FREQUENTLY ASKED QUESTIONS

Here are some commonly asked questions we’d like to share.

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Wealth and Financial Planning

What are the different types of financial advisors?

​There are many different descriptions within the financial services industry for financial management companies, including asset management, wealth management, and family office services. So when choosing an advisor, it’s key to understand the differences between these terms and the capabilities that different types of managers offer.

Asset management is pure investment management, such as buying mutual funds (with decisions overseen by a mutual fund manager). For example, hedge funds are also just asset (e.g., investment) management.

Robo-advisors are firms that automate investment management by using computer algorithms to build and manage portfolios. Therefore, they are typically asset managers without a lot of additional services. When investors’ financial situations are more complex, they will need more of the services a wealth management firm provides.

What are the different types of financial advisors

The industry has evolved and there are now wealth management firms because investment returns, over time, are impacted by more than just the investment solution.

What are some unique services offered by wealth management firms?

Wealth management firms offer an array of planning services to guide you through transitions such as:

Concentrated Stock: Firms that have expertise in strategic diversification, hedging, income generation, and tax minimization. They guide their clients through the complexities of a concentrated stock position while working towards maximizing its potential value.

ESG / Impact Investing: Some firms specialize in ESG or Impact Investments to help bridge your financial and social objectives. Seek firms that might be a certified B Corporation member or a signatory of the Principles for Responsible Investment (PRI).

Tax Planning: This could be as simple as tax-loss harvesting, but also would mean coordinating with a CPA or an Enrolled Agent to decide how to distribute assets among different accounts that have different tax consequences, and what tax year in which that occurs. One tax year may have a lower tax rate for the investor than another.

What is an Enrolled Agent? According to the IRS website,

  • An enrolled agent is a person who has earned the privilege of representing taxpayers before the Internal Revenue Service by either passing a three-part comprehensive IRS test covering individual and business tax returns, or through experience as a former IRS employee. Enrolled agent status is the highest credential the IRS awards. Individuals who obtain this elite status must adhere to ethical standards and complete 72 hours of continuing education courses every three years.

Other Wealth Management Services include:

Comprehensive Wealth Management Services
Comprehensive Wealth Management Services

What is Family Office?

Family Office services includes asset management, wealth management, and a host of other services. In fact, a family office is not too different from a small business. Some investors who sell their small businesses establish family offices to take care of their wealth because of the large revenues and expenses involved.

For instance, the family may have employees on their staff, complex alternative investments, or tax Schedule K-1s they have to manage. They might have a lot of real estate investments or art collections. Family offices may have earmarked some assets for charitable and philanthropic causes. And security tends to be a key issue from physical and cybersecurity perspectives.

Finally, a major goal is to make sure the wealth gets passed on to future generations and that it lasts. Family governance, education, documentation management all fall within the services of a family office.

What does the SEC regulation “Best Interest” mean?

​In a recent Forbes article, the Securities and Exchange Commission (SEC) is enforcing a new rule, Regulation Best Interest, that aims to fix that. The regulation, a successor to the Department of Labor’s defunct fiduciary rule, establishes a “best interest” standard for broker-dealers and mandates additional transparency for clients.

The new SEC regulation changes how brokers may identify themselves, and aims to bring clarity to consumers looking for help with managing their wealth. Here’s what you need to know. Regulation Best Interest aims to hold brokers to a higher standard. The new regulation requires brokers to stop referring to themselves as advisors if they aren’t working under a fiduciary standard. In addition, it imposes four obligations on them:

  • Disclose information about their recommendations.
  • Exercise diligence, care and skill when making a recommendation.
  • Abide by policies that address conflict of interest.
  • Complying fully with policies and procedures designed to fulfill the regulation.

Regulation Best Interest also requires both RIAs and brokers to provide their clients with a new document that discloses key facts about a firm: Form CRS, a client relationship summary. This brief document outlines the services offered by a firm; all fees, costs, conflicts of interest and mandated standards of conduct associated with its services; and a review of the firm’s legal or disciplinary history.

View the full March 2021 article: What Regulation Best Interest Means For Your Financial Advisor

When is it a good time to seek a wealth advisor?

Typically, the time for someone to start working with a wealth advisor is when they go through life transitions and find themselves in a more complex financial sitiuation, such as:

  • Inheritance
  • Retirement
  • Divorce
  • Sale of a business
  • Changes in your job or company such as an Initial Public Offering
  • Passing of a spouse. For example, if the spouse had been the financial manager of the family, there would likely be the need for help and guidance through complicated and difficult times.

People who might find themselves with the fortune of a complex financial situation and need guidance on tax-efficient strategies, concentrated stock management, portfolio diversification needs, charitable giving, or just peace of mind.

The Divorcee
DIVORCE
Making an Impact
IMPACT INVESTING
Preparing for Retirement
RETIREMENT
Window
Widower
Selling a Business
Selling a Business
Managing a Concentrated Sock
Concentrated Stock

What is the typical fee structure for advisory firms?

The fee structure for many wealth managers (Registered Investment Advisors or Broker-Dealers) varies based on the value of the investable assets the advisor is managing. Typically starts at 1.0% to 1.5% and may offer lower fees based on higher investment totals while others offer a flat fee.

Some advisors may base their fees on their investment performance but that varies widely by the advisor and by year.

According to a Vanguard study that looked at a 20-year timeframe, the average investor saw returns of about 2.5% versus the market returning 8%. That’s a difference of 5.5%, which is an enormous underperformance. Factors could be that many investors tend to be emotional, and maybe swayed by news headlines and biases, or find it challenging to stay with a disciplined investment approach in up and down markets.

Further analysis suggests that the VALUE of a wealth manager is closer to 3% of a client’s assets. The value-add is the ability to guide clients through difficult times of market distress and uncertainty. When a client stays on path with their long-term financial goals, the fee they pay can be a prudent long-term investment.

What factors (or pitfalls) should I consider when choosing an advisory firm?

A variety of factors may be important and not all firms offer comprehensives services such as: tax planning, retirement or estate planning, business planning or ESG/impact investing.

Factors to Consider When Choosing a Firm

A key questions to ask:

Who is on the team and how will that team be communicating especially beyond the investment solution?

A client is hiring a relationship with a trusted advisor and potentially knows more about you and your family than some of your friends, so communication and trust levels are extremely important.

A typical pitfall is chasing returns and hiring a manager based on past performance. Financial advisors and wealth management firms can have great years and some years where they may lag, so performance should never be the only metric.

The bottom line is that an investor should evaluate a firm through a number of factors.

Another not-so-obvious consideration might be what the firm’s values are. For example, being a Certified B Corporation. The certification means that the business meets the highest standards of verified social and environmental performance, public transparency, and legal accountability to balance profit and purpose.

Additionally, being a signatory of the Principles for Responsible Investment (PRI) which includes global organizations unified under the belief that an economically efficient, sustainable global financial system is a necessity for long-term value creation.

If environmental, societal, and governance oversight is important to you, seek firms with deep expertise in the Impact Investing space.

Charitable Remainder Trusts

What is a Charitable Remainder Trust (CRT)?

It is a trust where non-charitable beneficiaries (usually the grantor and grantor’s spouse) receive payments at least annually during their lives or for a number of years, and a charity receives the trust assets remaining at the end of the trust term. A charitable trust is also referred to as a “split interest trust”. This is because the beneficial interests in the trust are “split” between the initial non-charitable beneficiaries and the charitable beneficiaries that receive what remains at the end of the trust term.

How Does A CRT Work?

The grantor initially funds the CRT with low basis, highly-appreciated assets.

  • When the CRT sells the highly appreciated assets, the CRT itself is not subject to capital gains tax, thus preserving the full value of the appreciated assets to reinvest in a diversified portfolio.
  • The capital gains taxes will be spread out and payable as the Beneficiaries receive payments from the CRT.
  • In addition, the grantor receives an immediate income tax deduction.

Is income tax imposed on the distributions and who pays it?

CRTs are exempt from income tax. The CRT assumes the grantor’s adjusted cost basis and holding period in the property. If the CRT sells appreciated property, neither the grantor nor the CRT will pay immediate income tax on the sales.

However, when the Lead Beneficiaries receive payments (at least annually), those payments are subject to income tax. ​

How long can the CRT last?

A CRT may last for the Lead Beneficiaries’ joint lives or for a term of years (the term may not exceed 20 years). In addition, the actuarial value of the CRT remainder left to charity must be least 10% of the initial CRT value, determined at time of funding. This “10% test” creates a floor as to how young the Lead Beneficiaries can be. If the Lead Beneficiaries are too young, the CRT will fail the 10% test. For a lifetime CRUT, the Lead Beneficiaries must be at least in their 40s and for a lifetime CRAT, the Lead Beneficiaries need to be at least in their mid-70s.

How often are distributions made?

Distributions are typically made annually or quarterly but can be weekly, monthly or semi-annually as well. ​

How are the distributions amounts determined?

​The IRS rules require the amount be at least 5% but no more than 50% of the trust assets. The maximum distribution amount depends on the length of the CRT term or for lifetime CRTs, the Lead Beneficiaries’ life expectancies.

Do I get a charitable deduction?

​Yes, the grantor receives an immediate income tax deduction equal to the present value of the projected remainder interest that passes to the charity.

The deduction may be limited to 30% or 20% of AGI for the year, depending on the type of property you give to the CRT (short term v. long term capital gain property) or the type of charitable organization named as remainder beneficiary (church/school/public charities/donor advised funds v. family private foundations). The good news is that you may carry over any unused charitable deduction amount from any year in which the remaining deduction surpasses these limits, up to 5 years.

Are there restrictions on what charity can be named as remainder beneficiary?

And can I change the charitable beneficiary during my life?

Yes, the charitable remainder beneficiary must be an organization described in Internal Revenue Code Section 170(c), such as a public charity, donor advised fund, religious organization or a private foundation. You may change the charitable beneficiary during your life, but it is best to give an independent trustee this power to avoid risk of the CRT being included in your taxable estate. ​

Can my private foundation be the remainder beneficiary?

Your private foundation can be the remainder beneficiary, but the income tax deduction will usually be less.​

Who can be the trustees?

Often, grantors will name themselves or their spouses as trustee. The grantor’s other family members may also act as trustees. An independent trustee may be needed if CRT holds unmarketable or hard to value assets such as closely held stock or artwork, or if the grantor thinks he may want to change the charitable beneficiary later. ​

Do I have to pay gift tax when I set up a CRT?

Generally, no. However, if someone other than grantor or his spouse receives the payments, then the grantor has made a taxable gift to that someone equal to the present value of the annuity or unitrust amounts paid to that person over the trust term, calculated when the CRT is created. ​

Is the CRT includible in my estate?

Generally, by gifting assets to a CRT, a grantor removes those assets from his taxable estate. The remainder passing to the charities is not includible in the grantor’s taxable estate. There is no estate tax consequence so long as the grantor and her spouse are the only Lead Beneficiaries. ​

Transitional scenarios described above are hypothetical based on possible financial needs and goals of a client(s). This material contains references to concepts that have legal, accounting and tax implications, and is not intended as legal, accounting or tax advice. Information presented is believed to be factual and up-to-date, and are subject to change.Click here to view BakerAvenue's full disclosures.

When you need to discuss your personal and professional life transitions, BakerAvenue is here for you.