Weekend Reading for Financial Planners (May 1-2)

Author: Michael Kitces

Team Kitces

Michael Kitces is Head of Planning Strategy at Buckingham Wealth Partners, a turnkey wealth management services provider supporting thousands of independent financial advisors.

In addition, he is a co-founder of the XY Planning Network, AdvicePay, fpPathfinder, and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com, dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

What’s in Biden’s American Families Plan? (Gabriel Rubin & Richard Rubin, Wall Street Journal) – This week, President Biden announced the third phase of his economic and tax proposals (the first being the American Rescue Plan for coronavirus pandemic relief, and the second being the infrastructure legislation proposed last month). Dubbed the “American Families Plan“, the core of the final piece of legislation is a wide range of support for families themselves, including: making the recent expansion of the Child Tax Credit from $2,000-per-child to $3,000-per-child and $3,600 when the child is under age 6 (as established by the American Rescue Plan) permanent instead of lapsing after 2025 (along with making permanent the American Rescue Plan’s expansion of the child and dependent care credit as well); support for child care expenses that would cap the cost of child care at no more than 7% of income for families with children under the age of 5 (though the exact mechanism to determine and pay for this is yet to be announced); an expansion of 4 years of “free” (government-provided) schooling for children and young adults by extending the existing K-12 approach to also include two years of preschool (for 3 and 4 year olds) and 2 years of tuition-free community college after high school; an expansion of the Pell Grants program; and a new government-funded paid leave program that would ultimately allow up to 12 weeks of paid parental, family, or personal illness leave (covering up to $4,000/month of wages, with a minimum of 2/3rds average weekly wages replaced, but starting with a simple approach of introducing just 3 days of paid bereavement leave per year). On the other hand, given the projected cost of the legislation – approximately $1.8 trillion – the proposal also includes so-called “revenue-raisers” in the form of various proposed tax increases (to help offset costs) of significant note to financial advisors, including: an increase in the top income tax bracket from 37% back to the 39.6% rate it was prior to President Trump’s Tax Cuts and Jobs Act of 2017; increase the long-term capital gains rate to the ordinary income rate (39.6%, plus the 3.8% Medicare surtax, for a total of 43.4%) for capital gains above $1M; applying the 3.8% Medicare surtax on income from businesses (including S corporations) earning more than $400,000; the elimination of step-up in basis and instead a “forced sale” of appreciated assets at death, triggering capital gains when someone passes away (but with a $1M-per-person exemption to shelter gains for the ‘average’ household); and limitations on both carried interest rules for private equity firms, and a limitation on 1031 like-kind exchange to defer no more than $500,000 of capital gains. Notably, at this stage, President Biden’s proposals are just that – proposals – and it remains to be seen whether the legislation will pass, and/or in what manner they may be altered during the legislative process in Congress to get the requisite votes to pass. Stay tuned for more updates as the discussion flows. (“Full” details available from the White House on the American Families Plan proposal can be found here.)

Biden’s Capital-Gains Tax Plan Would Upend Estate Planning by the Wealthy (Richard Rubin & Rachel Louise Ensign, Wall Street Journal) – When President Biden first announced a draft of his prospective tax plan on the campaign trail last year, the primary focus was on potential increases to ordinary income and long-term capital gains tax rates on upper-income individuals, along with the potential that the Federal estate tax exemption may be reverted back to its pre-Tax Cuts and Jobs Act limit (cutting the per-person exemption from approximately $11.7M down to ‘just’ $5.85M). With the announcement of the American Families Plan this week, though, it turns out that the Biden administration is taking a different approach: rather than reducing the estate tax exemption, it is proposing to eliminate the automatic step-up-in-basis rules and instead to treat death as a taxable event that would trigger any unrealized capital gains (which, notably, may then be taxed at the newly proposed top capital gains rate of 39.6% for any capital gains above $1M of income), with an exemption of $1M per person to shelter capital gains for most (as Federal Reserve data shows that even for families in the top 10%, with a median net worth of $2.6M, median unrealized gains are “only” $519,000, such that a $1M-per-person exemption would still result in the equivalent of the current step-up-in-basis rules). For the ultra-high-net-worth, though, unrealized long-term capital gains can amount or one or several million dollars or more, which would not be sheltered by the newly proposed exemption (even at $2M per couple with portability from the first spouse to the second), and result in an additional tax event at death… which in turn may substantively impact estate planning for the most affluent clients. Key implications include: donating appreciated securities, either at death or during life, will become even more appealing as a way to whittle down capital gains exposure in particular; saving in retirement accounts will become even more appealing, as those accounts may be taxed as ordinary income already but do not face an additional layer of taxation at death itself; gifting assets during life to shift capital gains exposure to heirs may become more appealing (depending on what “loophole closers” may be implemented to limit this); and “capital gains harvesting” (selling appreciated assets during life to deliberately recognize the capital gain earlier) may become more appealing for those who can spread out the gains at 20% (or lower) capital gains rates and avoid the newly proposed 39.6% top rate that would apply if appreciated assets are held until death (and then all triggered as “sold” in a single year at death). Notably, though, it remains to be seen whether the legislation will be passed in its current form, especially given concerns about the potential impact on closely held and family businesses that may struggle with the additional liquidity pressures of triggering capital gains at death (on top of the existing estate tax structure that would remain in place as well).

Making The Top 1% Its Own Tax Class (Barry Ritholtz, The Big Picture) – Under current law, there are three tiers of long-term capital gains tax rates: 0% (for those in the bottom two ordinary income tax brackets, up to $40,400 as individuals or $80,800 as a married couple), 15% (for those in the “middle” tax brackets, up to an income of $445,850 for individuals or $501,600 for married couples), and 20% on capital gains above those thresholds (corresponding to the 35% to 37% ordinary income brackets). Under its new tax proposal, the Biden administration would apply a 4th tier, with a 39.6% capital gains tax rate (equal to the newly proposed top ordinary income tax bracket) on capital gains above $1,000,000 (it remains unclear whether this will be the same threshold for individuals and married couples, or not), to (roughly) correspond to public concerns of income inequality (as the $1M threshold is estimated to apply only to the top 0.3% of households). As Ritholtz notes, this would also effectively concentrate capital gains taxes into the taxation of private and publicly held stocks, given that the top 1% of households (by net worth) own an estimated 50% of the outstanding equity of the markets, and the top 10% overall hold nearly 88% of shares… which in turn helps to explain why capital gains have come front and center to the tax debate (from new capital gains rates to the newly proposed taxation of capital gains at death): “because that’s where the money is”. Of course, the debate that will now arise is what the repercussions might be – for the stock market, or business and the economy overall – for such a substantial increase in the long-term capital gains rate, and the indirect ramifications of eliminating the difference between long-term capital gains and ordinary income rates for upper-income individuals (which makes other issues like “carried interest” largely a moot point?). Nonetheless, the point is simply that when income inequality itself is increasingly driven not just by “earned income” per se, but increases in the value of equity that is publicly or privately held, tax policy appears to be going through a concomitant shift where the focus is not on increasing income tax rates but capital gains tax rates instead. Ultimately, Ritholtz questions whether the 39.6% proposed rate will really hold, and predicts that a compromise to a lower amount like “just” 25% may still be in the cards – but the broader point remains: a shift in tax policy appears to be underway, where not only is there growing focus in treating the top 1% as its own tax class, but one where the capital gains rate is becoming the new hot button issue, not “just” the ordinary income tax brackets themselves.

Does Work Reveal The Secret Sauce Of Retirement Success? (Joe Kesler, Humble Dollar) – At its core, the very concept of “retirement” is to “retire” from work, yet Kesler notes that in practice a proper understanding of “work” itself is the key to a successful retirement. The starting point is to ask two key questions: what is it about work that we actually want to eliminate… and conversely, what is it about work that’s rewarding that we might not want to lose? In this context, arguably there’s a lot more good that can come from work, including that it allows us to be part of something bigger than ourselves (from doing good in the world to helping others thrive and prosper), it allows us to feel fully engaged when we occasionally have those creative breakthroughs and “aha moments” at work, it provides us with a sense of identity, it creates social bonds with co-workers (which can be especially bonding when doing joint work together to accomplish a noble purpose and greater good), and of course work provides income that we can enjoy and spend. All of which is notable, because the traditional view of retirement is that it’s all about accumulating enough wealth to replace the income that may be lost from work… but doesn’t necessarily address how we replace the other four components that are also lost when we retire. Accordingly, Kesler suggests that even (or perhaps especially) if we’re not going to keep working in retirement, we need to have a plan for the other aspects of work that are lost, including being ready to: get engaged in clubs and other activities to keep our learning and creativity engaged; redefine our identity when there’s no longer a clear (work-related) answer to the question “what do you do?”; and build (new) deep friendships to replace the social network lost when work ends; redesign how we spend our time when it no longer follows the work-day structure (e.g., new hobbies or volunteer activities). On the other hand, one of the nicest aspects of retirement is that, unlike work, it’s easier and more straightforward to “eliminate the toxins” of undesirable activities or toxic relationships, where you may not be able to tell your toxic boss or co-worker off and walk away… but you certainly can in retirement!?

Golden Years At Work Are The Hidden Treasures Of The Old (Camilla Cavendish, Financial Times) – The traditional view of our lifetime journey to happiness is that decades of work allows for the ability to retire with a decent pension (or the financial savings to produce an equivalent one of our own), so we can enjoy a life of ease and fun on the golf course (or some similar leisure activity). Accordingly, not only does the investment industry “sell” the vision of the golden years of retirement, but the working world is predominantly obsessed with how to recruit (and make productive) the new Generation Z to replace those older retiring workers. Yet at the same time, medical advances mean not only are more and more people are likely to live to age 100 and beyond, but more and more will have “productive” lives well into their 70s and even 80s… raising the question of whether some workers may be trying to leave the workforce “too” quickly? And the problem is being exacerbated by the fact that people are having fewer children than they used to, which not only pressures various pension and Social Security systems around the world (when there aren’t as many young workers to pay into the system for each retiree as there were in the past), but is also creating outright talent shortages in various industries that can’t train and replace experienced people quickly enough. As a result, the British government recently raised the retirement age of judges and magistrates from age 70 to 75, is trying to dissuade nurses from leaving their jobs (where for the British health care system, 1/3rd of nurses were over the age of 50), and Spain is now launching a program that will pay people an additional income of up to 12,000 Euros/year to keep working beyond age 66 and not retire. Of course, the reality is that not all “older” workers are up for still working – there are 80-year-olds who still act as though they’re 40, but many are not (and of course, there are also 40-year-olds who act as though they’re 80!). Still, though, with a growing awareness of the value of experience in the workplace – and recent studies showing that those who found businesses even in industry like tech have more success when they start the business in their 50s than in their 20s – suddenly the question is not what the “right” age to retire is, but a much more fluid line between when it’s a good idea to keep working and when it’s actually best to retire?

Advisors Need Training To Help (Later) Retirees With Dementia (Karen DeMasters, FA Magazine) – A recent new white paper entitled “Cognitive Overload: The Coming Surge In Diminished Capacity Cases And What Wealth Management Firms Can Do To Protect Their Clients And Themselves” highlights the growing need for advisors to have a plan and tools in place to help protect their clients (as well as their advisory firms from the risks) that will arise from increasing cases of client dementia. As, in practice, a full 1-in-4 Americans aged 65+ suffers from some level of cognitive impairment that impacts financial decision-making. For clients managing their own accounts, they can be at risk for making poor financial decisions, taking on too much investment risk (or changing it too quickly in volatile times), as well as becoming targets for identity theft and fraud. Accordingly, advisory firms will be increasingly challenged to help clients as the demographic age wave continues rolling into “retirement”, especially as the median age of the 69-million-strong Baby Boomer generation reaches 65 in 2021, and the oldest Boomers are now 75 (where the risks of cognitive, behavioral, and financial literacy issues can multiply). In turn, advisors sit in a unique position to serve as an “early warning system”, as research indicates that those who would eventually be diagnosed with Alzheimer’s disease or dementia started missing the due dates on their bills about six years before the diagnosis, creating an opportunity for the advisor to help clients’ families address these matters before they become even more problematic. Firms that fail to address the issue face a number of diminished-capacity-related risks, including the potential loss of client assets, a loss of relationship with heirs, and a growing range of regulatory risks as regulators increasingly look to advisors to have a role in preventing elder financial abuse fraud… not to mention the financial costs of building out a service model to support clients with diminished capacity. For firms that want to take action to protect themselves, the starting point is to establish a more robust system to secure (and keep updated) the Trusted Contact information for clients, training their advisors to identify and detect cognitive impairment, and even implementing assessments to help identify impairment (before it becomes a serious issue), and providing more education to elderly clients to help protect them against financial fraud that is increasingly targeting them.

Stop Asking Clients for Feedback (Julie Littlechild, Absolute Engagement) – The traditional advice for improving an advisory (or any) business is that to provide better solutions for clients, firms should more regularly ask and survey their clients for feedback. But Littlechild suggests that often what matters most in serving clients better isn’t the feedback, per se, but the act of asking for their input that is more valuable. Given generally high client satisfaction ratings and high retention rates industry-wide, while it may feel good to get positive feedback, such feedback will rarely guide us and help us improve or see what might be blind spots or even missed opportunities in our practices. In other words, feedback just tells us how we’re doing, but input is about how they’re doing, how they’re feeling, what their challenges are, and what their priorities are… which are the questions that really unlock doors to new value for clients. As Littlechild points out, “Client feedback allows you to measure your progress over time but doesn’t always tell you how to improve. Client input, however, allows you to intentionally design a client experience that is truly engaging, profound and meaningful.”  This also speaks to the opportunity we have to reimagine client relationships as collaborative partnerships, as opposed to acting as a “Wizard of Oz” all-knowing expert. Or stated more simply, instead of sitting in the lab trying to concoct what we think clients want in a relationship, or guessing what would be of the greatest value to them right now, we can ask them! Clients will give you all the answers, if you ask the right questions. Though that does mean that how we ask for input is just as important as what we ask for input on. This needs to be done in a way where clients recognize we’re not just going through the motions but want honest, unfiltered perspectives about how they’re feeling and what else might be on their mind that we can potentially help with (from services the firm may offer, to new tools/technology it may be rolling out). Though notably, while making clients part of the process and getting input on what would be valuable to them can be good, be careful in asking clients for input… as, just like employee satisfaction surveys, it’s worse to ask and not do anything than it is to simply not ask at all. So invite clients to collaborate, but be certain to have a clear plan for making it a process, implementing what comes out of it, and making sure clients know what you’ve heard and what you’ve done so they know they were listened to.

The Pros And Cons Of Being A Data-Driven Advisor (Angie Herbers, ThinkAdvisor) – One of the indirect benefits of business increasingly moving from an analogy to a digital world is that not only can more and more be automated or at least expedited, it can also be tracked and quantified, resulting in a growing proliferation of “business intelligence” tools that make it easier to track trends, spot patterns, and find opportunities. After all, good data helps to capture how the firm is interacting with clients, from understanding whether they’re happy with the technology the firm provides (how often do clients actually log in and use the tools?), to satisfaction with the service the firm provides (what is the average turnaround to clients and how do they rate the interactions), to measuring the productivity of employees delivering those services (and if necessary, implementing new processes to improve the situation if necessary). Yet, as Herbers notes, there are limitations to being “too” data-driven as well. After all, almost by definition, data only captures what has already happened – or at best, what is happening “now” in real-time – which means a process of “look at data, fix what’s wrong, look at data, fix what’s wrong” can only improve what the firm already does, but can’t help it innovate or create changes related to firm needs that might be different in the future. In fact, the irony is that it’s often the creativity that comes from being blissfully (or willfully) ignorant of the data that leads to some of the greatest innovations. Nonetheless, taking a good look at your data and asking “how can we make it even better” (including and especially when it’s not broken) is a good pathway to understand where additional investments into the business could have the best outcomes (including and especially when considering how the business might benefit by doing something new and different).

RIAs That Excel At Technology Still Don’t Look Like Tech Firms (Matt Sonnen, Wealth Management) – For advisory firms that want to become more tech-savvy, sometimes the vision goes so far as to turn the business into a form of “tech” company, where clients interact primarily via a “beautiful” technology experience of portals and easy-to-use tools. Yet, Sonnen notes that in the end, if clients “just” wanted a technology solution, they could buy a technology solution, while advisory firms are fundamentally a service business first and foremost, and it’s crucial to remember that clients who hire advisory firms want service (that’s why they didn’t simply buy the DIY-tech alternative). Which means in practice, the best use of technology may not actually be to support the client experience, per se, but to support the behind-the-scenes processes that make the firm’s back-office faster and more time-efficient in order to free up more time for face-to-face client interactions instead. For instance, instead of using technology to automatically send clients a (generic) birthday wish, use technology to remind the advisor to call and wish the client a Happy Birthday, and instead of offering the planning software through a portal for clients to interact with, use the planning software interactively with clients in the office to be able to collaboratively guide them through a planning experience. Such that the technology doesn’t replace the advisor’s client service but helps the advisor deliver service that feels more personalized when it comes from the advisor. In other words, one of the best uses of technology in an advisory firm is not to replace parts of the advisor-client relationship, but to contribute to a stronger human relationship.

The Benefits Of Increasing Trust In Financial Services (Elisabetta Basilico, Alpha Architect) – The financial services industry has long struggled with a trust gap with the public, one that was only amplified over the past decade as the financial services industry was blamed for the financial crisis, the popping of the real estate bubble, and the economic challenges that followed. And unfortunately, financial advisors exist as part of the broader financial services industry… and carry the consequences of a low-trust relationship with the public. Which is important, because a recent paper by Jeremy Burke and Angela Hung in the Journal of Pension Economics and Finance aptly titled “Trust and Financial Advice” finds that “financial trust” is highly correlated to a wide range of financial-advice-seeking behavior, with respect to both retirement advice, and financial advice in general (with only 32% of low-trust-scorers seeking financial advice, but 53% of those with above-median trust). In addition, those with higher financial trust were also more likely to follow that advice in terms of both how they allocated their portfolios and their subsequent investment behaviors. Accordingly, the results suggest that lifting standards for financial advice – e.g., a fiduciary standard for all financial advisors – isn’t just a matter of consumer protection, but could potentially increase advice-seeking behavior and follow-through, such that while the industry often cautions that a higher standard of care may increase costs and reduce profitability, in practice higher levels of trust could increase both the growth rates and retention rates of advisory firms and actually improve the economics of the advice business!

Point And Click Credentials (Sean Walters, Investments & Wealth Institute) – In a world where it’s hard for consumers to distinguish one professional from another, professional designations are often used as a marker to differentiate oneself from the competition, as an effort to demonstrate that the professional is more knowledgeable, more capable, and more worthy of trust and winning the client’s business. With the caveat that, in practice, consumers don’t always know which professional designations actually convey such additional knowledge and capabilities, and which are just, as Walters terms, “point and click” credentials where the advisor simply pays a fee to use a badge or certificate that didn’t take much or anything beyond the fee itself to obtain (which, if the client discovers aren’t actually credible, can undermine trust in the advisor). In the financial services industry, this phenomenon has proliferated into dozens and hundreds of “professional” designations, of varying degrees of actual professionalism, which makes it hard for both consumers and sometimes even for advisors to figure out which are actually credible. Accordingly, Walters provides a hierarchy for the different types of programs, from “certificate” programs (which are simply an educational offering that provides some kind of document, badge, or certificate to convey satisfactory learning of what was taught), to actual “certification” programs (which are different, because true certification programs are built to attest that the individual has achieved certain competency standards in the field), to “licensure” (which is effectively “mandatory certification” where one must obtain the knowledge and be able to show that the competency standards are being met). In this context, “designations” can actually be certifications or certificates (which are very different in their actual depth). So for an advisor who is considering a new designation to earn after their CFP certification, it’s important to consider the desired depth, and whether the advisor is actually “just” pursuing a certificate for a particular domain of knowledge, or actually wants to prove themselves with certification?

The Transformational Decade Ahead for the Planning Profession (Bob Veres, Advisor Perspectives) – While the financial advice business has been undergoing a slow multi-decade evolution from its roots as a way to augment the sales of mutual funds, limited partnerships, and life insurance, to a world of fee-for-service financial advice (where advice is purchased for advice’s sake), Veres notes that the coming decade appears to be one of accelerating change unlike any decade we’ve seen previously. And ironically, while the question of whether robo-advisors would disrupt human advisors is now a settled matter (they didn’t), Veres suggests that a coming wave of technology to enhance the business of financial advice may actually be the transformative key to the next stage of evolution. In particular, the key distinction is that advisor technology in the future will all be situated on a single “data warehouse”, with different advisor software pulling whatever data is needed for everything from client communications to client reports, which makes it possible not only to do planning more efficiently, but get proactive in ways never before seen (e.g., all client mortgage rates in the centralized database could be compared every day to current mortgage rates online, and prompt the advisor any day that mortgage rates shift to the point that any particular client might benefit from a refi… and then reach out to them to make the proactive recommendation). In turn, new tools like Holistiplan and FP Alpha are already building solutions that can scan client documents (e.g., 100+ page tax returns) and glean key tax data and identify opportunities the advisor might delve into further. And new planning software like Elements turns financial planning from a long-term multi-decade projection into a continuously updated series of key financial metrics (from household income to debt ratios) that clients can monitor and try to improve on a continuous basis (rather than once-per-year planning reviews). At the same time, the rise of the internet means that consumers increasingly can seek out specialists – the best to solve their unique high-stakes challenges – regardless of location, which substantively alters the competitive landscape as well (but also provides a pathway to providing greater value and charging higher fees). And deepening specializations give more pathways for financial advisors to both increase trust with consumers, and even refer to one another across specializations, further fueling the growth of the financial advisor world in the aggregate. And ultimately, while arguably all of these trends have been in place for many years already, the pandemic – and its forced reinvestment into a wide range of technology – may, in the end, prove to be the catalyst that accelerated these changes to make 2020 the decade that financial advice really became a profession?

I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!

In the meantime, if you’re interested in more news and information regarding advisor technology, I’d highly recommend checking out Craig Iskowitz’s “Wealth Management Today” blog, as well as Gavin Spitzner’s “Wealth Management Weekly” blog.

Gavin Spitzner contributed this week’s article recap on the Cognitive Overload white paper and Julie Littlechild’s research on Client Feedback.