Many of you know that I am a big believer in the National Association of Personal Financial Advisors (NAPFA). They are, IMHO, the special forces of financial advisors. To further separate themselves from the rest of the pack, they recently introduced a new fiduciary standard for NAPFA Registered fee-only advisors. Today’s story revolves around their 4th bullet point – A Duty of Compensation.
Per their recent press release
The NAPFA Fiduciary Standard is grounded in five core duties—Care, Loyalty, Compensation, Competence, and Engagement…
In essence, they are saying
- Take care of your clients. Don’t try to do something you are not qualified to do. Understand and manage your biases so they don’t hurt your client.
- Be loyal only to your clients. Be honest. Act with integrity. Disclose conflicts of interest. Be transparent. Put client interest above your own, etc. You don’t work for a company; you work for the client.
- Be competent. Continuously learn and improve.
- Be fee-only. Do not accept commissions. Disclose all fees. Terminate agreements when the cost of service exceeds the value delivered to clients.*
- Engage with clients on their terms. If they require a service you’re not qualified for, obtain the necessary education or outsource.
*The fourth standard, Duty of Compensation, requires that the advisor be fee-only. But it is so much more. The last bullet point says an advisor must:
Decline or terminate engagements where the fiduciary reasonably believes the cost of service exceeds the value delivered to the client.
A Client Story
Eleven years ago, a prospect came to me, wanting to retire. They had a nest egg of a little over $1 million and needed income of around $40,000, healthcare for 5 years until Medicare, totaling around $ 14,000, and vacations of around $4,000/yr for 10 years. They both wanted to collect Social Security (totaling $34,000) as soon as possible at age 62 because of a family history of a parent passing at 59.
My analysis showed their plan was funded. But I thought they could do better. I also wished for them to wait until the higher-income earner was age 70 to collect Social Security for the survivor benefit. If they collected as soon as possible, and my client, who was afraid of passing, did pass away early, the surviving spouse would collect about $22,000/yr, most of which would go to healthcare. She would’ve been in trouble.
So every year we updated his analysis, which showed a better likelihood of success if he waited to collect Social Security. And every year their nest egg declined.
Over the last 11 years, they’ve bought cars and camper vans, built garages, and increased their income as markets performed better than expected. They’ve withdrawn around $100,000/yr, more than the $1.1 million they initially invested with me. But their account has declined.
This year, they finally began collecting Social Security at age 70. Between the two of them, they’re projected to receive $80,000 in Social Security benefits, which are taxed at zero on the federal and state level. More importantly, if he passes, she gets $57,000/yr instead of $22,000/yr. And they still have $350,000 left of the initial investment.
The Duty of Compensation
Unfortunately, my $10,000/yr fee is no longer in their best interest. It’s my minimum fee. I charge roughly $5,000 for comprehensive financial planning, and 0.5% for investment management. I prepare and file taxes for free. Sometimes, my clients save enough in taxes alone to cover my fees.
For example, their original plan projected that they would pay $12,415 in taxes this year. By changing their income strategy to draw down their accounts until age 70 when they collect an increased Social Security, I’ve reduced their income tax to zero.
Some advisors tell their clients to collect as soon as possible, without considering a survivor benefit at all. It’s the best way to preserve their asset-based fee.
When I informed this client that my fee was too high, he said he wanted to stay on anyway. Instead, I offered him another local NAPFA advisor who was just starting out and would work with him. I also offered to help him set up a DIY plan with ultra-simple management. He opted for the DIY.
Takeaway
The Duty of Compensation standard in NAPFA’s new Fiduciary Standard isn’t the same fiduciary standard many advisors espouse. They put on one hat, act as a fiduciary, then switch hats and sell you an annuity, which might not be in your interest. Doing what’s right for the client isn’t always right for the advisor. But when you’re held to a higher standard, as NAPFA advisors are, clients can rest assured they are getting sound advice in their best interests and at a fair fee.
