Here is a common retirement investment scenario for Baby Boomers. Mr. Jones is retiring and has different options available in his pension plan.
- Option 1 – Accept a large lump sum, transfer it tax-free to an IRA and invest it for his future. He is personally accepting the risk of investing the money to help provide for the rest of his and his wife’s life.
- Option 2 – Begin receiving guaranteed monthly payments for the rest of his life (and his wife’s life with survivor benefits). This option places the risks and rewards of investing solely on the pension plan.
Since this decision is irrevocable and involves hundreds of thousands of dollars, Mr. Jones wants professional advice.
Not all advisers are paid the same way and Mr. Jones wants to know what motivates the adviser he is calling. Is the professional being compensated for their analysis, consultation, and knowledge? Is the professional giving free financial advice and is only compensated if an investment product is sold to Mr. Jones? A fee-based broker charges for their services by making a commission off of what they sell.
When you Pay a Financial Adviser, What are You Paying For?
Advisers who are paid solely by managing investments, selling investments or insurance may be more likely to give advice that pays a commission. An adviser like this is incentivized to recommend Mr. Jones take the lump sum and roll it over to an IRA. After all, that would generate revenue for the adviser. There may be some cases where the adviser would recommend the monthly lifetime income, but that would provide no compensation to the adviser described here. Is that likely?
On the other hand, Mr. Jones may choose to partner with a professional who is compensated simply for providing this type of financial planning advice. In other words, the cost for advice may be completely independent of the cost of products. Then there is no incentive for the advice to be skewed either way. The professional would be providing her best advice because that’s exactly what Mr. Jones is paying for – unbiased advice.
A Commissioned Financial Adviser has Conflicts
Consider another common example. Let’s assume Mr. Jones also has a large balance in his employer’s 401(k). As illustrated above, an adviser compensated by selling investments cannot be paid unless the 401(k) is rolled over to an IRA. Buying investments inside the IRA is the only way for the adviser to be paid for his advice. There are many technical reasons Mr. Jones may want to consider not rolling over his 401(k) to an IRA, but his adviser has a conflict.
Because financial advisers have been compensated like this, the U.S. Department of Labor has released a rule requiring financial advice (for retirement accounts only) to be in the best interests of the client. This is often referred to as the fiduciary rule. (Not all financial advisers are legally required to act in their clients’ best interests.) Many financial organizations are filing lawsuits in an attempt to stop this fiduciary rule from becoming law. This rule will be implemented over time to give traditional firms time to change.
Good Financial Advice is Worth the Price
Do motivations matter? We believe so and have built a business model where we put our clients’ interests first at all times. In fact, we put it in writing. If you’d like to explore what a partnership with our team involves, we’d be honored to talk with you.
For more detail on pension election decisions (monthly income vs. lump sum), watch these short videos.
Published: October 5, 2016
Author: Terry Prather, CFP®, ChFC®, MSFS
Phone: (812) 602-6307
Share your thoughts by tweeting to @PayneWealth or follow us for more useful info!The information in this material is only as current as the date indicted, and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which are subject to change and which Payne Wealth Partners, Inc. does not undertake to update. While all information prepared in this document is believed to be accurate, any statements of opinion constitute only current opinions of Payne Wealth Partners, Inc., which are subject to change and which Payne Wealth Partners, Inc. does not undertake to update. Accordingly, you should not put undue reliance on these statements.