Weekend Reading For Financial Planners (May 9-10)

Author: Adam Van Deusen, CFP

Team Kitces

Adam is a Financial Planning Nerd at Kitces.com. He previously worked at a financial planning firm in Bethesda, Maryland, 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.

Retirement, Tax Planning Expertise Pays Off With Wealthier Clients: Study

(Rob Burgess | ThinkAdvisor)

In recent years, an increasing number of firms and advisors advertise that they offer comprehensive financial planning services and seek to differentiate on the depth of their expertise. Nevertheless, the true expertise of different advisors can vary significantly, and consumers might have a hard time evaluating different options – especially since by definition, the consumer won't have the expertise to judge who really is an expert, and when it comes to expert services there's often no way to know who really delivers results until after the fact – such that at best, consumer may have to lean towards clues like the advisor's years of experience as a proxy for expertise.

A recent study by the American College of Financial Services (which offers advanced designations in several planning areas) surveyed 478 financial advisors, and sought to evaluate not only the types of services offered by respondents and their years of experience, but also created an "Advisor Expertise Index" to measure their expertise in different planning disciplines. In general, the study found no relationship between an advisor's years of experience and their expertise in different planning areas (e.g., tax planning or retirement income planning), with those who scored the lowest on the Index having an average age of 57 and 19 years of experience and the most advanced group having an average age of 53 years and 16 years of experience. Notably, among those who offered particular planning services, 57% didn't demonstrate advanced proficiency in retirement income planning, with the same result for tax planning as well (the largest knowledge gaps amongst planning areas studied).

On the other hand, those advisors who did demonstrate advanced expertise in particular planning areas appear to be rewarded by serving wealthier clients. For instance, for those with advanced-level tax planning expertise, 75% of their clients had a net worth greater than $500k, while this figure was only 57% for those with intermediate-level expertise and 35% for advisors with basic tax planning expertise. Similarly, 72% of clients of respondents with advanced-level estate planning expertise had a net worth of at least $500k, while only 58% of clients of respondents with intermediate-level knowledge and 41% of those with a basic level of expertise did the same. Which suggests that there is a potential payoff to greater expertise in key planning areas in the form of wealthier clients (and the potentially higher planning fees they might pay).

Notably, Kitces Research on Advisor Productivity similarly found that teams with senior advisors with the CFP marks averaged higher revenue per advisor than those who did not ($425,000 for teams with a solo senior advisor with the CFP marks versus $300,000 for those without, and $600,000 for teams with multiple senior advisors with the CFP marks compared to $358,333 for those with no CFP professionals). Kitces research found less of a productivity return from adding post-CFP designations, though such expertise may still help advisors win new clients in a competitive landscape and support greater client growth rates (even if productivity doesn't lift because higher-revenue clients also tend to have greater expectations of service and working hours commensurate with the additional fees they're paying).

In sum, given the technical nature of financial planning, having expertise in key areas can both lead to a higher level of service (and client outcomes), and potentially attract more (and wealthier) clients. Which offers an opportunity for relatively newer advisors to stand out and for those who want to serve a particular client type (e.g., offering advanced retirement income planning for pre-retiree and retired clients) to attract and deliver a high level of service for these (potentially wealthier) clients.

State Securities Regulators Approve Updates To Marketing Model Rules To Match SEC

(Kenneth Corbin | Barron's)

For decades, RIAs were not allowed to use any type of client testimonials in their marketing, under the rationale that advisors would simply 'cherry-pick' the clients who had achieved the best results to solicit for testimonials, resulting in a skewed impression of what clients were actually likely to experience in working with the advisor.

That changed in 2020, however, when the SEC completely revised its original Marketing Rule to 'modernize' it in accordance with the rise of testimonial marketing in other industries through online review sites like Yelp and Google. The new Rule 206(4)-1, which became final in 2021 and enforceable beginning in 2022, permits testimonials in RIA marketing, provided that the advisor doesn't attempt to curate (i.e., cherry-pick) which reviews to publish or that they also publish a specific set of disclosures about the nature of the testimonial.

The caveat, however, was that the SEC's new Marketing Rule only applied to advisory firms under the SEC's jurisdiction, and not to the many smaller RIAs that are instead regulated at the state level. And while some states adapted their own securities regulations to conform with Rule 206(4)-1, around half of all states have retained the old ban on testimonials. Meanwhile, the North American Securities Administrators Association (NASAA)'s own Model Rule 102(a)(4)-1, which many states use to shape their own securities regulations around dishonest or unethical business practices, retained language that explicitly bans testimonials as well. With the result being that while all SEC-registered advisors, as well as select state-registered advisors, are free to use testimonials in their marketing, a significant additional subset of state-registered advisors are still banned from using them.

But now, several years after the SEC's Marketing Rule became effective, NASAA this week adopted amendments to four model rules to bring them in line with the SEC's marketing rule, potentially allowing more state-registered RIAs to use testimonials (as well as endorsements and specific performance reporting within specified guardrails). Notably, while the rules go into effect immediately from a NASAA perspective, it's up to each state (that hasn't already expanded permitted marketing practices) to adopt the amendments into their own securities regulation (which suggests that state-registered firms will want to keep updated on whether their relevant regulator(s) have adopted the new amendments before expanding their marketing practices).

Ultimately, the key point is that after a long wait, the playing field is on its way to becoming more even for state-registered RIAs compared to their SEC-registered peers in terms of permitted marketing practices, allowing the former to, among other things, leverage the "social proof" effect of testimonials to build trust with the firm's target clientele.

Dozens Of RIAs Have Faced Data Breaches This Year

(Alec Rich | Citywire RIA)

As the advisor technology landscape has expanded over the years (along with firms' adoption of new technology tools that allow them to provide a deeper level of client service), so too have the range of digital threats to firm and client data. And at a time when advancing Artificial Intelligence (AI) capabilities could provide malicious actors with more tools to conduct attacks, the threat environment could become even sharper.

According to data compiled by the Massachusetts Office of Consumer Affairs and Business Regulation (of Massachusetts residents affected by data breaches), 108 financial services companies, including dozens of RIAs (as well as broker-dealers), experienced data breaches as of April 30. While some of the attacks directly targeted the firms themselves, other breaches came through third-party relationships. Data stolen through the broader range of breaches included Social Security numbers, financial accounts medical records, drivers licenses, and credit or debit numbers.

For advisory firms, defense against cyber threats can come at both the firm and client level. For firms, leveraging a checklist of key cybersecurity steps and practices can help protect systems from unauthorized access. In addition, training staff on the latest threats (including more advanced spear-fishing attacks, where particular employees are targeted) and cyber hygiene practices can reduce the threat of data breaches. Advisors can also support clients by helping them understand safe practices, from being skeptical of phone calls and emails requesting financial or account information (particularly at a time of advancing voice-cloning technology) to how they can secure their account accesses with the firm.

In the end, while it's not possible to protect against all potential cyber threats, advisory firms can take steps to make themselves a harder target. Because just as advisors help their clients manage risk when it comes to investment management, taking steps to mitigate cyber risks (and the potential for hard-dollar losses) can be a particularly valuable service as well.

A 4-Step Framework For Managing Client Equity Compensation

(Brady Lochte | Advisor Perspectives)

For many clients, the vast majority of their employment compensation comes from cash-based salary and bonuses, offering immediate liquidity and relatively simple tax treatment. But for others, a significant portion of their pay package comes in the form of equity compensation, which can come with liquidity, employer, and tax risks.

Given the more complicated nature of equity compensation, financial advisors are well-positioned to offer hard-dollar value for clients by creating a strategy to handle it. To start, equity compensation discussions can be framed in terms of "employer dependence risk", as holding a significant stake in employee stock doesn't just introduce concentration risk but also career risk as poor company performance that hurts its stock prices could also be associated with layoffs as well. Next, an advisor can work with the client to create a comprehensive equity compensation inventory that includes exactly which equity grants the client owns, when each tranche vests and becomes liquid, how each type of grant is taxed (e.g., ordinary income vs capital gains), and whether blackout windows (when the stock cannot be sold) apply and when.

With the client's equity compensation laid out clearly, the advisor can then move into modeling three-to-five year tax projections to assess the value of different types of strategies. For instance, some clients might benefit from the immediate sale of all liquid shares, executing staged sales around low-income periods, tax-loss harvesting coordinated with equity sales, and/or strategic Roth conversions in low-income years. In addition to tax strategy, advisors can also coordinate sales with their clients' cash flow needs, both in the short term and for expected major purchases in the longer term.

Ultimately, the key point is that equity compensation planning isn't a one-time decision, but rather a regular process that can benefit from a structured framework that gives advisors and their clients a clear picture of the unique risks and opportunities involved in the client's situation and allows them to make the best possible decisions to reduce employer dependence risk while taking advantage of available tax planning opportunities!

Creating An Effective RSU Sale Strategy With Clients

(Daniel Zajac)

A common form of equity compensation is the Restricted Stock Unit (RSU), where an employee receives a certain number of company shares after fulfilling a particular vesting period. Once they are vested, employees owe tax on the fair market value of the shares at that time and face the decision of whether to sell the shares immediately (with no additional tax implications) or hold them into the future (with any gains or losses on a future sale [with cost basis set on the vesting date] given capital gains treatment), a choice that comes with cash flow, portfolio concentration, and tax planning considerations.

While some clients might need to sell their vested RSUs immediately to pay for ongoing lifestyle expenses, others might consider holding onto the shares (especially if their employer's stock has performed well recently). This creates an opportunity for the advisor to discuss the client's long-term goals (e.g., how does a concentrated position affect their overall portfolio diversification and retirement plans), intermediate-term cash-flow needs (e.g., a planned large expenditure that's a few years away could be supported by engaging in a tax-focused, phased sale of shares), and, at a more basic level, helping the client create a strategy for how they want to handle their RSUs (as the 'default' decision might be to hold onto them).

For clients who have existing vested shares, it's important to recognize that selling shares is not an all-or-nothing decision and that individual lots that vested at different times can be sold to maximize tax efficiency. To facilitate this, the advisor can create a "sale stack" that orders individual lots first into short-term losses and long-term loses, and then by the after-tax value from most tax efficient to least tax efficient (i.e., taking into account each lot's basis and whether a sale would trigger a short- or long-term gain). When selling shares, loss lots can be good first candidates, as they provide a capital loss that can be used to offset shares sold for a gain. When selling shares for a gain, the advisor and client might decide to equalize the losses with the gains to create no additional tax liability from the sale in a particular year, or perhaps create an annual capital gains tax 'budget' as shares are gradually sold off.

Some clients might come to the table with a large number of shares with very low basis (which, if sold, would create a large capital gains tax burden). While an advisor could create a managed sale plan (perhaps using the capital gains 'budget' strategy), particularly if the client needs to sell shares to meet cash flow needs, potential tax-conscious strategies for these shares (depending on a client's particular preferences and circumstances) could include holding onto them until death (at which point heirs would receive a step-up in basis), giving them to charity (both avoiding incurring capital gains and potentially obtaining the charitable deduction for the full value of the shares), or using an exchange fund to create additional portfolio diversification while continuing to defer capital gains.

In sum, financial advisors can play a valuable role in helping clients manage their vested RSUs in a way that reduces concentration risk and meets cash flow needs in a tax-efficient manner. Which could ultimately result in significant hard-dollar savings (and perhaps referrals to co-workers who would benefit from this type of RSU planning as well?).

Determining When The Net Unrealized Appreciation (NUA) Rules Are (And Aren't) A Good Deal

(Nerd's Eye View)

In many large (publicly traded) businesses, it's common to reward employees with employer stock, often granted directly in/through a profit-sharing or Employee Stock Ownership Plan (ESOP), or at least by allowing employees to purchase shares themselves inside of their 401(k) plan. The advantage of this strategy is that it helps to encourage an "ownership mentality" of the employees – who literally become (small) shareholders of the business. The disadvantage, however, is that when employer stock is purchased/owned inside of a retirement account, it is ultimately taxed as ordinary income when withdrawn (as is the case for any distribution from a retirement account), and loses the opportunity to take advantage of favorable long-term capital gains rates.

To help resolve the situation, though, the Internal Revenue Code allows employees a special election to distribute appreciated employer stock out of an employer retirement plan and have the "Net Unrealized Appreciation" (NUA, i.e., the embedded capital gain) taxed at favorable capital gains rates outside of the account. However, to take advantage of these special NUA rules, there are specific requirements – that the stock must be distributed in-kind, as part of a lump sum distribution, and after a specific triggering event.

The good news of the NUA strategy is that it creates an opportunity to convert unrealized gains from ordinary income rates into lower tax rates on long-term capital gains instead. However, the caveat is that in order to use the NUA rules, the account owner must report the cost basis of the stock immediately in income for tax purposes, and pay taxes at ordinary income rates. In addition, if the NUA stock is quickly sold, that long-term capital gains bill immediately comes due, too.

Which means in reality, the NUA rules don't merely allow for the gains to be taxed at lower rates. They cause the gains to be taxed at lower rates immediately (at least if the stock is sold immediately), in addition to triggering ordinary income taxation of the cost basis immediately, when all of those tax liabilities might otherwise have been deferred for years or even decades. Which means deciding whether to take advantage of the NUA strategy or not is really more of a trade-off, than a guaranteed tax savings success.

As a result, the best practice for NUA distributions is to really scrutinize the cost basis of the employer stock inside the qualified plan and, if necessary, cherry pick only the lowest-basis shares for the NUA distribution to ensure the most favorable tax consequences. Fortunately, the NUA rules do allow such flexibility – to take some shares in-kind, and roll over the rest – but that still means it's necessary to actually do the analysis to determine whether or how many of the NUA-eligible shares should actually be distributed to take advantage of the strategy (or not)!

Altogether, while the NUA strategy can be fruitful, it's not necessarily a 'free lunch'. Which offers financial advisors the opportunity to support their clients by taking a tactical approach to distributing NUA shares, which could ultimately result in significant tax savings compared to distributing all of the shares at one time.

5 Ways To Help Clients Make More Effective Advisor Introductions

(David DeCelle | Advisor Perspectives)

Given the high levels of value and service that financial advisors can provide, clients are sometimes excited to tell friends and family who could benefit from their advisor's services. A potential problem, though, is that the client might not know how to make an effective introduction. For instance, they might give a friend their advisor's phone number, which leaves it up to the contact to make the next move and actively reach out (a task that could easily get lost amongst the other items on their to-do list).

Amidst this backdrop, advisors can arm clients with information that would help them make more effective introductions. To start, the advisor might highlight moments when the advisor's services might be relevant to a friend or family member (e.g., approaching retirement or simply dealing with more financial complexity). Next, the advisor can note the types of individuals they help best to give the client confidence that people they introduce might be good fits. Also, the advisor can offer the client a preferred process for making introductions to ensure a connection is made (e.g., including the advisor on an email to the contact rather than just passing the advisor's email address along). In addition, giving clients a clear, pithy way to explain the advisor's value can remove the burden for them of having to explain exactly what the advisor does. Finally, letting the client know that the advisor will approach the interaction with the lead thoughtfully and without pressure could reduce a client's concerns that their relationship with the advisor might be damaged if they make an introduction of an individual who isn't a good fit for the advisor.

In sum, while advisors don't necessarily want to turn their clients into 'promoters' for their services, in reality, clients are often self-motivated to help others benefit from working with their advisor. Which suggests that providing them with information and processes that can help them make more effective introductions could ultimately result in a win-win-win situation for the client, their friend or family member, and the advisor alike!

How To Avoid Turning Clients Into (Unintentional) Salespeople

(Beverly Flaxington | Advisor Perspectives)

While generating client referrals is a popular marketing tactic advisors pursue, actually getting clients to make referrals can be challenging and/or awkward for some advisors. For instance, given that clients are already compensating their advisor through the fees they pay, asking them to make referrals could seem like a step too far (as an advisor might worry that clients would look unkindly on being deputized as 'salespeople' to help the firm grow).

Instead of directly asking clients for referrals, reframing the 'ask' around helping clients identify individuals who might benefit from the advisor's services could allow advisors to be more confident in their approach and reduce the chances that clients are put off by a request. For example, an advisor might mention to a client how they want to help more people instead of discussing how they want to grow their business.

The advisor can also reduce the burden on the client by asking for "introductions" rather than "referrals", as the former might feel less burdensome on the client (who might feel they need to 'pre-qualify' a contact themselves before making a referral). Alternatively, an advisor could approach the conversation by asking the client their advice on how the advisor might find opportunities to talk with more individuals about the services they can offer, which could unearth opportunities with specific individuals or even larger groups in the client's network without appearing too 'pushy'.

Ultimately, the key point is that while client referrals can be a lucrative marketing tactic, encouraging clients to participate in this practice can be a delicate dance. Nonetheless, by leaning into the advisor's desire to help more individuals and reducing the 'workload' on the client, the advisor might find that they receive more introductions from clients who are enthusiastic to make them.

Becoming More Referrable In A New Client's First 90 Days

(Bill Cates)

When thinking about potential sources of client referrals, an advisor might first consider long-standing clients who have experienced the advisor's value proposition for years or perhaps decades. However, newer clients can also represent a fruitful source of referrals, particularly because they get to experience a more intense level of planning during their first few months with the firm.

Driving referrals from newer clients can be a function of making the onboarding process both valuable and personal. On the value side, an advisor might not only go through their standard planning process for new clients, but also take the time to ensure clients understand what's happening along the way (e.g., by walking clients through their first portfolio statement, as the format and some terminology might be new to them). Also, going beyond specific planning modules to zoom out and help clients articulate their broader vision (and then showing how the advisor's planning strategies can help them reach it) can create an 'aha' moment for clients that might not have been apparent to them.

Personal touches can help cement the advisor-client relationship and drive referrals as well. Potential ideas include sending a handwritten note welcoming the client to the firm, organizing a one-on-one coffee or meal with the client, or arranging a personal call from a team member who will be serving the client. Advisors can also create a regular cadence of client 'touchpoints' (whether personalized check-ins or more 'standardized' events such as webinars and client appreciation gatherings) to boost engagement with clients through and beyond the onboarding process.

In the end, the first few months of a new client's time with a firm is not just about delivering and executing on a financial plan, but also about showing how financial planning can help them achieve their larger life vision and building a personal relationship that will make them want to stay with the firm for years to come (and perhaps refer friends and family members to reap these benefits as well!).

Greed: The Good, The Bad, And The Ugly

(Meghaan Lurtz | (Less) Lonely Money)

The word "greed" can conjure many (mostly negative) images, from Michael Douglas' character Gordon Gekko in Wall Street to Scrooge McDuck diving into his pile of gold coins. However, greed isn't confined to fictional characters or the fabulously wealthy; rather, it's an impulse that can strike just about everyone.

In some cases, greed could be a good thing. For instance, if a desire to earn more money drives an individual to produce a product or service that will be a net benefit to others, everyone is likely to be better off from this positive-sum development. For example, when a financial advisor serves more clients, both the advisor (who earns more income) and the new clients (who are able to access the advisor's value proposition) stand to benefit.

On the other hand, greed can turn 'bad' if it means acting unethically or hoarding resources for oneself and not thinking of others (notably, this type of behavior doesn't necessarily mean that an individual has pathological issues but rather can result from broader feelings of scarcity or uncertainty). Further, the 'ugly' side of greed can be seen in studies indicating that greedier people are less happy, with lower life satisfaction, greater emotional instability, lower self-esteem, and less trust in others. Which can expand outward if the greedy individual tries to bring others down with them.

Notably, in a world of visible greed and uncertainty, generosity emerges as a potential antidote. By sharing one's time, money, individuals not only can develop their connections with others, but become happier and more fulfilled in the process. Which suggests that the ultimate impact of the urge to be greedy isn't simply how much money or other resources one accumulates, but rather whether it is used solely for one's one purposes or to lift up others as well.

Resisting The Siren Song Of Lifestyle Creep

(Derek Hagen | Meaningful Money)

Early in one's career, thriftiness can be a necessity given a potentially modest starting salary. However, as one moves up the career ladder and sees their earnings (along with the incomes of their peers) increase, it can be tempting to 'keep up with the Joneses' in terms of spending as well.

However, such 'lifestyle creep' (i.e., increasing spending alongside income, in particular to match the consumption of peers) can be financially detrimental, as it has the dual effects of reducing one's ability to save for the future and increasing lifestyle standards that will need to be provided for later in life. Which can ultimately lead to a later retirement date (and perhaps a more perilous probability of success) down the line. Notably, 'lifestyle creep' is different than 'lifestyle design', where (increased) spending decisions are made purposefully and are focused on what an individual values (e.g., an individual who plans an international trip because they want to experience a unique culture versus one who does so to one-up their neighbor who always talks about their travels). While such 'lifestyle design' spending might reduce the amount that goes into savings, it can both make life more rich and, when well-planned (perhaps with the assistance of a financial advisor?) not necessarily detract from the ultimate success of one's financial plan.

In the end, it's natural to want to spend more money as one's income increases over time. The key, though, is to do so intentionally and to minimize the influence of outside opinions on what one 'should' buy. Which could ultimately lead to greater satisfaction today and a more secure financial future tomorrow.

Survival Is The Only Success

(Nick Maggiulli | Of Dollars And Data)

Stories abound of individuals who had seemingly 'made it', whether in terms of wealth or public esteem, only to lose it all after taking extreme risks (sometimes including illegal activity). Notably, though, one doesn't have to want to strive to be particularly rich or famous to be tempted by excess risk.

Many financially successful individuals have 'made it' in the sense that they have amassed enough wealth (or are on track to do so) to reasonably meet their financial needs now and well into the future. At this point, they might reasonably downshift their financial risk-taking to reduce the chances of experiencing a negative event that could put their (on-track) plan into peril. However, there are no shortage of temptations for such individuals, some of which come with seemingly high odds of success but significant potential downside. For instance, a hypothetical investment that has a 95% chance of returning 30% in a given year but a 5% chance of losing 100% might be tempting, but playing this game (with a significant percentage of one's net worth) repeatedly over time could lead to financial disaster (particularly given that the investor might not have needed the potential upside in the first place!).

In sum, financial (and lifestyle) success isn't necessarily about who thrives at a particular point in time, but who can survive in the long run. Which could mean passing up on 'can't miss' investment or other opportunities that offer some upside but come with significant downside potential (whether it's financial losses, or, as fraudsters have experienced, the loss of freedom that comes with jail time).

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.