trying To Get Client Cash Off The Sidelines

(Miriam Gottfried | The Wall Street Journal)

In the decade-plus leading up to 2022, interest rates were near rock-bottom levels, which meant that savings accounts, money market funds, and other cash-like instruments paid very little. While the higher interest rate since then has meant higher costs for borrowers, it has also boosted the return on cash, with money market funds offering yields above 3%. Which has some investors considering whether they might keep a larger percentage of their assets in cash rather than invest more dollars in riskier instruments.

For advisors, a natural response to clients who want to keep significant cash holdings is to note the prospect of an inflationary period that could erode the returns of cash (or even lead to a negative real return). In addition, rates on certain instruments (e.g., savings accounts and money market funds) are subject to change, so that today's 3% return could be much lower if interest rates were to fall. That said, even if they do understand these arguments conceptually, some investors might still be nervous about increasing their allocation to stocks or even bonds (perhaps because they are still spooked by the sharp drop in both asset classes in 2022).

Amidst this backdrop, advisors have a few potential tools to get client cash 'off of the sidelines'. To start, clients (perhaps those in retirement) could earn a positive real return with little default risk by investing in Treasury Inflation-Protected Securities (TIPS), perhaps by creating a 'ladder' aligned with their need for cash.  Higher-income clients might also consider high-quality municipal bonds to get higher yields than cash while earning interest exempt from Federal (and sometimes state) taxes. Some clients might be attracted to "downside protection" ETFs that could offer higher upside than cash while limiting downside losses (though some advisors and clients might find that a traditional, but conservative, asset allocation might provide desired outcomes at lower cost and complexity). And for clients who do want to maintain cash holdings, cash management solutions are available to give advisors greater control (and potentially provide higher returns for clients than other cash-like instruments).

In the end, while an allocation to cash can be comforting to certain clients, advisors are well-placed to introduce opportunities (within a broader asset allocation) that could provide higher returns (at less additional risk than clients might expect) that can help them beat inflation and potentially better allow them to achieve their financial goals.

Treating Diversification As An Ingredient, Rather Than The Solution

(James White and Victor Haghani | Advisor Perspectives)

"Diversification is the only free lunch" is a well-known axiom in investing circles, promoting the idea that by diversifying across assets and asset classes, an investor can reduce the risk to their portfolio (while offering significant upside potential as well). A problem, though, is that without a single definition of what diversification actually means, some investors might find themselves creating portfolios that might not be as diversified as they think or that come with greater complexity or cost without adding additional value.

For example, some investors might treat diversification like a buffet, trying to add as many different assets and asset classes as possible. Today, with greater availability of alternative investments (e.g., private equity and hedge funds), some investors might assume that allocating dollars to these investments could provide additional (beneficial) diversification compared to investing in stocks and bonds. However, assessing whether a new potential investment will provide a greater risk-adjusted return is the key, as some assets could be highly correlated to current portfolio investments (but perhaps come with greater downside potential and/or expenses) and not necessarily add value to the investor's portfolio (even if it's theoretically more 'diversified').

Altogether, while diversification remains a valuable principle in portfolio management, financial advisors can offer value to clients by determining whether a client's asset allocation provides the needed diversification to match their risk tolerance and goals and, when potential new assets are considered, to determine whether they are truly additive to the portfolio!

Ode To The SEP IRA

(AJ Ayers | Money Changes Everything)

There are many available choices for business owners and freelancers looking to save for retirement (and reduce their current-year taxable income in the process), from Solo 401(k)s to cash balance plans. However, with different rules and requirements for each (in addition to varying amounts of paperwork to create and maintain them), choosing one can be challenging.

Ayers suggests that for many solo business owners and freelancers (particularly those with income between $20,000 and $150,000), the SEP IRA could be the ideal option, offering a combination of flexibility and simplicity. One of the key benefits of the SEP IRA is that contributions can be made after the calendar year is over (with those filing for an extension being able to contribute until October 15^th of the following year), which can be helpful for those with lumpy incomes and expenses (that can make it difficult to make consistent contributions throughout the year). Setting up and managing a SEP also tends to be simpler than doing so for a Solo 401(k) or other plans, perhaps increasing the likelihood that an individual will actually do so and continue to fund it (rather than getting discouraged along the way and not setting up any account). At the same time, the SEP might not be the best option for certain business owners, including those with W-2 employees (as they would be required to contribute the same percentage for eligible employees, which could get expensive) or for those with higher incomes (who might benefit from plans that allow higher contributions).

Ultimately, the key point is that the SEP IRA could be a valuable retirement savings tool for certain business owners and freelancers, allowing for flexible, simple contributions (with financial advisors being able to play a valuable role in helping clients set up their SEP, calculate and make appropriate contributions in a given year, and manage the investments within it to meet their goals!).

The Growing Popularity Of Cash Balance Plans For High Earners

(Anne Tergesen | The Wall Street Journal)

For many Americans, saving up to the annual 401(k) contribution limit can be a challenge given other cash flow needs. However, those with high incomes and sufficient cash flow to save could find themselves hitting these limits regularly, which could leave them looking for additional tax-advantaged retirement savings options.

One tool that has grown in popularity is the cash balance plan, with 23,000 employers offering them as of 2020 (up from 1,477 in 2001) and these plans holding more than $1.2 trillion in assets. Because they are technically pensions, cash balance plans don't have the same annual contribution limits as 401(k)s, with certain individuals able to contribute north of $300,000 depending on their age and income (though cash balance plans are often offered alongside 401(k)s to provide high-income employees with additional contribution and employer match opportunities and to satisfy nondiscrimination testing). These plans have become particularly popular amongst doctors, lawyers, and others who have high salaries but might have started their retirement savings relatively late (due to additional years of education and student loan payoff requirements).

In sum, cash balance plans could be valuable tools for certain business-owner clients (or those whose employers offer them), allowing these high-earning individuals to boost their retirement savings while also reducing current-year taxable income at a time when they might be in the highest tax brackets (suggesting a helpful role for financial advisors in introducing this possibility and helping clients determine how much they might contribute while still meeting current cash flow needs).

The Nuts And Bolts Of Establishing Solo 401(k) Plans For Self-Employed Clients

(Ben Henry-Moreland | Nerd's Eye View)

Among the several different types of retirement plans that are available to self-employed workers, solo 401(k) plans can offer the most flexibility and the ability to contribute the highest amount of tax-advantaged savings. But alongside those advantages, there are some specific rules and regulations that are unique to solo 401(k) plans, which can add to the complexity of setting up and maintaining a plan. And for advisors who serve self-employed clients, managing a solo 401(k) plan is often a different process than managing other types of investments.

However, the advantages of solo 401(k) plans – which include higher contribution limits for individuals with moderate incomes as well as the ability to make Roth contributions to the plan (plus additional nondeductible contributions which can be converted into even more Roth dollars) – mean they can often be worth the added complexity, particularly for individuals who want to save a high percentage of their income and/or build tax-free Roth savings. They can also permit participants to take loans from the plan, creating a source of emergency funds without the need to make a (potentially taxable) distribution.

Setting up and maintaining a solo 401(k) plan involves creating plan paperwork (including a written plan document and adoption agreement), keeping records of contributions and withdrawals, and for plans with more than $250,000 in assets, filing Form 5500-EZ annually with the IRS. Business owners typically outsource some or all of these tasks, and they can do so in one of two ways: by choosing a pre-approved, 'off-the-shelf' plan with a broker-dealer firm (who then serves as custodian for plan assets), or by hiring a third-party plan provider to create a 'self-directed' plan, which can invest in a wider range of assets.

Although both types of solo 401(k) plans come with particular benefits, there are also tradeoffs to each approach. Off-the-shelf plans can be easier to administer, since the broker-dealer handles most of the plan paperwork and holds the plan assets often for little to no cost. However, off-the-shelf plans also tend to offer fewer options; for example, TD Ameritrade's merger with Charles Schwab resulted in the elimination of Roth features from their off-the-shelf solo 401(k) plan.

Self-directed plans, meanwhile, offer more ability to tailor a plan's features to an individual's needs. These features can include the ability to make Roth or nondeductible contributions, to take loans from plan assets, and to invest in non-traditional assets such as real estate, crypto assets, and precious metals – many of which are not allowed by most off-the-shelf solo 401(k) plans. But self-directed plans can be complex to manage, with the possibility of assets being held in multiple locations (as well as the responsibility of the plan participant to avoid investing in prohibited assets or making prohibited transactions), and costs that typically include startup fees of several hundred dollars, along with additional fees for ongoing maintenance.

The key point is that advisors can offer a valuable service by guiding their self-employed clients to the right solo 401(k) plan option, and by filling in the gaps between whatever services the plan provider performs and what the client is responsible for (such as opening accounts, keeping track of contributions and distributions, or preparing Form 5500-EZ). Ultimately, with the potential for added wealth that solo 401(k) plans can create, making the process of managing the plan a little easier for clients is a great opportunity to provide value that the client can see from year to year.

The Mysterious Art Of Conducting

(Matthew Aucoin | The Atlantic)

When attending a major orchestral performance, the most prominent individual typically seen is the conductor, who commands attention despite not playing an instrument themselves. Which begs the question: what do conductors actually do and how do they show their worth?

Notably, the professional conductor is a relatively recent position, emerging in the 19th century alongside growth in the number and quality of musical instruments (along with the size of musical groups)…because while two or three musicians might be able to govern themselves, members of a larger group will have a harder time keeping up with each of their fellow performers. In this way, conductors help bring order to what could otherwise be a chaotic compilation of sound. In addition to avoiding auditory mayhem, the best conductors bring out the best from the piece being performed and the musicians performing it, for example by adjusting the mood or leaning into a particularly effective musician or section.

At the same time, while a conductor might be referred to as 'maestro' (and can be paid much more than even the best musicians they conduct), they have to earn the respect of the members of the orchestra. In addition to technical skill (which orchestra members can often identify within the first few minutes of working with them), respecting the musicians (e.g., by physically showing them what they want from the group rather than by telling them what they 'should' do) is also a key element of earning their trust (at worst, orchestras can go into an unconscious 'autopilot' mode, focusing on each other rather than the conductor if they feel the conductor isn't being constructive).

In the end, while a conductor might take center stage, at their best they are drawing out the best from the musicians who are performing on stage, bringing together the sound of dozens of individuals and instruments to create a greater whole (with a high bar for determining whether they are actually adding value!). Which is perhaps not dissimilar from financial advisors, who must weave together various resources and data streams to produce financial plans while also building trust with clients in order to create a successful long-term relationship.

Financial Advisors As Conductors, Not Quarterbacks

(Daniel Yerger | MY Wealth Planners)

Financial advisors are sometimes referred to as the 'quarterbacks' of a client's financial life, leading the way to help them achieve financial success. Yerger suggests, however, that a better comparison (particularly in an age of advancing financial technology) is with a musical conductor.

Just as successful conductors make the most out of the musicians and instruments under their charge, financial advisors can bring together the disparate parts of a client's life to craft solutions that weave all of these elements together and help the client achieve their goals. While, today, this can entail taking on many different tasks themselves (perhaps with the assistance of various software programs), or with the support of human staff, advisors in the future might find themselves 'conducting' multiple Artificial Intelligence (AI)-powered 'agents' that are able to gather and synthesize client data. Which perhaps will lead the most successful advisor 'conductors' to be those who also lean into their role as a trusted, confidence-building human face (just as pilots continue to be valued professionals in a world of autopilot technology) and sounding board for clients (who might not be able to get the same sense of understanding from AI or other tech tools alone).

In sum, financial advisors of the future might not be 'quarterbacks' who lead their clients to financial 'victory', but rather 'conductors' who leverage the tools available to them (including their own discernment and humanity) to provide clients with increased confidence, not only in the technical dimensions of their financial plans, but also that another person is there to help them co-create a future in which they thrive, both financially and in living their ideal lives.

How Financial Advisors Can Move To 'Higher Ground' In A World Of AI

(Bob Veres | Inside Information)

Over the past few years, much ink has been spilled regarding the potential effects of AI technology on work, from how it might make some professionals more efficient to how it could end up replacing human workers in certain areas. This conversation has spread to financial advice as well, with some seeing AI as a direct threat to human-provided financial advice while others have highlighted how it might allow humans to provide a deeper level of advice more efficiently.

Veres notes that conversations concerning the interaction of technology and financial advice are nothing new; whether it was the introduction of financial planning software programs or robo-advisor technology, there have been many potential 'threats' yet human advisors continue to flourish today. Part of this is because of how humans have incorporated these technologies and offered a higher level of service for their clients, whether in terms of the depth of analyses or the efficiency with which they can be produced.

While AI tools are still being developed (and their ultimate limits are not yet apparent), human advisors might still consider how they can move to 'higher ground' and continue to succeed well into the future. To start, while it will be hard to compete with the breadth of knowledge AI tools contain and the speed at which they can process, human advisors could still have an advantage in terms of depth on more nuanced topics that don't have a single 'right' answer. Human advisors might also prove superior at handling uncertainty, leveraging their personal experience with a client to craft recommendations (and provide psychological support) when challenging contingencies occur. Finally, human advisors can lean into their natural curiosity, peeling back the layers of a particular client's situation to identify core values that might not come across through computer-based input.

Altogether, while AI tools can offer impressive capabilities, humans could still have an advantage when it comes to building trusting relationships with clients. Which suggests that a valuable way to maintain relevance in a future AI-powered world could be to lean into what makes an advisor human (while also taking advantage of AI advances to gain time to provide a deeper level of service to clients?).

We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or send an email to [email protected] to suggest any articles you think would be a good fit for a future column!

In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "WealthTech Today" blog.