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Retirement Planning > Saving for Retirement

Know Your Clients. Well.

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The financial industry is broken down, basically, into two groups: Those who are regulated as fiduciaries, and those who aren’t.

However, wouldn’t you agree that most financial advisors held to the lower regulatory threshold would argue that they still hold themselves accountable to the higher standard?

In other words, acting in the clients’ best interest is, or should be, a concern, or a standard for the majority of advisors, not the minority.

(Related: Want Better Sales? Ask Better Questions)

Let me ask you something: If you don’t take the time to show, to discover, or to determine the financial path a client is currently on, then can you objectively prove you acted in the client’s best interest? Can you objectively show you even helped the client?

An LTCI Planning Case

Consider this: If clients wanted to buy long-term care insurance (LTCI), but, based on their current spending trajectory, they would exhaust their retirement savings within the next 10 years, then would it be prudent to add an additional cost for additional insurance that, due to elimination periods and daily co-pays, would be unusable?

About a decade ago, a couple that eventually became clients came to us because their advisor was recommending a $6,000-annual-premium LTCI policy. The advisor never took the time to figure out how much the couple would spend in retirement. He simply concluded that their $500,000 of retirement assets must be protected again potential long-term care (LTC) expenses.

The couple’s goals, spending and age of retirement would have put them on a path, such that, when statistically they were most likely to use the policy, they would no longer be able to pay the premiums or the co-pays if they did go on claim.

While we could argue the policy was suitable, we can’t argue it was in their best interest to focus on insuring a potential risk, when their desired retirement age and spending amounts gave a near certainty of exhausting their retirement savings.

I suppose, advocates of LTCI would say this is debatable.

IRA Math

Let me make this simpler.

A few years ago, during the Q&A part of a talk I was giving to a group of advisors, another advisor challenged my statement that we need to review a client’s tax returns and perform forward projections to conclude whether a Roth individual retirement account or a traditional IRA is most appropriate. He believed Roth IRAs were superior to traditional IRAs.

My answer to him was more elaborate than this, but I think this will suffice. Imagine a client is two years out from retirement, and he or she is currently in the 22% federal tax bracket but will dip into the 12% bracket at retirement. I see this often.

In this example, contributing or converting to a Roth IRA before retirement, taxes those dollars at 22%, when just two years later it could be taxed at 12%.

To illustrate the difference, let’s just use $20,000 as the contribution amount.

There’s two ways to increase Roth IRA assets.

  1. Make $20,000 in Roth IRA contributions.
  2. Convert $20,000 to a Roth IRA.

If, over the two-year period, a married couple contributed $20,000 to their Roth IRA, rather than to their traditional IRA, they’d have a tax-free balance of $20,000 in their Roth IRA.

If they contributed $20,000 to their traditional IRA, they’d have a taxable balance of $25,641 in their traditional IRA — $25,641, because $20,000 in traditional IRA contributions creates $5,641 in tax savings.)

Two years later, if we use a no-growth assumption, when this couple is in the 12% bracket (about $100,000 gross income), the after-tax balance of the traditional IRA will be $22,654, or $2,654 more than that of the Roth IRA.

The money could be invested in cash, and the client would experience a net after-tax gain of approximately 13% over two years.

Now, what about if this case involved a Roth IRA conversion, rather than a contribution?

If the couple were to convert $20,000 from their traditional IRA to their Roth IRA, and to do so while they were in the 22% tax bracket, the net amount added to the Roth IRA would be $15,600, after taxes were subtracted.

If the couple had left the $20,000 in the traditional IRA until retirement — when their tax rate would be 12% — then the after-tax amount would be $17,600.

This time, the value is only $2,000 greater, but it’s still an increase of approximately 13% over what the couple would have gotten by contributing $20,000 to the Roth IRA.

What if the money were invested? Using the last example, after a 10% gain, the Roth IRA would have $17,160 in value. The traditional IRA would have $19,360 in value.

Therefore, the greater the potential investment gains are, the more the advantage of using the traditional IRA is magnified.

Does this mean traditional IRAs are superior to Roth IRAs? No! Important, I intentionally used a short time period, because for things like taxes, the shorter the projected time period, the greater the accuracy will be for forward projections. You could make a great argument for Roth IRAs for those years away from retirement.

For younger clients, Roth IRA conversions can certainly make sense, especially during periods of short-term declines in taxable income. However, if you’re not looking at a tax return, then do you actually know, for sure, what bracket they’re in? You can’t possibly, for sure, unequivocally, 100% know this. If you don’t know, then you’re guessing. Should you, as the trusted advisor, guess?

Multiple Verifications

One more thought. This one hit me last week.

Last week, I went in for an unexpected shoulder surgery. Minutes before they wheeled me into surgery, during the last pre-op conversation, the surgeon walked in, and pulled back the hospital gown to expose my right shoulder. He grabbed his green felt-tipped marker and wrote his initials next to mine, which I was instructed to do shortly after getting into my gown. This was the final effort to make sure both parties, the knife wielder and the soon to be knife pillow, were both clear which shoulder was to be operated on. This got me thinking, are we this clear with our clients?

There’s an interesting dichotomous relationship here. Think about it…surgery is a pretty big deal, so the surgeon operating on the correct shoulder should be a given, but something this important cannot be given the benefit of the doubt.

In at least four separate ways, the surgeon’s staff confirmed, marked, or indicated which shoulder was going to be operated on.

Is this any different than what your clients expect from you? When they ask if they should contribute to a Roth IRA or a traditional IRA, doesn’t something as important as their retirement deserve several verifications?

In the end, as an industry, we need to stop being so unilaterally in favor or not in favor of financial products or tax strategies. And, as we continue to move toward a universal fiduciary standard of our own, regardless of what regulators might or might not be doing, we must change. In order to objectively prove we have acted in a client’s best interest, we must be able to objectively show, illustrate, or display where the client was and where they were headed prior to implementing a single piece of advice.

As clients continue to live longer, as our world continues to transition to digital, which lives forever, future caregivers won’t have the background information and they will expect illicit documentation to show where their loved ones were before and after they met us.

— Read 8 More Dave Ramsey Myths Debunked on ThinkAdvisor.

Michael J. Markey Jr. (Photo: MM)

Michael Jay Markey Jr. is a co-founder and owner of Legacy Financial Network and its associated companies. He has been a member of the Million Dollar Round Table member and a winner of Court of the Table and Top of the Table honors. 


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