Selecting the right financial advisor is an important decision. Knowing what qualities to look for and how to evaluate an advisor’s expertise can be challenging. What criteria should you use? What is the yardstick by which to measure a good advisor?
As a realtor once shared with me, “My value isn’t just in helping you find the perfect home, but also in steering you away from properties that could be problematic down the road.”
This sentiment captures a key aspect of what a professional advisor brings to the table. While we are often judged on the actions we take and the strategies we implement, our true value frequently lies in helping clients sidestep potential pitfalls. Just as a skilled realtor guides clients away from properties with hidden issues, a knowledgeable financial advisor aims to protect you from financial mistakes that could jeopardize your long-term goals. What may seem like minor errors initially can have a significant impact on your wealth when their effects accumulate.
Below are some real-life examples of situations where we have helped clients avoid mistakes.
TRANSITION TRAPS
Neglected Assets in Divorce
It goes without saying that divorce is usually a stressful process. And to make matters worse, divorce lawyers often don’t help with the distribution of assets once the divorce is finalized. Five years after a divorce, we discovered in reviewing a new client’s division of marital assets that the husband’s 401(k) had never been split, and the spouse did not receive her 50%. Worse, the new wife was named as beneficiary of the 401(k).
Potential Price Tag: 50% of the value of the account.
Inheriting Retirement Accounts
It is now a fairly common occurrence to inherit an IRA or annuity from a parent or sibling. Correctly handling the distribution of these accounts is critical. In 2020, the rules changed regarding when and how distributions are required. Depending on when you inherited, you may be eligible for a stretch IRA in which you take annual required minimum distributions (RMDs) over your lifetime, or you may need to plan for a 10-year payout. Either way, looking ahead and planning is required. In our work, we’ve found missed RMDs and missed opportunities to optimize taxes due.
Potential Price Tag: Missed RMDs are assessed a penalty. The cost of suboptimal tax planning is harder to quantify but could be 10% to 30% of the account’s value.
ESTATE PLANNING PITFALLS
No will or out-of-date beneficiary designations
Dying intestate (without a will) creates a headache for your heirs, who must petition the court for executor powers and be subject to more supervision. Moreover, if you die without naming a guardian for your minor children, and their other parent is not still living, the court will name a guardian. All this amounts to more time, money, and hassle.
With no named beneficiary or an out-of-date designation, your account may be inherited by someone other than your choosing. It is not uncommon to find beneficiary designations with ex-spouses and deceased family members. When did you last check all your beneficiaries?
Potential Price Tag: Time and legal costs for heirs, delays in estate distribution, and the risk of your assets going to the wrong recipient or the court appointing a legal guardian for your minor children.
Having an estate plan but not following through on re-titling assets
Kudos to you if you have gone through the hard work of setting up an estate plan. Often times we find that new clients haven’t followed through on re-titling their accounts to put their assets in the trust or re-titled the deeds on their property. The estate plan may or may not work without that step.
Potential Price Tag: Your estate plan may fail to accomplish your goals.
MISSED OPPORTUNITIES
Paying no tax
This example will probably surprise you, because paying no tax seems like a good outcome! But if you have significant retirement assets and little earned income, you have probably missed an opportunity to optimize taxes by either proactively taking IRA distributions before your RMD, converting an IRA to a Roth IRA or taking capital gains and paying little tax on them.
Potential Price Tag: Future tax rates of up to 37% on IRAs and 20% on capital gains.
Using your Health Savings Account (HSA) incorrectly and not earning on it
Health savings accounts are still new to many, even though they have been around for over 15 years. New clients often have been using them to pay their current medical bills when they could be allowing them to accumulate tax deferred and potentially tax free. HSAs are often languishing in a very low interest account, earning nothing. By moving them to an investing platform, and allowing them to grow with a long-term view, savers can provide another resource for higher future medical needs.
Potential Price Tag: Lost opportunity to grow a powerful tax-free asset for future medical needs.
Giving cash to charities
For higher net worth individuals who are charitably inclined, giving cash rarely makes sense. Using appreciated securities either to fund a Donor Advised Fund or a direct gift, is an easy way to save on taxes. You need to be able to identify the right tax lot, but with good records that shouldn’t be a problem. If you are receiving RMDs, a Qualified Charitable Donation (QCD) is another route to saving on taxes, and potentially, Medicare premiums.
Potential Price Tag: Potential capital gains tax savings of up to 28% and reduced Medicare premiums.
INSURANCE OVERSIGHTS
Not adequately insuring your life or that of your spouse
Not having an adequate amount of life, disability or liability coverage can put your family’s financial future at risk. No one likes paying for insurance and many families neglect this area at great risk. We regularly help new clients understand an appropriate amount of insurance for their circumstances and recommend increasing coverage using low-cost insurance options when they are inadequately insured.
Potential Price Tag: Zero to millions of dollars.
Ignoring your cash value life insurance policies
If you bought policies 30 years ago, and have never reviewed and evaluated them, they are probably not optimized to your current situation. You could be paying more than you need to, hold more or less insurance than you need and not maximizing the cash value buildup in the policy, or worse, earning a very low return on the cash value.
Potential Price Tag: Not maximizing your wealth accumulation.
INVESTMENT MISSTEPS
Not paying attention to cost basis
Many DIY investors neglect to identify and maintain accurate cost basis records, leading to overpayment of capital gains taxes. More than 50% of the time we assume management of a portfolio, we find that no care has been taken to identify a cost methodology (average cost, first in first out, high cost). While this is easily remedied, it requires an understanding of the rules and a review of the specifics of the security’s history. It also requires good historical recordkeeping, which most financial institutions can help with. The typical mistakes we encounter are using average cost for mutual funds when another selection method would be more advantageous, failure to keep cost basis records, and not paying attention to which security lot is selected for sale.
Potential Price Tag: Higher capital gains taxes could result in higher federal and state taxes, 0% to 30%.
Not engaging in loss harvesting
For long-term investors, market downturns are a silver lining in an otherwise gloomy market. By proactively selling positions at a loss, you harvest losses that can be used to offset future gains. But beware, you will need to avoid the wash sale rule, so you will need to cognizant of how to execute trades to maintain your market exposure and recognize the tax losses. It is rare to find investors who are doing this.
Potential Price Tag: Higher capital gains taxes which might have been delayed or reduced.
Buying an annuity with a rider and not understanding how to use it
It almost goes without saying that most new clients who own variable annuities with income riders, have no idea what they own and how to use the product. In these situations, there is no easy short-cut; it requires reading the voluminous contract, understanding the terms and fitting the features into the client’s financial needs. Consequences are that you may be paying too much for features you aren’t using or going to use, or you may be missing out on extra income.
Potential Price Tag- lost opportunity to obtain income or save on fees within the annuity.
Having too much of your portfolio in cash
For many investors, market turmoil can be paralyzing. Time and time again we see new clients with too much cash in their long-term retirement accounts. The reasons are all over the map, but without a good long-term vision and plan, they allow cash to sit idle in long-term retirement accounts which hinders growth and wealth accumulation.
Potential Price Tag: Lost opportunity to build retirement nest egg.
Investing in one stock or sector
Today’s executives are likely to be the recipients of stock as compensation, which can lead them to be overly concentrated in one stock. Likewise, we have seen professionals who feel they know an industry well and concentrate too much of their wealth there. Not only are they raising their risk level, but they are also neglecting other sectors and companies that offer greater rewards. Over concentration in a stock or sector can dramatically increase returns but can also have equally dramatic negative impacts.
Potential Price Tag: increased risk and volatility, leading to panic selling at the wrong time.
Financial mistakes can be costly, but they’re often preventable with the right guidance and proactive planning. By working with a knowledgeable financial advisor, you can navigate complex financial landscapes, identify potential pitfalls, and implement strategies to protect and grow your wealth. Investing in professional advice today can save you from significant financial setbacks tomorrow, ensuring a secure and prosperous future for you and your loved ones.