Ask Liz Weston

Get smart with your money

fiduciary

Q&A: Should you pay for a financial plan before hiring an advisor?

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Dear Liz: My spouse and I are retired. We have substantial investment assets, significant cash reserves and considerable equity in our home. Over nearly 40 years together, we’ve worked with several financial advisors, but every decade or so, we’ve become dissatisfied and moved on. Now, at this stage of life, we want a clearer roadmap for the next five to 10 years and beyond.

We’ve read your columns for years and have taken your advice about fiduciary financial advisors seriously. We’re currently looking for a new independent advisor, but we’re finding that many only offer financial planning if we also hire them under an assets-under-management (AUM) arrangement. Others will provide a standalone financial plan for a flat fee prior to having a client come on board for asset management.

We feel strongly that before committing to a long-term advisor relationship, we should first get an independent, comprehensive financial plan — essentially a snapshot of where we are now and how best to move forward. Does that approach make sense? Should we prioritize paying for a standalone financial plan before deciding whether to hire someone for ongoing investment management?

Answer: As you’ve discovered, many fiduciary fee-only advisors bundle financial planning advice with investment management because AUM fees are more lucrative than charging for plans. But that doesn’t mean it’s the best approach for every client.

Paying for a financial plan means shelling out more money up front, but you’ll get the opportunity to check out the advisor’s approach, communication style and attention to detail before entrusting them with your investments. The plan should include all the usual areas such as insurance, taxes, asset allocation and estate planning, with a special emphasis on the topics that are important at your stage of life, such as sustainable withdrawal rates, paying for long-term care and protecting your assets from fraud and cognitive decline.

Q&A: Advisor may have overlooked tax bill alternatives

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Dear Readers: The following comment was prompted by my response to the letter from a couple in their 70s asking if they had made a mistake moving their $2-million portfolio, including $340,000 in a taxable account, to a new advisor. The advisor recommended investment sales that resulted in a $50,000 capital gain tax bill, and their accountant disapproved. I wrote that the tax pro might not be in the best position to judge whether the sales were necessary, since accountants are typically focused on reducing tax bills but sometimes diversification is necessary to avoid even bigger financial consequences down the road. Here’s another perspective.

Dear Liz: The comment that the accountant is not in the best position to evaluate is correct, as the accountant is only looking at the taxes. However, as a retired portfolio manager and chartered financial analyst, I really doubt that it was appropriate for the investment manager to take this large of an amount of capital gains. It would only make sense if this taxable portfolio had nothing but speculative issues in it, which I would find doubtful for a couple in their late 70s. If the taxable account was too high in equities or poorly diversified by industry weightings, adjustments can be made in the larger retirement account to bring the combined account into better balance. It may have been appropriate to take some gains, but they can certainly be spread out over several years, as taking them all at once likely puts the couple in a higher tax bracket.

Answer: You’re making a good point that the couple had other options besides “ripping off the Band-Aid” and incurring one big tax bill rather than taking the gains more gradually. Their new advisor, as a fiduciary, should have discussed the options with them and helped them understand the impacts, including the expected tax bills and potential impact on Medicare premiums. If those discussions didn’t happen, that’s all the more reason to seek out a second opinion from another fee-only financial planner.

Q&A: How do I find out if an advisor is a fiduciary?

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Dear Liz: You often emphasize the importance of using a financial planner or advisor who is a fiduciary. But how does one know whether a given planner or advisor is a fiduciary? Is it just the planner or advisor claiming to be one? Are there any licensing laws or professional organizations that grant such a designation?

Answer: Many people assume financial advisors are required to put their clients’ best interests first, but that’s typically not the case. Most advisors are held to a lower “suitability” standard, which means their recommendations must be suitable for the client’s situation but not necessarily the best choice. The advisor can recommend an investment that is more expensive or that doesn’t perform as well as available alternatives, simply because the recommended investment pays the advisor a higher commission.

Fiduciary advisors commit to putting their clients’ interests ahead of their own. Certified financial planners (CFPs), certified public accountants (CPAs) and attorneys all have fiduciary duties to their clients, as do registered investment advisors (RIAs).

The gold standard for fiduciary advice is the fee-only model, in which the advisor is compensated only by fees the client pays. Fee-only means the advisor does not accept commissions or other compensation paid by third parties. Fee-only compensation can take a number of forms, including hourly, retainer or flat fees or a percentage of assets the advisor manages for the client.

The first step in determining whether an advisor is a fiduciary is to simply ask. The answer should be yes, full stop, and the advisor should be willing to put that commitment in writing. Next, ask to see the advisor’s Form ADV, which details how the advisor is compensated.

Theoretically, a fiduciary advisor may be able to accept commissions, but they’re obligated to clearly disclose the compensation to clients and maintain the clients’ interests as their top priority.

The phrase “fee-based” is sometimes used by advisors who want to appear to be fiduciaries when they’re not. An ethical advisor is crystal clear about how they’re getting paid.

Before hiring any financial advisor, you should also use BrokerCheck at https://brokercheck.finra.org/ to research their backgrounds and look for any disciplinary history. Also, check with the organization that granted their credentials to verify that those credentials are current.

Q&A: Is it better to have a fee-only financial advisor?

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Dear Liz: As a certified financial planner for the past 31 years who has never run afoul of any regulatory body, I cringe every time I hear you recommend people seek out only fee-only financial planners!

While we certainly do fee-based work where appropriate, sometimes it is simply better for the consumer if their advisor receives a commission not a fee. As an example, assuming all other factors being equal, if a client were to maintain an account for 10 years with a fee-only advisor charging 1% per year, wouldn’t the client pay considerably more in fees than if they placed their portfolio in a commission-based account where the advisor were to receive a one-time 5% fee?

I certainly understand conflicts can arise, but don’t they do so in most aspects in life? And isn’t this really just a matter of ethics? Can’t a fee-only advisor lack ethics just like an advisor who receives commissions?

Answer: The most important differential among advisors is whether they’re fiduciaries and therefore obliged to put their clients’ best interests first. As a certified financial planner, you’re held to a fiduciary standard and must disclose any potential conflicts of interest to your clients.

Most advisors are held to a lower “suitability” standard. That means the advisor can recommend investments that pay higher commissions, even if those investments aren’t the best option for their clients.

Fee-only financial planners typically are fiduciaries and have opted for a compensation arrangement that avoids the conflicts of interest inherent with commission-based recommendations. These planners are paid only by the fees they charge their clients, which can be hourly rates, project fees, retainers or a percentage of assets under management.

Q&A: What you can expect from a fiduciary advisor

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Dear Liz: This is concerning the couple in their 70s who were persuaded to move their nearly $2-million retirement portfolio to a different broker, resulting in a capital gain of $184,000 and a capital gain tax bill for $50,000.

The question I wonder is whether the $184,000 capital gain also kicked them into a higher Medicare premium bracket (which you frequently warn your readers about) or whether they were already in the higher bracket for other reasons (i.e. the amount of their annual required minimum distribution, plus the size of their Social Security or pension benefits).

The problem with their new broker is that this couple seem surprised to learn they would have a capital gain and a sizable capital gain tax bill by transferring their portfolio from their existing broker to the new broker. Shouldn’t the new broker, with its “fiduciary” duty, have warned them that they would incur a huge capital gain and a sizable capital gain tax bill and also checked to see what the influence of the capital gain would be on this couple’s Medicare premium (if any)?

Answer: The couple did not say they were surprised by the tax bill. They said their accountant was not pleased, which apparently caused them to question their decision.

Let’s define some terms. “Broker” in this context typically refers to a stockbroker. Stockbrokers normally aren’t fiduciaries, meaning they’re not required to put their clients’ best interests first. Instead, stockbrokers are usually held to a lower “suitability” standard, which means they can recommend investments that aren’t the best option for their clients as long as those investments aren’t actually unsuitable.

Registered investment advisors, on the other hand, are fiduciaries. This couple’s new RIA should have explained why the investment sales were necessary and detailed the costs, including the tax bill and any affect on Medicare premiums. The RIA should have explored other options as well, such as leaving the portfolio alone or extending the investment sales over multiple years. The RIA would have recommended a course of action, but would execute whatever plan the couple ultimately chose.

Q&A: Was it a mistake to incur a large tax bill?

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Dear Liz: We are a retired couple in our late 70s. I worked as a carpenter and my wife worked as a nurse. We saved and invested for the long haul with a well-known discount brokerage. Last summer, we were wooed by another financial services firm with a “much better idea.” Our combined portfolio at the time was $1,985,000. We transferred our holdings, including $340,000 in a taxable account.

The transfer triggered a capital gain of $184,000 as the new company sold the old funds and reinvested the money according to their plan. This caused us to owe about $50,000 in income tax this year rather than breaking even or receiving a refund. Our holdings have grown to $2,013,119 after our 2026 required minimum distributions have been taken. Was this a good move given the large tax bill? Our tax accountant is very critical of the sale of these funds.

Answer: Your accountant may not be in the best position to evaluate whether this was the right move for you.

Tax pros are typically focused on saving their clients money. That often means delaying or avoiding moves that could trigger capital gains taxes. Sometimes, though, such moves are necessary to avoid even bigger financial costs down the road.

The stock market gains of recent years mean that many people have portfolios that are now too heavily invested in stocks, particularly if they haven’t been regularly rebalancing their investment mix. These stock-heavy portfolios can leave people painfully exposed to downturns.

I redacted the names of the firms, but both companies you mentioned in your letter have good reputations. Your previous brokerage caters to do-it-yourself investors who want to minimize fees, while your new one provides fiduciary advice, meaning that they’re required to put their clients’ best interests first. It’s easy to imagine you investing for decades on your own without an advisor’s help or appropriate rebalancing; the new firm sees how risky your portfolio has become and diversifies it after careful discussions with you about your age, situation and goals.

Imagination is not reality, though, and the most concerning part of your letter is your vagueness about why you moved your money. You should be able to articulate in basic terms why this transfer made sense. “Our portfolio was too risky” or “I had too many of the same type of stocks” or “I realized I needed help” are all appropriate reasons. “A much better idea” is not.

The right move now might be to get a second opinion from a fee-only financial planner. Someone who charges by the hour could review your portfolio and let you know if you’re now on the right track. You can get referrals from the Garrett Planning Network at https://garrettplanningnetwork.com/.