Q&A: Planning Issues

Q: I am one week away from selling a second-generation family business and receiving far more money than I’ve ever had the pleasure to manage (approximately $4.5 million net). I will be working for the company that has acquired our business, so I don’t need any of the proceeds of the sale right away. (I am 47 years old.) Could you give some suggestions as to how to properly invest and manage such a sum? P.S.: I enjoy your comments to people trying to “use� the system or to get away with something less than ethical.

A: I see. You’re getting $4.5 million and you want some free advice? Talk about being used. . . .

Seriously, you need more than the little advice a newspaper columnist can give you. Don’t be embarrassed about being clueless--few of us would know exactly how to handle that much moola, beyond having one heck of a binge at Nordstrom or Newport Beach Yacht Sales, or whatever your retail outlet of choice might be.

Even if you did think you knew what you were doing, I’m not so sure it would be a good idea to do it all on your own. Having a second set of eyes to look over your financial choices--someone who isn’t intimidated by seven-figure checks--would be invaluable, and could prevent you from making some stupid mistakes. You are in a position to have an accountant, a lawyer and a planner--each of whom might be helpful in evaluating the others.

The good news is that there are lots of smart, skilled financial planners out there who are dying to help you.

You have the kind of money that attracts the best of the best--fee-only financial planners who make their bread and butter by managing big wads of cash. Poorer folks have to contend with commission-based salespeople trying to sell them annuities.

You get to have top-flight personalized advice, a tailor-made portfolio and goodies such as tax advice and estate planning from people who know what they’re doing.

They won’t come cheap. Expect to pay around 1% of your assets a year. That $45,000 may seem like a lot now, but trust me, you could blow a lot more than that with one bad investment call.

You’ll want to interview several candidates before you decide to hire one. You can get a list of fee-only planners from the National Assn. of Personal Financial Advisors at https://wwwnapfa.org or by calling (888) FEE-ONLY. If you have rich friends, chat them up about who manages their money. Also check out the information The Times has about choosing financial planners, at http://ukobiw.net/finplan (it’s free--you’ll like that).

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Q. In choosing a financial planner, how much weight should I place on his or her membership in professional associations? I’ve discovered that a planner I had intended to go to is not a member of the National Assn. of Personal Financial Advisors, or a CPA-PFS. Would you advise looking elsewhere?

A. Oops, you’re mixing associations and credentials.

NAPFA is a professional association for fee-only planners--those who do not take commissions for their recommendations and who are compensated solely by their clients. Its membership is quite small--only about 600 members--largely because most of the financial planning profession accepts commissions.

The PFS, or personal financial specialist, is a financial planning credential available only to certified public accountants who have met certain experience and knowledge requirements in financial planning. Although many CPA-PFS holders are fee-only, that is not a requirement of the designation.

It’s easy to get confused with the alphabet soup out there in financial planning today. Every profession and group insists that it’s the best or the only, but in fact there is no one golden standard.

The most common financial planning credential, and the first one I’d look for, is that of certified financial planner, or CFP. (In the interests of full disclosure: I completed the CFP training program two years ago.) The PFS is another good starter credential, as is the ChFC, which stands for chartered financial consultant.

Notice I said “first� and “starter.� Anyone who has finished the course work would admit that the training helps you know more, but it also shows you how much more you need to know. What’s even more important is what education and experience the planner has had since gaining the credential, what his or her ethical standards are and whether you and the planner are a good match.

Membership in certain professional organizations is a good sign, but, again, it can’t be considered a guarantee of excellence. CFPs who are members of the Institute of Certified Financial Planners, a membership organization, are required to maintain certain ethics standards and to continue their educations. Active CPAs and ChFCs have membership organizations with ethics and ongoing education requirements as well. You can check out these organizations on their Web sites: https://www.icfp.org, https://www.cpapfs.org or https://www.financialpro.org/sfsp. You’ll find NAPFA’s standards at https://www.napfa.org.

You also can check out all the free information we have for you at http://ukobiw.net/finplan before you get started looking for a planner. I also recommend Charles A. Jaffe’s book “The Right Way to Hire Financial Help.� You’re putting your financial future in someone else’s hands, so it pays to do some homework.

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Q: I was wondering if anything can be done about the following: I received money from my ex’s individual retirement account as part of a divorce settlement. I had it transferred to my bank and asked the financial advisor in charge there if I could take some of that money for the purchase of a home; the rest was put in a mutual fund.

He did not tell me that this amount would be calculated as income and taxed unless I replaced it within 60 days. As a result, I owe the IRS close to $20,000 in taxes, part of which I paid, depleting all my certificates of deposit and most of my money market at the bank. I make only a teacher’s salary and he knew it. He told the investigator from the bank that he informed me of the penalties. He did not; otherwise, I would not have taken the money. I could have used my money market account or I probably would just not have purchased a house at that time. Am I stuck with paying all this money to the IRS?

A: You learned the hard way that just because someone calls himself a financial advisor doesn’t mean that he a) knows what he’s talking about; or b) follows any ethical standards.

The Certified Financial Planner Board of Standards, which regulates the CFP trademark, estimates that between 250,000 and 400,000 people call themselves financial planners. The vast majority have no special training, degrees or certification in the field. (If you want to know more about choosing a financial planner and what all the designations mean, visit http://ukobiw.net/finplan.)

When it comes to tax advice, you should be particularly suspicious of anyone who isn’t an enrolled agent or a certified public accountant. (An enrolled agent is a federally licensed tax specialist.) Any transaction that involves a retirement fund should be checked out with one of these professionals before proceeding.

That doesn’t mean you have to roll over and play dead, however. You can contact the government regulators who oversee the bank. (Federal Deposit Insurance Corp. at https://www.fdic.gov can help you determine which regulator that might be.) You can also hire a lawyer to write the bank a pointed letter about how its employee messed up. Given the amount of money at stake, the $250 to $500 you would pay could be a worthwhile investment.

Since you clearly could have tapped money from other sources, it makes sense that you wouldn’t have used the IRA money had you understood the consequences. No, you probably shouldn’t have relied on the bank employee’s advice, but he shouldn’t have lied to the bank investigator. If he’s calling himself an advisor and giving bad tax advice, he needs to be held accountable.

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Q: I have a friend who is training to be a financial planner with a financial services company. She is urging me to transfer my 401(k) savings with Fidelity Investments to a variable universal life insurance policy with this firm. She said something about converting my money to tax-free status when I draw it out, as opposed to my 401(k), which will be taxable. I have not been able to find out much about this in my readings or Internet searches and I hesitate converting anything. Are you familiar with this program, and is it a worthwhile choice? I am 50 and my husband is 51, and between us we have approximately $500,000 in our 401(k)s. We already have a universal life insurance policy at group rates covering him and me for $100,000 and $135,000, respectively, at a very reasonable monthly cost.

A: This person is no friend, and if her company is recommending such a policy it should be reported to the state Department of Insurance.

This whole scheme is to benefit her, not you, and it could cost you a comfortable retirement. What she is asking you to do is to withdraw your money unnecessarily from a tax-deferred investment so that she can earn a commission when you buy a new life insurance policy. You would have to pay regular income taxes on any money you withdraw from your 401(k), plus a 10% federal penalty and 2.5% state penalty for taking the money out before age 59 1/2. In other words, you could lose half or more of your nest egg to taxes and penalties. And that’s just to start: You would end up paying more in administrative and management expenses, because investments via life insurance policies are usually much more costly than direct investments in mutual funds.

She’s touting tax-free withdrawals from the policy, but what she’s not telling you is that these withdrawals would be a loan against the policy’s cash value. If you don’t repay the loan, your heirs get less when you die.

I think it’s telling that you didn’t mention a need for more life insurance. It doesn’t make much sense to purchase more insurance if you already have adequate coverage; it doesn’t make any sense to take money out of a 401(k) to buy such insurance.

If you want to learn more about when a variable universal life policy might be appropriate, visit the tutorial at http://ukobiw.net/insure101.

Here’s a final note to all the insurance agents who write to me, complaining I’m too hard on the industry: This is the kind of nonsense that is absolutely endemic to your business. If you’re not willing to do something to clean it up, eventually the regulators will. Given how many people are being talked out of their money in schemes like this, it can’t happen too soon.

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Q: I recently met with a financial advisor who appeared to be steering me clear of no-load mutual funds. He said that “no-load funds do not really exist--it’s a misconception.�

After our meeting, I researched the funds he mentioned, and all had a 5.75% maximum sales charge. I appreciate his time and counseling, as I do want guidance about how I should allocate my money to meet my financial goals, but I don’t want to pay a percentage every time I invest more money in a fund. Is it possible that he is making his money from this load fee? And that there are indeed no-load funds but that he just won’t make money from them? Should I ditch this guy?

A: Of course, of course, and of course.

Of course no-load funds exist. Of course he’s making money when clients take his recommendations. And of course you should ditch him--but perhaps not for the reasons you think.

Brokers have to get paid somehow. If you’re using this broker’s time and seeking his guidance, he’s going to want to get paid in the form of commissions on what you buy. If you buy a no-load--a mutual fund that has no up-front or back-end sales fee--the broker makes squat, and he’s not in business to be a not-for-profit counseling service.

You can blink your eyes innocently and say you didn’t understand, but wasting the guy’s time--or stealing his advice to implement on your own later--is akin to pumping a lawyer acquaintance for free legal advice or asking a doctor you meet at a party to take a look at your bum knee. It’s cheap and it’s sleazy.

The fact that you’re asking these questions, by the way, indicates that either you do need a professional’s advice, or that you should do a lot more research to educate yourself about mutual funds before you invest. I recommend picking up a copy of Eric Tyson’s “Mutual Funds for Dummies� for a start.

If you do decide to use a professional, however, don’t use this broker; he never should have told you that no-load funds are a ‘misconception.� They do exist and are used successfully every day by do-it-yourselfers, and by advisors who are paid by fees from their clients rather than by commissions. He should have just been honest with you about how he gets paid, so you could make an informed choice.

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Q: Your reply to the “investor� who claimed that a broker had told him that “no-load funds do not really exist--it’s a misconception� was good as far as it went.

However, I think you should have made some effort to help the reader understand what the broker really said. Obviously he wasn’t telling your reader that no-load funds don’t exist. Any idiot would know that they do. But that’s what this “investor� heard, and everything else the broker said came out as “blah-blah-blah.� You could have helped the reader by explaining that the broker was in effect saying: “There’s no free lunch. Yes, no-load mutual funds don’t have a sales charge, but they get their money in many cases with higher management fees or 12b-1 fees, which are used for advertising, promotion, etc. This is expressed as a percentage of your return, so over time, it’s possible you could end up paying the no-load fund more in charges than if you’d gone with a broker-sold fund.�

You missed an opportunity to not only be fair to the broker, but also to make a point with this investor that listening is a very, very important part of the investment process. By panning the broker, you ended up endorsing no-load mutual funds. Is that what you wanted to do?

A: You’re so bright you’ve obviously forgotten that time in your learning curve, perhaps when you were 2 or 3 years old, when the mechanics and terms of investing weren’t second nature to you. For many people, however, most of what they hear about personal finance sounds like blah-blah-blah.

It’s up to brokers, if they are consulted, to use simple, clear language and not to make stupid statements like “no-load funds do not exist.� That is indeed what our reader heard, and he was honestly wondering if it was true. If that makes him an idiot in your eyes, so be it.

I’ve heard the “misconception� argument before from brokers, and it’s not a compelling one. No-load funds aren’t the only ones with annual expenses; broker-sold funds tend to have significant ongoing charges as well. Indeed, smart investors look for funds with below-average annual costs, since all those fees cut into overall returns.

As for endorsing no-load funds, I’m happy to do so--for investors willing to take on the task of setting up and monitoring their own portfolios. I invest in no-loads myself and aim for funds with annual expense ratios below 1%.

People who need help with their portfolios may prefer to consult a broker. They will end up paying commissions in the form of loads to buy their funds. In exchange for paying those fees, they should get a broker’s help as well as straight talk about the role of commissions--not a lot of claptrap about misconceptions.