Tag: Retirement

Calculating Accurate Regulatory AUM Vs Reporting Assets Under Advisement (AUA)

Calculating Accurate Regulatory AUM Vs Reporting Assets Under Advisement (AUA)


In today’s increasingly competitive landscape for advisory firms, financial advisors are looking for any way they can to differentiate. Whether it’s their experience and credentials, specialization or depth of services, or simply the sheer size of the firm, based on its assets under management. After all, the reality is that – justified or not – a sizable reported AUM does imply a certain level of credibility and represents a form of social proof (the firm “must” be good, or it wouldn’t have gotten so much AUM, right!?).

As a result of this trend, though, advisory firms are increasingly pushing the line in counting – or potentially, over-counting – their stated assets under management. Which is important, because not only is overstating AUM a potential form of fraudulent advertising, but the SEC has very explicit rules to determine what should be counted as AUM (or not) for regulatory purposes.

Specifically, the SEC states in its directions for Form ADV Part 1 that regulatory AUM should only include securities portfolios for which the advisor provides continuous and regular supervisory or managementservices. And while most financial advisors today are regularly working with clients regarding their investment securities, not all advisors are necessarily providing “continuous and regular” services on their client accounts. In fact, if the advisor doesn’t have direct authority to implement client trades (either with discretion or after the client accepts the advisor’s recommendation), it’s virtually impossible to include the account as part of regulatory AUM.

The greater challenge, though, is that the increasingly common offering of comprehensive financial planning services – where advisors provide holistic financial planning advice on all of a client’s net worth – does notmean the advisor can claim all of those assets as regulatory AUM. In fact, most of the time the advisor should not include outside 401(k) plans and other non-managed assets that were advised upon as part of the financial plan, nor the value of brokerage accounts holding mutual funds and various types of annuities (unless the advisor truly provide ongoing management services), nor TAMP or SMA assets (unless the advisor retains the discretionary right to hire/fire the manager and reallocate to another one). In fact, even having discretion over an account doesn’t automatically ensure it being counted as regulatory AUM, particularly if it’s a passive buy-and-hold account, unless the advisor can actually substantiate that monitoring and due diligence is occurring outside of any ad-hoc or periodic client review meetings!

Fortunately, for advisors who want to report some number representing the total scope of their advice – including the amount of assets that don’t count as regulatory AUM – it is permissible to report on Assets Under Advisement (AUA) in the advisor’s marketing and in Part 2 of Form ADV, as long as the advisor can document and substantiate the calculation process. But the fact that it’s permissible to report both AUM and also a (typically large) AUA amount doesn’t change the fact that, when reporting regulatory AUM itself, it’s crucial to report the right number!

The Importance Of Regulatory Assets Under Management

It is a standard of the media, especially trade publications, to cite an advisory firm’s assets under management (AUM) when interviewing the advisor. In some cases, the size of the firm simply helps to provide context to the advisor’s comments (e.g., was he/she speaking on behalf of a “large” firm or a “small” one?). In other scenarios, though, the advisor’s AUM is used as an implied marker of credibility – the larger the advisory firm, the more “successful” it must be, and the more valid the comments “must be” of the advisor being interviewed.

The amount of an advisory firm’s assets under management also appears to have an implied credibility factor with consumers. In this regard, the concern for regulators is more substantive. To the extent that consumers might assume that an advisory firm with higher AUM has been more successful, or is a “safer” choice (more continuity), or might offer more services or have more resources because of its size, or simply rely on the firm’s size as “evidence” that it must be a good firm (how else would it have gotten so much AUM if it wasn’t!?), a misrepresentation of the firm’s AUM can amount to fraudulent advertising. Especially since industry benchmarking data suggests that more affluent clients really do tend to choose advisory firms with higher AUM.

And notably, a proper determination of AUM is also important for regulatory purposes, in a world where under SEC Rule 203A-1, “smaller” registered investment advisers with under $100M of AUM must file with state securities regulators, while “larger” firms reporting more than $100M of AUM may register with the SEC (and must register with the SEC within 90 days of reported regulatory AUM exceeding $110M, or must file Form ADV-W and revert back to state registration within 180 days if the firm falls below $90M).

Accordingly, the SEC strictly defines what actually constitutes “Regulatory” Assets Under Management (RAUM) for an advisory firm when it markets itself to the public, and requires these amounts to be reported directly into Item 5.F on Part 1 of the Form ADV filing.

5.F On Part 1 Of The Form ADV Filing

Defining Regulatory Assets Under Management (RAUM)

The SEC defines Regulatory Assets Under Management (RAUM) for the purposes of Item 5.F on Part 1 of Form ADV as “securities portfolios for which you provide continuous and regular supervisory or management services.”

The SEC’s supporting Instructions for Part 1 of Form ADV provide the definitions and explanations of the key phrases: “securities portfolios” and “continuous and regular supervisory or management services”.

An account is defined as a “securities portfolio” if at least 50% of the total value of the account consists of securities, where a “security” includes any stock, bond, Treasury note, swap or futures contract, or any other investment registered as such. For the purposes of this test, cash and cash equivalents (including bank deposits, CDs, etc.) are also treated as securities, as are all the assets in a private fund (including uncalled capital commitments for the private fund).

For most financial planners and wealth managers operating as an investment adviser, virtually all client accounts will likely be treated as securities portfolios. The more complex requirement, though, is determining whether the advisor provides “continuous and regular supervisory or management services” to that account.

The general criteria to determine whether the advisor is providing continuous and regular supervisory or management services on those securities portfolios are if either:

  1. a) the advisor has discretionary authority over the account and provides ongoing supervisory or management services with respect to the account; or,
  2. b) the advisor does not have discretion, but does have an ongoingresponsibility to make recommendations of specific securities based on the needs of the client, and if the client accepts the recommendation, the advisor is responsible for arranging or effecting the purchase or sale.

In other words, determining whether the advisor is providing continuous and regular supervisory or management services essentially boils down to: a) does the advisor provide ongoing management or advice; and b) is the advisor responsible for implementing the transaction (either with discretion, or once the client accepts the recommendation). Or as Tom Giachetti of Stark & Stark states even more simply: “If you can’t trade it, you can’t count it [as regulatory AUM]”.

Notably, though, while the ability to effect trades – either with discretion, or the client’s permission to implement a recommendation – is a fairly straightforward litmus test to determine if the advisor would not be able to count the assets as regulatory AUM, the ultimate determination still also relies on whether the advisor provides “continuous and regular” supervisory or management services. Which in practice is often far less clear cut.

To make the determination, the SEC prescribes three primary factors to consider: the terms of the advisory contract, the form of the advisor’s compensation, and the advisor’s actual portfolio management practices.

Terms Of The Advisory Contract. Does the advisor’s agreement with the client actually stipulate that the advisor is responsible for ongoingmanagement services (as opposed to a more limited scope or one-time engagement)?

Form Of Compensation. Being compensated based on assets being managed implicitly suggests that the firm is providing ongoing services with respect to those assets. Although being compensated by AUM fees is not a requirement, the SEC does note that simply charging hourly fees based on time spent with the client (which implies services aren’t ongoing outside the client meeting), or a retainer based on the overall net worth of the client or the assets “covered by” a financial plan (which implies the advisor isn’t being compensated primarily for asset management), suggests that the advisor’s focus is not on providing continuous and regular supervisory or management services.

Management Practices. To what extent does the advisor’s actual investment process demonstrate that continuous and regular management services are being provided? Clearly, ongoing trading activity would demonstrate ongoing services. Notably, infrequent trading (e.g., a buy-and-hold strategy) does not automatically mean the advisor isn’t providing continuous and regular services, but it does create an additional burden on the advisor to substantiate what, exactly, is being done on an ongoing basis to substantiate that the assets are actually being supervised or managed.

In fact, the SEC explicitly notes that advisors who make an initial asset allocation recommendation, but don’t do continuous and regular monitoring and help implement reallocation trades, would not be providing continuous and regular services (and thus cannot count those client assets as regulatory AUM). Nor would just providing trading recommendations (e.g., what to buy or sell) without any ongoing management responsibilities, or providing impersonal (not-client-specific) investment advice (e.g., via a market newsletter).

Similarly, the SEC states that merely providing advice on an intermittent basis (e.g., upon client request), or on a standard periodic basis (e.g., quarterly or annual meetings to review the account and make adjustments), are not continuous and regular management services. In other words, even meeting with clients “regularly” on a quarterly basis is not continuous and regular asset management; the advisor must also substantiate that due diligence monitoring and other management services are occurring between the quarterly (or less frequent) meetings as well!

On the other hand, it’s also notable that continuous and regular services can be in a supervisory capacity, and not necessarily a hands-on management role. Thus, having discretionary authority to allocate client assets amongst various mutual funds (which in turn have their own managers) may still allow those assets to be treated as regulatory AUM. Similarly, using third-party managers (e.g., via a TAMP or SMA) and operating as a “manager of managers” is also permitted, but only if the advisor retains discretionary authority to hire and fire those managers and/or to reallocate assets amongst them. (If the advisor doesn’t have discretion to hire and fire the third-party managers without the client’s permission, or to reallocate amongst the third-party managers, though, it isnot regulatory AUM!)

Calculating The Total Amount Of Regulatory AUM

Once it is affirmed that the advisor is providing continuous and regular supervisory or management services, and the client accounts do constitute “securities portfolios”, it’s time to actually add up the amount of assets under management.

In this context, the advisor should still only include accounts (or portions thereof) for which the advisor actually provides continuous and regular supervisory or management services – i.e., even if the advisor meets the rest of the requirements, the holdings of a securities portfolio that aren’t continuously and regularly monitored or supervised aren’t included in the AUM calculation. On the other hand, as long as they’re otherwise managed, advisors should include any family accounts, proprietary accounts, or even accounts for which the advisor is not directly compensated (e.g., “house” accounts).

When reporting the calculated amount of regulatory AUM on Form ADV (or for filing the annual ADV update or an “other than annual” ADV amendment), assets should be reported based on their fair market value, using values calculated within 90 days prior to the filing of the ADV (or update). Fortunately, while the SEC does provide substantial latitude to the advisor in determining what is a “reasonable” estimate of value – which is straightforward for market-traded securities, but can be more challenging for infrequently traded or illiquid assets. However, the SEC does expect that the advisor is consistent in using the same values for AUM calculation purposes that are used to report values to clients (e.g., in quarterly or annual portfolio statements) and when calculating the advisor’s own fees.

Notably, when determining total AUM, the SEC directs investment advisers to calculate regulatory assets under management without reduced the value by any indebtedness associated with the account (e.g., margin loans or other securities-based loans). In other words, regulatory AUM is calculated based on the advisor’s gross assets under management (including securities purchased with borrowed amounts), not the net value of the accounts! (From a regulatory perspective, the requirement to use gross assets, and including such a wide range of assets, was intended to prevent advisors from excluding assets to try to stay below the thresholds for registration and reporting systematic risk requirements after Dodd-Frank.)

Determining Whether RIA Assets Count As Regulatory AUM (OR AUA)

Common Mistakes And Pitfalls For RIAs Calculating Regulatory AUM

With recent high-profile fraud cases like Dawn Bennett, the SEC appears to be increasingly scrutinizing whether investment advisers are accurately stating their AUM. And notably, the whole purpose of determining regulatory AUM isn’t just to report it on Form ADV, but that “regulatory” AUM is the only AUM that an advisor should claim as such. Whether that’s in Part 1 of Form ADV where asked, or the matching amount in the ADV Part 2 brochure, or on the financial advisor’s website or other marketing materials.

But in practice, it appears that the most common problems are not the “straightforward” scenarios of deliberate fraud – where an RIA knowingly overstates its regulatory AUM. Instead, it’s situations where the advisor unwittingly overstates AUM by failing to properly exclude assets/accounts that don’t actually meet the requirements for inclusion as regulatory AUM.

For instance, common mistakes and pitfalls when determining AUM includes counting:

All investments in all accounts, without segregating out non-managed accounts that might happen to be included in the advisor’s portfolio accounting software (but aren’t actually accounts receiving continuous and regular management services from the advisor, and therefore shouldn’t be counted).

All investments in a hybrid advisor’s book of business, without recognizing that the brokerage assets, for which the advisor doesn’t have an advisory agreement nor discretion, should not be counted as regulatoryAUM. In other words, a hybrid advisor that has $20M in C-share mutual funds in a brokerage account (and receives a 1% trail) who also has $30M in advisory accounts under a corporate RIA should only be reporting $30M in regulatory AUM, and not $50M. Generally, if there is no discretion with the client, and no ongoing advisory agreement to substantiate continuous and regular services with the client (which typically isn’t the case for brokerage accounts), the mutual funds, variable annuities, etc., probably should not be counted as (regulatory) AUM!

– Fixed annuities, along with fixed-indexed annuities, which are not counted as securities at all, and therefore should not be included when discussing the advisor’s regulatory AUM.

– TAMP or SMA assets where the advisor may have recommended the third-party manager, and may be paid an AUM fee, and may have implemented a “discretionary” account because the third-party manager has discretion… but the advisor doesn’t have discretion to hire/fire/change third-party managers, which renders the accounts/assets ineligible to be counted as regulatory AUM.

– The value of “outside” 401(k) plans on which the advisor provides investment recommendations, but doesn’t actually provide ongoing and regular management services because the advisor doesn’t actually have the authority or capability to effect trades (because the advisor doesn’t control or have access to the account). Notably, if the advisor has login credentials to the client’s account, and can effect trades, the assets may be included in regulatory AUM… but having access to client login names and passwords for third-party accounts could trigger custody under Rule 206(4)-2!

– Assets for which the advisor is a consultant – e.g., in the case of working with institutional clients as a plan consultant or advisor to the investment committee – but where the advisor doesn’t have discretion and/or cannot implement the trades. Just because the advisor gives advice regarding those assets, doesn’t mean they can be claimed as assets under management!

– Otherwise discretionary assets that are bought and held, and only reviewed when clients come in for periodic review meetings. While the definition of regulatory AUM is not limited to “just” active managers, if a passive advisor wants to substantiate regulatory AUM, it’s necessary to share that there is an ongoing supervisory due diligence process to monitor client accounts and the underlying investments all year long, not just at review meetings!

– Assets for which advice is given on an ad-hoc basis as part of an hourly or financial planning retainer agreement. Notably, the mere fact that advice is being charged for on an hourly or retainer basis does not automaticallydisqualify the assets from being considered as regulatory AUM. But if the advisor is only charging for client-facing time, and no other time, it implicitly demonstrates that the advisor is not engaging in continuous and regular supervisory or management services. And in the case of a retainer-based advisor, it’s not enough to just show ongoing fees and regular client meetings; again, as in the case of a passive advisor, it’s also necessary to show what monitoring, supervisory, and/or management services are being provided on an ongoing basis as well.

Regulatory AUM Vs Financial Planning Assets Under Advisement (AUA)

In recent years, the growth of financial planning has increasingly broadened the scope of assets on which financial advisors provide advice. As a result, it’s now increasingly common for advisors to provide advice about the client’s entire net worth, and all of his/her assets (and liabilities), including both the accounts that the advisor manages, and those the advisor merely “advises” (and financial plans) upon.

Nonetheless, assets on which the advisor merely advises and includes in the financial plan are not assets under management for regulatory purposes – which means they should not be claimed as assets under management at all.

As an alternative, though, a growing number of advisory firms are also claiming “assets under advisement” – or AUA – which includes the value ofall assets that are touched by the advisor/client relationship. This would include most of the various assets discussed earlier that are part of the client’s household net worth but not eligible for being counted as regulatory AUM. In the broadest of situations, AUA might simply include the total net worth of all clients for which the financial advisor does financial planning or otherwise provides advice.

Fortunately, the SEC does permit advisors to describe, in Item 4 of the Part 2 Form ADV brochure, their assets under advisement. (The SEC never directly uses the term “assets under advisement”, but it does permit advisors to compute the “client assets managed” in a different manner than “regulatory assets under management”.) However, if the advisory firm does report AUA (or some other alternative approach to calculating “managed” assets, it should be done separately from (i.e., in addition to) regulatory AUM, and the RIA should keep documentation describing the methodology used to calculate AUA and substantiating the total amount reported. (Which in turn should be kept for 5 years, as part of the general requirement for retention of books and records under Rule 204-2.)

Of course, if more and more advisory firms begin to report their AUA in addition to their AUM – which seems likely, given both the temptation to report what will typically be a larger asset AUA amount for marketing purposes, and the shift of financial advisors to more holistic financial planning where advice really is given on a wider range of assets – it seems only a matter of time before regulators intervene to more strictly define the calculation of Assets Under Advisement (AUA) as well. For the time being, though, the SEC (and state securities regulators) are providing more latitude to RIAs to calculate and report their own AUA (as long as the methodology is disclosed and the amount can still be substantiated). But even with AUA being permitted, it’s still crucial for financial advisors to actually report it as such, and not overstate their regulatory AUM instead!


Can I Still Contribute to an IRA – Even if I Don’t Get a Tax Break?

Can I Still Contribute to an IRA – Even if I Don’t Get a Tax Break?

Let’s start by reviewing the basics about traditional IRAcontributions, and about the income limits that apply to them.

First, it’s important to understand that, unlike Roth IRAs, the IRS income limits for traditional IRAs apply only to the tax deductibility of traditional IRA contributions.


That is the answer to the main question.

You can contribute up to $5,500 per year, or up to $6,500 per year if you are age 50 or older. What’s more, if your spouse is not employed outside the home and does not have a retirement plan, you can also set up a spousal IRA. That will enable you to make matching contributions to a traditional IRA for him or her, even though he/she has no income.

But let’s get back to those income limits…

The 2017 income limits for tax deductible contributions to a traditional IRA if you ARE covered by an employer retirement plan are:

  • Married filing jointly – fully deductible up to $99,000; phased out between $99,000 and $119,000; not permitted at $119,000 and above
  • Single or head of household – fully deductible up to $62,000; phased out between $62,000 and $72,000; not permitted at $72,000 and above
  • Married filing separately – deduction phased out between 0 and $10,000; not permitted at $10,000 and above

If you are not covered by an employer retirement plan, but your spouse is, you can take a deduction for a traditional IRA up to the following income limits:

  • Married filing jointly – fully deductible up to $186,000; phased out between $186,000 and $196,000; not permitted at $196,000 and above
  • Married filing separately – deduction phased out between 0 and $10,000; not permitted at $10,000 and above


The contribution however will not be tax deductible. But that doesn’t mean you shouldn’t make a contribution anyway.

In fact, it’s an excellent strategy for a number of reasons…

Retirement Investment Diversification

Having an IRA, in addition to an employer-sponsored plan, is an excellent way to diversify your retirement investments. At a minimum, it will enable you to have more than one retirement plan, which should increase the types of investments that you have.

This is especially important since many employer plans limit your investment options. For example, they may give you a choice between a handful of mutual funds as well as company stock.

But with a self-directed IRA, you can literally have unlimited investment options. The IRA will give you the ability to invest in assets that you cannot hold in your employer plan.

Tax Diversification in Retirement

A nondeductible IRA can provide you with a certain amount of tax-free income in retirement. The investment income that you earn in plan will be tax-deferred, and will therefore be taxable when you begin taking distributions. But since your contributions were not tax-deductible, they will represent tax-free distributions in retirement.

For example, let’s say that you contribute $5,500 to a nondeductible IRA each year for 10 years. At the end of that time, the account is worth $100,000, comprised of $55,000 in contributions, and $45,000 in investment income.

If you were to withdraw $10,000 per year in retirement, $4,500 would be taxable income, but $5,500 – which represents your pro rata nondeductible contributions – will be tax-free.

That strategy will provide you with at least some income in retirement that will not be taxable. That’s tax diversification in retirement.

Making Your Retirement Portfolio Even Bigger

You can save up to $18,000 per year in a 401(k) plan. But if you also save an additional $5,500 in an IRA, you’ll have $23,500 going toward retirement each year. If you are in a position that you can afford to make such contributions, it can really supercharge your retirement planning. It might even open up the prospect of early retirement.

Looking at it from another direction, the strategy also offers the opportunity to increase retirement savings if you are over 50 and don’t have much saved. That’s because both 401(k)s and IRAs have a “catch-up” provision. At 50 or older, 401(k) contributions can be as high as $24,000 per year. IRA contributions can be as high as $6,500.

If you are 50 or older, he can save up to $30,500 per year – $24,000 + $6,500 – toward his retirement. That kind of savings can build up a retirement plan in no time at all.

Setting the Stage for a Lower Tax Roth IRA Conversion

This is another underappreciated reason for doing nondeductible contributions to a traditional IRA. Roth IRAs provide an opportunity to have tax-free income in retirement. They are funded with nondeductible contributions, and the earnings accumulate on a tax-deferred basis. But when you turn 59 1/2, and if you have had your Roth IRA for at least five years, you can take distributions of both your contributions and investment earnings completely tax-free.

The tax-free benefit is the reason why so many people do Roth IRA conversions. That’s the process of converting other retirement plans – 401(k)s, 403(b)s, 457s and traditional IRAs – into Roth IRAs. In doing so, you convert other retirement savings that would produce taxable distributions in retirement, to the Roth IRA, which will provide tax-free distributions.


But the exception is if you have made after-tax contributions, such as those made to a nondeductible traditional IRA. Since no tax deduction was taken on the contributions, there will be no income tax due on that portion of the conversion.

Let’s take another look at earlier example, of a $100,000 traditional IRA that is comprised of $55,000 in nondeductible contributions, and $45,000 in accumulated investment income.

If you were to do a Roth conversion on that account, only the $45,000 that makes up the accumulated investment portion will be subject to income tax. There’ll be no tax consequences on the $55,000 in nondeductible contributions.

If you were in the 25% federal tax bracket, and you converted $100,000 in retirement assets to a Roth IRA, you’d have to pay $25,000 in federal income tax. But if that plan includes nondeductible contributions of $55,000, the tax bite would be only $11,250 ($45,000 X 25%).

Just as important, if the full $100,000 was taxable, it would probably also push you into a higher tax bracket, resulting in an even larger tax liability. That will be less likely to happen with a traditional IRA which includes nondeductible contributions.

So in a real way, setting up a traditional IRA with nondeductible contributions really sets the stage for a lower tax Roth IRA conversion.

But Hold On – You May Be Able to Do Direct Roth IRA Contributions!

This strategy wasn’t part of Anup’s question, but it may be important for Anup or for other readers who are in this situation. That is, even if you exceed the income limits for deductible traditional IRA contributions, you may still be able to make Roth IRA contributions.


There is a “window” in the income limits between deductible traditional IRA contributions and Roth IRA contributions.

Consider the following…

The Roth IRA income limits for 2017 are:

  • Married filing jointly – fully allowed up to $186,000; phased out between $186,000 and $196,000; not permitted at $196,000 and above
  • Single, head of household or married filing separately but you DON’T live with your spouse – fully allowed up to $118,000; phased out between $118,000 and $133,000; not permitted at $133,000 and above
  • Married filing separately but you DO live with your spouse – phased out from 0 to $10,000; not permitted at $10,000 and above

Notice if you’re married filing jointly, you can make a Roth IRA contribution up to an income of between $186,000 and $196,000. But you can make a deductible traditional IRA contribution at an income level of only between $99,000 and $119,000, if you’re married filing jointly, and you’re covered by an employer retirement plan.

Do you see where I’m going with this? If your income is higher than $119,000 – and you can no longer make a tax-deductible traditional IRA contribution – you can still make a Roth IRA contribution if your income does not exceed $186,000.

So let’s say Anup is earning $160,000. Since he is covered by a 401(k) plan at work, he can still make a contribution to a traditional IRA, but it won’t be tax-deductible.


Why should he do that? Well, for starters, at that income level, neither a contribution to a traditional IRA nor a Roth IRA will be tax-deductible. And both will allow tax-deferred investment income accumulation. But the difference is that with the Roth IRA, a person will be entitled to tax-free withdrawals in retirement.

So if you are in that income limit “middle ground” between a tax-deductible traditional IRA contribution and a Roth IRA contribution, you should make a contribution to the Roth IRA instead.

That will also prevent the need to do a costly Roth IRA conversion later.

Thus this was an excellent question! It gives us a chance to take a look at something that seems simple on the surface, but has a lot of potential for better options when you consider it from all angles!

Anti-Money Laundering (AML) Rule Looms For Advisers

Anti-Money Laundering (AML) Rule Looms For Advisers

While most regulatory focus over the past year has been on the Department of Labor’s fiduciary rule, back in mid-2015 the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) proposed that anti-money-laundering (AML) provisions be extended to cover independent RIAs, which would include a requirement for RIAs to establish policies and procedures to identify “suspicious activity” and designate a compliance officer to oversee the program… along with conducting employee training, and even obtaining an independent audit to affirm the process is being executed appropriately. And while much of President’s Trump focus so far has been on rolling back regulations, the administration’s regulatory freeze memo had an exception for areas implicating national security or financial matters, which would leave the way clear for FinCEN to proceed with a new rule (given that money laundering can otherwise potentially be used to finance terrorism). At this point, the public comment period on the AML proposals has already closed, and FinCEN is ostensibly working on a proposed rule that might be issued in the year or two (there is no concrete timeline yet). As a result, it remains to be seen how the AML procedures might actually apply to RIAs, and whether there may be exceptions for smaller RIAs and/or those relying primarily on third-party custodians. Nonetheless, given that broker-dealers and banks have long been subject to AML regulations, it seems increasingly likely that something will ultimately apply to RIAs as well, and become part of what the SEC reviews when examiners visit an RIA firm in the future.

Why Congress Should Allow Financial Planning Fees To Be Paid From A Retirement Account

Why Congress Should Allow Financial Planning Fees To Be Paid From A Retirement Account

Current Rules On Paying Financial Planning Fees From A Retirement Account

While the rules are fairly straightforward for deducting investment advisory fees paid from a taxable account (treated as a Section 212 expense which is claimed as miscellaneous itemized deduction and limited to a 2%-of-AGI floor), there are more rules to consider when paying advisory fees from a retirement account.

Because ongoing investment advisory fees are Section 212 expenses underTreasury Regulation 1.404(a)-3(d), they can be paid directly from a retirement account without being treated as a taxable distribution or subject to early withdrawal penalties.

However, it is crucial to note that a retirement account only pay its ownretirement-account-related expenses. Unlike a taxable account, which can pay advisory fees for a retirement account without being deemed a constructive contribution, retirement accounts that pay the fee of a taxable account would be treated at least as a taxable distribution (with potential early withdrawal penalties as well). At worst, though, such an IRA expenditure (on behalf of an outside account) could be treated as a “prohibited transaction” under IRC Section 408(e)(2) and IRC Section 4975, which can trigger a penalty tax of up to 100%, plus disqualify the retirement account altogether (i.e., be treated as though the entire retirement account has been fully distributed for tax purposes).

And the risk of paying non-IRA expenses with IRA dollars isn’t just limited to paying outside advisory fees. Paying financial planning fees would also be treated as a prohibited transaction, since they aren’t considered Section 212 expenses, because they don’t pertain directly to the collection of tax or the production of income. In the extreme, this can potentially even cause an issue with “bundled” investment advisory and financial planning fees, at least if the financial planning portion of the fee is a material component – again risking a prohibited transaction that incurs both the penalty tax and disqualifies the account. At best, even if it avoids prohibited transaction treatment, using IRA assets to pay a financial planning fee would be deemed a (taxable) distribution for the dollar amount of the fee.

Why Financial Planning Fees Can't Be Paid From A Retirement Account

Why It’s Behaviorally Appealing To Pay Financial Planning Fees From Retirement Accounts

One key insight of behavioral economics is that we aren’t fully rational when it comes to how we mentally account for our assets. In theory, household resources are fungible, and a dollar is a dollar, regardless of whether it came from the household’s most recent paycheck, a savings account, or a retirement account. However, real people don’t behave this way.

Shefrin and Thaler’s mental accounting framework finds that people tend to categorize their wealth across three broad buckets: current income, current assets, and future income (i.e., the assets that will support and fund future income). We have a tendency to treat these buckets differently, even if their financial value is fungible. Our propensity to consume is typically highest for current income (e.g., income and cash in a checking account), somewhat lower for current assets (e.g., investment accounts associated with shorter-term goals and less liquid assets such as home equity), and even lower yet for future income (e.g., dedicated retirement savings).

Propensity To Consume By Mental Account

In addition to our general propensity to consume varying by mental account, we also apply both time and category constraints (i.e., budgets) within our various mental accounts .  For instance, when deciding whether or not to buy coffee from a “current income” mental account, we may also ask ourselves whether doing so would violate category (e.g., only spend a certain amount on food) or time-based (e.g., only spend a certain amount this month) spending constraints. Yet, these categorical associations may vary across accounts. Buying coffee from “current income” may seem perfectly normal while buying coffee with funds from a 401(k) would likely violate our categorical associations for a “future income” account (at least for those in the accumulation stage).

Thus, one benefit of paying for financial planning services from a future income account is that the two are categorically connected, given that financial planning typically pertains to long-term planning (including future income in retirement itself). In contrast, paying $1,500 for a financial plan out of current income is more challenging, because it violates most of our categorical associations for monthly income, as financial planning isn’t something most think of as an “ordinary” monthly expense.

Another benefit of paying for financial planning from a future income account (e.g., retirement account) is that it can be a less salient transaction. By contrast, the traditional way of paying financial planning fees – from current income or assets – makes it more susceptible to the bottom dollar effect, increasing the potential psychological cost associated with the purchase. In other words, $1,500 financial planning fee “feels” like a bigger expense when we see it come out of our checking account than when it comes out of a future income account, and we notice it more when we have to actually write the check from our current income or assets. Which can be particularly problematic given that competition for our current income is fierce, and an intangible and hard to evaluate service like financial planningtypically isn’t going to stack up well, as there are always more tangible goods and services which can provide more immediate satisfaction.

In fact, these dynamics go a long way to help explain how financial planning is typically paid for today – as an AUM fee from future income accounts.Planners focusing on hourly planning and retainers have seen limited adoption so far, likely because they rely on paying for financial planning from a current income mental account. Though, of course, consumers with little long-term savings may have no other choice.

Why It’s Problematic That Financial Planning Fees Can’t Be Paid From Retirement Accounts

As noted earlier, the AUM model has many great behavioral characteristics for those who have substantial assets), but a 1% AUM fee (and the minimums it often necessitates) unfortunately puts financial planning services out of reach for many. While companies like Schwab and Vanguard are demonstrating that a certain level of fiduciary advice can be provided to consumers with modest assets on an AUM basis, these models may not work for clients who want more local, personalized, one-on-one financial advice, especially with an emphasis on coaching and facilitating behavioral change in order to achieve financial goals. While not an intentional feature of our current tax laws, the inability for those with modest resources to purchase comprehensive financial planning services with their future income assets does, unfortunately, exacerbate inequality in access to financial advice.

For instance, a consumer with a $1,000,000 IRA has the ability to pay $10,000 or more annually for professional financial planning services from their future income assets. Yet, as discussed earlier, a consumer with a $10,000 IRA isn’t allowed to pay a one-time financial planning fee of $1,000, even though the less wealthy consumer may benefit as much, if not more, from financial planning services. That’s not to say that more is always better when it comes to purchasing financial services—it’s not—but the gap between what the wealthy and non-wealthy are allowed to spend from their future income buckets for financial advice is substantial.

Manageable retirement assets may be small or nonexistent because consumers are young and haven’t saved much yet, older and have struggled to make progress with their saving, or simply because their savings are all locked up in an employer-sponsored plan. But regardless of the reason, the only remaining option is for fees to be paid from current rather than future income, which, for reasons noted above, many consumers find unsatisfactory.

Further, these problems may persist regardless of household wealth or income. In a 2016 study of household spending based on data from a financial aggregation app, researchers found evidence that even households with sufficient savings and cash holdings live “hand-to-mouth”, consistent with the idea that these cash holdings have already been mentally earmarked for some other purpose (e.g., a cash cushion for unforeseen expenses or shocks to income). Therefore, even a household with a $20,000 cash reserve may feel like they can’t afford a $1,500 financial plan. They may feel this way because their current income is too tight to absorb a sudden $1,500 expense, and their $20,000 cash reserve is mentally earmarked for contingencies that would not include hiring a financial planner.

If the aim of public policy is to promote consumer and societal well-being, then we should ask ourselves how various policies may impede or facilitate those goals. Utilizing data from the National Longitudinal Survey of Youth, Michael Finke and Terrane K Martin Jr. found evidence of improved financial outcomes for those who work with a comprehensive financial advisor, though not those who work with an investment specialist. Studies by Morningstar and Vanguard have similarly affirmed the value of comprehensive financial planning advice (beyond “just” investment advice). If it is the case that working with a financial planner can improve financial outcomes, then it’s important to make it easy for consumers to pay for those services from the desired mental accounts.


Perhaps to the chagrin of some fee-only advisors, it’s worth acknowledging that loaded A-share mutual funds actually have many positive behavioral characteristics as a means to pay for financial advice. And in some cases, A-shares have actually facilitated access to project-esque planning services paid for out of future income buckets, because clients who may not be willing to pay $1,500 for a financial planning project out of their current income may be willing to pay a 6% commission on a $25,000 retirement account. By contrast, if the only option was a levelized AUM fee, the advisor’s minimum might have to be higher than that $25,000 account, limiting access to advice for the consumer who can’t pay the financial planning fee from current income.

In other words, the claim that A-shares provide a means to effectively serving certain client segments is not entirely dubious. However, the reason why A-shares are effective is not because inherently conflicted product sales are needed to reach these clients, but rather because A-shares provide the only means for clients with modest resources to pay for services with their future income assets. Nonetheless, the fact remains that some advisors may currently feel “forced” to rely on commissions, just to serve a clientele who can only afford financial planning from retirement accounts, and commissions are the only way to make those accounts “liquid” enough to pay the fee!

Clearly, this is not an ideal mechanism to facilitate the payment for advice, as the conflicts of interest introduced through the sale of mutual funds and other investments with large upfront commissions are problematic (and particularly when those who sell the investments don’t actually intend to provide much financial advice anyway). On the other hand, what is often vilified as an “unreasonable” commission for a standalone sale (e.g., 5-6% front-end load) might, in fact, be very “reasonable” compensation for broader financial planning services that were actually delivered and paid for by that commission.


Given these dynamics, arguably it’s time to revisit the control and flexibility that consumers are provided over their future income buckets, as “forcing” compensation through commissions just to pay for advice from a retirement account is not ideal – and particularly for those who need substantial advice and have very modest retirement accounts.

Example. A young graduate has accumulated $1,000 in a 401(k), but is buried in student loan debt and about to switch jobs. He would like to get a basic financial plan for $1,000, but doesn’t have the available cash in his checking accout, and thus would “have to” use his retirement account to pay for advice.

Arguably, paying a planning fee equal to 100% of a modest account balance may very well be a better use of those funds than parking it in an S&P 500 index fund for the next 40 years. Getting out of debt, learning to budget, and developing good financial skills at a young age are all tremendously valuable. Sure, that $1,000 may turn into $20,000 or so by retirement, but establishing a solid plan early in life is likely worth a lot more than $20,000 come retirement. This is particularly true if a financial planner can help meaningfully change an individual’s income and career trajectory. Unfortunately, though, trying to use the funds in a retirement account would trigger taxes and an early withdrawal penalty at best, or a prohibited transaction at worst!

Fortunately, there are many ways that consumers could be given more control over their future income buckets. One simple solution is to allow consumers to write checks or transfer funds to licensed financial advisors from their retirement accounts.

From a regulatory perspective, this would necessitate clarifying and substantiating which financial advisors are actually providing financial planning advice and which are simply making investment recommendations or selling investment products (which is arguably an important clarification for consumers, anyway!).

Another option to facilitate paying for financial advice from retirement accounts is to give consumers greater flexibility to roll money out of employer-sponsored retirement plans. This actually has the dual benefit of making employer-sponsored plans compete harder to maintain participant dollars, while also providing flexibility for those who feel they may benefit from working more directly with a professional. An effective alternative may be a system that operates more similar to how Health Savings Accounts (HSAs) work today, where most employees stay with the employer selected plan, but flexibility does exist, including the flexibility to transfer the assets and hire an advisor.

Other avenues for a financial advisor to be compensated through employer-sponsored plans are an option as well. For instance, employer-sponsored plans could be permitted to add portals which allow advisors to access, manage, and be paid for their services – including the non-taxable (and non-prohibited) withdrawal of a financial planning fee without the need for any rollover. Some may object that advisors have little opportunity to add investment alpha through this type of arrangement, which may be true, but as noted above, the primary benefit would be allowing consumers to utilize their future income resources to pay for financial planning services such as behavioral coaching, tax planning, and other higher impact value-adding services that advisors provide.

Though, perhaps the simplest approach would simply be to modify IRC Section 212 to recognize financial planning fees, along with fees for tax preparation and the management of property, which would allow financial planning fees to be deductible when paid from an after-tax account and to be paid pre-tax from a retirement account (with perhaps a complementary safe harbor under the Section 4975 prohibited transaction rules to make it clear that a “comprehensive” financial planning fee that goes beyond the retirement account doesn’t disqualify the account).

Ways To Guard Against Abuse

A skeptical reader may suspect that all of this talk about mental accounting is just an attempt to rationalize new revenue opportunities for the financial planning industry. It’s fair to acknowledge that what economists refer to as “rent-seeking” is a legitimate concern (e.g., industry members seeking regulatory policies that further their interests at the expense of consumers or competing firms), but it shouldn’t be assumed that what’s good for advisors is necessarily bad for consumers. With some safeguards in place, it is possible that both advisors and consumers could benefit from consumer ability to pay financial planning fees from retirement accounts.


Planning-related “churning” – charging a high volume of ‘unnecessary’ fees for superfluous advice – is one potential concern that could arise from increased ability to pay planning fees from a retirement account.

To guard against this, time- or dollar-based restrictions could be put in place regarding distributions to pay planning fees. For instance, a consumer may be limited to one project engagement over a certain dollar limit every 12-months. Additionally, an annual fee limit for distributions paid towards retainers or other ongoing engagements could be put in place, akin to the “maximum” level of deduction or credit applied to many other tax preferences under the Internal Revenue Code. However, to avoid the problem of cutting those without substantial assets off from using their future income assets to engage a professional (as is currently the case with AUM), these guidelines would ideally provide reasonable flexibility.

For instance, instead of just a flat dollar amount or percentage-based limits, the rules could establish some fixed guidelines as well as more dynamic ones. For instance, annual distributions could be limited to the greater of $5,000 or 2% of assets. A $5,000 plan should be more than enough to get most average consumers a solid financial plan, while those who need more than $5,000 worth of planning would likely be eligible for higher limits under the 2% of assets guideline.

Interestingly, A-shares again provide a real-world example of some attractive compensation dynamics. The structure of A-share compensation implicitly acknowledges that higher percentage based fees are reasonable for smaller accounts, reasonable fees should decline as a percentage of the account as the account gets larger (as A-share typically have breakpoints at higher asset levels), and larger one-time fees should be subject to greater scrutiny for transactions that are excessive in frequency.


Notably, one of the biggest potential risks of making it easier for retirement accounts to pay financial planning fees is that, similar to commissions and even some AUM fees, some consumers may take on high-cost providers without fully realizing what they’re actually paying.

Richard Thaler’s “Smart Disclosure” framework provides an opportunity to make disclosures more meaningful and help consumers become more aware of what they are paying. If consumers received a standardized summary of fees at the end of the year – both for investment management, and financial planning – they could use these fee disclosures to evaluate what they are paying relative to the fees experienced by other consumers. Ideally something similar to Thaler’s “Choice Engines” would exist to help consumers make use of their standardized disclosure and evaluate alternatives.

Ultimately, the reality is that there is a lot of room for improvement in addressing the behavioral dynamics associated with the mental accounting of paying for financial planning services.

Our current tax framework allows advisors to be compensated for few of the services found to be truly value adding – like financial planning – yet explicitly permits compensation for a service (investment management) that is rapidly being commoditized and has not been shown to add value. Notably, in practice, most advisors actually bundle services in a way that confounds what they get paid for and what they actually do for clients, making any clear delineation of what consumers are actually valuing and paying for difficult, but at some point, the IRS may catch up to industry practices and realize there is a significant opportunity to enhance consumer well-being by allowing consumers to use their funds to pay for services beyond investment management!

Facilitating healthy financial behaviors not only benefits consumers directly but society more generally. By adopting more innovative tax rules to allow retirement accounts to pay for both investment management and financial planning services, regulators and policy makers can better incentivize financial advisors, while also giving consumers more opportunities to enhance their long-term financial well-being in a manner that aligns with their natural inclinations for financial decision-making.

The Coming Armageddon Of Annuity And Mutual Fund Share Classes

The Coming Armageddon Of Annuity And Mutual Fund Share Classes

Because of these fiduciary dynamics, I think we’re about to see a total collapse in the confusing number of share classes that exist today in the mutual fund and annuity arenas. At least, once DoL fiduciary actually goes through. I know it’s still up in the air about whether it’s just going to get delayed. But it currently looks like even if it does get delayed, it’s probably going to be modified or softened a little bit, but not necessarily repealed or rescinded. And as long as that core fiduciary requirement remains, every share class besides the cheapest one will quickly become irrelevant. Or become a lawsuit waiting to happen!

My guess is that we’ll find within just a year or two, mutual funds are probably going to come down to maybe two share classes. T shares for those that still do some kind of upfront commission business – so they can still get paid their 2.5% commission – and then some kind of institutional class advisory share, such as an I share or an F-3 share in the case of American Funds… with no commissions, no 12b-1 fees, and no sub-TA fees. The cheapest version of the raw investment that you can get, and then the advisor layers their advisory fee on top as appropriate. Because, if it’s meant to be an advisory share class, it’s virtually assured to be a fiduciary breach to use a share class with all of those additional costs when there’s an alternative that doesn’t have them.

Again, this doesn’t necessarily mean a collapse in advisor compensation, because you can still use advisory accounts with institutional share classes and charge your own advisory fee, instead of getting paid, say, 1% through C shares. And at least for some period of time, I suspect we’re going to continue to see T shares in place as well.

But I do think we’re going to see A shares quickly vanish in lieu of T shares. I also think we’ll see C shares quickly vanish in lieu of institutional class shares. And I think we’ll see similar scrutiny on retirement share classes and 529 share classes. Variable annuities will probably also come down to a core of two alternatives: one with a moderate upfront commission, and the other one that’s simply a fee-based contract.

It’s worth noting that the share classes probably aren’t going to vanish right away, in part because while DoL fiduciary is the catalyst that drives this, it still only applies to retirement investors. Which means, it only applies to retirement accounts, and advisors will still be able to use all those other share classes in non-retirement, taxable investment accounts, as well as for nonqualified annuities. But ultimately, I think it’s only a matter of a few years before eventually the SEC acts with its own fiduciary rule – if only to bring parity to the DoL fiduciary rule and get a level playing field. Then, the same rules really will apply for retirement and taxable accounts.

And there have already been a lot of broker-dealers saying they’re putting their changes in compensation in place uniformly across the whole platform now. As a result, the share classes that’ll be available are going to be the same for both DoL fiduciary retirement accounts and the rest. Because, otherwise, you’re kind of begging for a lawsuit against you if a lawyer ever sees that the client’s non-retirement accounts have more expensive versions of the exact same fund that you’re already using in their retirement account in a lower-cost alternative. For your own protection, it behooves you to be consistent across the board!

Which means, I think it’s only a matter of time (and it may not even take that much time), to see a total collapse in the huge number of share classes that exist today. Fund companies that have 16 share classes will probably be down to probably just two: a version with some upfront commission for brokers who sell them – like the new mutual fund T shares – and then the lowest-cost possible institutional or advisory share class, where the advisor would be expected to layer their own advisory fee on top.

Which, effectively, will complete our transition from getting paid 1% as levelized commissions, into getting paid 1% as an advisory fee for advisory services – in essence, the shift from being brokers who sell products, into advisors who actually sell advice.

In any event, I hope this provides some food for thought about how the proliferation of mutual fund and annuity share classes that has been underway for the past decade is probably soon going to go through a very sharp reversal and decline!

How to Improve Your Finances with Personal Financial Statements

How to Improve Your Finances with Personal Financial Statements

How often do you sit down to review your finances? Not just taking a glance at your latest statement looking for fraud, but really sitting down and analyzing your income, spending, savings, investments, and whether or not you are on track to meet your financial goals? If you are like most people, the answer is not very often. In fact, some people never take the time to understand their finances. They just complain and react without taking time to set goals and make a plan to achieve them.

As a Senior Financial Analyst at a Fortune 500 company, I spent my days doing this for $1 billion+ product lines to ensure we were on track to reach our goals for product profitability. If you want to reach personal profitability, you should look at your finances like a business. Read on to learn about three common financial statements and how you can use them in the pursuit of personal finance success.

Income Statement

For personal finances, one of the most important tools you have is a budget. Your budget isn’t a restriction on what you spend, it is a tool to plan for your income and spending to ensure you reach your financial goals.

Businesses use their income statement to understand and report income and losses for a specific period of time. Also known as a profit and loss statement or P&L, this is the most important tool you can use for your own financial planning.

Remember that an income statement includes both revenue and expenses. You can budget until you’re blue in the face, but you will never get rich if you don’t increase your income. My side hustle brought in $40,000 in 2014 in addition to my full-time job. It is easier to earn more on the side than you may realize, and having diverse income sources helps protect you from unexpected income losses in the future.

There are a handful of free budgeting websites and apps that you can use to connect your bank, credit, and loan accounts to automatically create a personal income statement every month.  Also, if you want to make it simple, there are a fewingenious ways to track your spending that cost you nothing and take almost no time to do.

Balance Sheet

Big businesses use a balance sheet to understand assets, liabilities, and shareholder’s equity in a business at a snapshot in time. Public companies are required to report this information quarterly, but I look at my own personal balance sheet once a month, and have done so since July, 2008.

What most businesses call a balance sheet, individuals call net worth. Calculating your net worth doesn’t have to be difficult. I use the free site NetworthShare to update my net worth every month.

Looking at my personal balance sheet, I can get a quick view into my assets, debts (travel rewards credit cards I pay off in full every month), and financial health with less than five minutes of work every month.

Cash Flow Statement

A cash flow statement appears to be less related to personal finances than the others on the surface, but it also has an important role in your personal finance statements.  This statement tells you where your money comes from and goes to within three major categories: operating, investing, and financing.

For our purposes, operating activities are any source of work or self-employment income and expenses. Investing is activities related to stock market and other investments, or investing in your own education and skills. Financing is debt related activity like buying a car or home with a loan.

Looking at your finances through this lens shows you how each part of your finances is working independently of the others. Maybe your investments are doing really well, but debt is keeping you from success. Maybe your job is supporting your investments and debt – that is very common.

There is no right or wrong here as long as you bring in more than you spend. However, looking at your cash flow into investing or financing, for example, can show how much you are doing to prepare for retirement or how much of your income is being eaten up by debt payments.

A Small Investment Can Pay Big Dividends

Putting together financial statements and taking the time to better understand your finances doesn’t cost you a cent! It only costs you a little bit of time. But don’t look at that time as an expense, look at it as an investment. By spending the time to understand your finances today, you know where to focus and work in the future. That can pay back huge dividends.

For me, it led to earning about one hundred thousand dollars in real estate. It led me to earning over six figures between a day job and a side hustle. It allowed me to quit my job to focus on my side hustle full-time and move to the beach in sunny Southern California. I now make more than double what I was paid at my old day job, but it wouldn’t have happened had I not started by understanding my finances.

Of course, everyone can’t expect to quit their job just because they understand their finances, but if you can get your finances under control and start working towards your goals, anything is possible.

So are you going to take action and understand your finances, or just let your finances happen like most people who drone forward in their day-to-day life wishing for something better? Stop wishing. Take control of your finances. It starts today with your personal financial statements. Who knows what tomorrow has in store?

Retrieved from http://wealthpilgrim.com/improve-finances-personal-financial-statements/.
Squaring-The-Survival-Curve And What It Means For Retirement Planning

Squaring-The-Survival-Curve And What It Means For Retirement Planning


It’s become a well-recognized phenomenon that life expectancies are on the rise, and have been for more than a century now. For many, this leads to the “inevitable” conclusion that someday we’ll all be living to age 150 and beyond, and that we need to plan for drastically longer retirement time horizons – or even that retirement itself will be transformed (or become irrelevant) if medical breakthroughs allow us all to enjoy 100+ years of active lifestyles. However, a fresh look at the data reveals that this may not actually be the likely outcome.

In this guest post, Derek Tharp – our new Research Associate at Kitces.com, and a Ph.D. candidate in the financial planning program at Kansas State University  delves into the nuances behind the changes in mortality rates over the past century and in recent decades, and what they imply about the future.

Because the interesting phenomenon of recent advances in life expectancy in particular is that while overall life expectancies have been rising, most of the gains are attributable to people living closer to the maximum human lifespan (rising up towards about 115 years), and not as much from increases in the maximum age itself. And in the past two decades, the empirical data suggests that the maximum lifespan of human beings has stopped increasing altogether, peaking out around age 115. As a result, future medical advances may simply make us more and more likely to live to that maximum age, but there’s little evidence to suggest that anyone is ever going to live to 150 and beyond… a phenomenon known as “squaring the (survival) curve”.

The significance of rising life expectancy being due primarily to an increasing likelihood of living to maximum age, but not increasing the maximum age itself, is that retirement planning may need to adjust for a longer active phase of life… or more pessimistically, for prolonged periods of substandard health as what might have killed us in the past now simply slows us down! The potential for continued squaring the curve may also dramatically change the pricing and even the relevance of various types of insurance products, as long term care insurance becomes less necessary (if we’re healthy for more of our lifespan), and annuity mortality credits become less available (because people die close together at the end of their maximum lifespan).

But the fundamental point is simply to understand that the ongoing rise in life expectancies doesn’t necessarily mean that someday everyone is going to live to age 150 and beyond. It may simply mean that more of us will live to approach what appears to be a “maximum” human lifespan around age 115… and in fact, recent shifts in who is living longer (and who is not) suggests that we may have already hit that longevity wall.

Squaring-The-Survival-Curve And What It Means For Retirement Planning



It’s become a well-recognized phenomenon that life expectancies are on the rise, and have been for more than a century now. For many, this leads to the “inevitable” conclusion that someday we’ll all be living to age 150 and beyond, and that we need to plan for drastically longer retirement time horizons – or even that retirement itself will be transformed (or become irrelevant) if medical breakthroughs allow us all to enjoy 100+ years of active lifestyles. However, a fresh look at the data reveals that this may not actually be the likely outcome.

In this guest post, Derek Tharp – our new Research Associate at Kitces.com, and a Ph.D. candidate in the financial planning program at Kansas State University  delves into the nuances behind the changes in mortality rates over the past century and in recent decades, and what they imply about the future.

Because the interesting phenomenon of recent advances in life expectancy in particular is that while overall life expectancies have been rising, most of the gains are attributable to people living closer to the maximum human lifespan (rising up towards about 115 years), and not as much from increases in the maximum age itself. And in the past two decades, the empirical data suggests that the maximum lifespan of human beings has stopped increasing altogether, peaking out around age 115. As a result, future medical advances may simply make us more and more likely to live to that maximum age, but there’s little evidence to suggest that anyone is ever going to live to 150 and beyond… a phenomenon known as “squaring the (survival) curve”.

The significance of rising life expectancy being due primarily to an increasing likelihood of living to maximum age, but not increasing the maximum age itself, is that retirement planning may need to adjust for a longer active phase of life… or more pessimistically, for prolonged periods of substandard health as what might have killed us in the past now simply slows us down! The potential for continued squaring the curve may also dramatically change the pricing and even the relevance of various types of insurance products, as long term care insurance becomes less necessary (if we’re healthy for more of our lifespan), and annuity mortality credits become less available (because people die close together at the end of their maximum lifespan).

But the fundamental point is simply to understand that the ongoing rise in life expectancies doesn’t necessarily mean that someday everyone is going to live to age 150 and beyond. It may simply mean that more of us will live to approach what appears to be a “maximum” human lifespan around age 115… and in fact, recent shifts in who is living longer (and who is not) suggests that we may have already hit that longevity wall.

(Derek Tharp Headshot PhotoMichael’s Note: This post was written by Derek Tharp, our new Research Associate at Kitces.com. In addition to his work on this site, Derek is finishing up his Ph.D. in the Personal Financial Planning program at Kansas State University, and assists clients through his RIA Conscious Capital. Derek is a Certified Financial Planner, and can be reached at derek@kitces.com.)

Life Expectancy Assumptions In Retirement

One of the most important assumptions in any financial plan is life expectancy. Assuming too short of a lifespan can result in an excessively high withdrawal rate that depletes all of a client’s assets prior to death. However, despite a desire from financial planners to avoid ever seeing clients run out of money, assuming an unrealistically long lifespan is problematic as well. Excessively low withdrawal rates may lead to a lower quality of life in retirement, a larger than desired legacy inheritance (which the heirs probably won’t complain about, but the retiree might regret!), unfulfilled life goals, and—assuming there may be a relationship between life satisfaction and longevity—possibly even a reduction in lifespan itself!

However, “life expectancy” can be a somewhat misleading term. Many people hear the term and think of it as a measure of how long they can “expect to live”. In reality, though, life expectancy is a measure of theaverage time a person within some particular population is expected to live. While the average is meaningful in many respects, it may not always provide the best measure for setting expectations about the actual age someone is likely to reach. Because mortality rates aren’t constant across a lifespan and the distribution of ages at death are heavily skewed (i.e., more people die old than young), commonly cited life expectancy measures—particularly life expectancy at birth, which is most often cited in the media—may result in misleading expectations.

For instance, a child born in 2014 has a life expectancy (average age at death) of 79. However, the median age of death for the same child is 83, and the modal (most common) age at death is 89! Given the shape of the distribution of ages at death (negatively skewed), it’s simply a mathematical fact that the mean is going to be lower than the median or the mode.

Life Expectancy and Projected Deaths Per 100,000 For Children Born In 2014

Understanding Longevity Expectations With Survival Curves

One way to explore some of the nuances within mortality figures is to visualize that data through the use of a survival curve – a figure which plots percentage of people still alive (i.e., the “survival rates” of a population) over time. Looking at the trends in how survival curves change over time can help us to not just see whether life expectancy is changing, but specifically where changes are occurring across the lifespan.

Projected Survival Curve For Children Born In 2014

As you can see in the survival curve above, only roughly 1-in-10 people born in 2014 is expected to die prior to age 60 (i.e., 90% are still alive), but beyond that point, the rate of death begins to increase substantially. However, over 60% of children born in 2014 are still expected to be alive when the cohort reaches their “life expectancy” (i.e., average age at death) of 79. The median (age 83) is equivalent to the 50th percentile, and the mode (89) is roughly around the 30th percentile. By age 100, only 2% of people born in 2014 are expected to still be alive. While simple statistics like life expectancy certainly serve a purpose, survival curves give us a much better look at the “story” behind the data.

Demographers and population biologists identify two broad forms of change that can influence the shape of survival curves over time. There can be a “scale effect”, which refers to an increase in maximum age attained (i.e., the oldest people are reaching older ages), or a “shape effect”, which refers to changes in the curvature of a survival curve (i.e., more people are surviving long enough to approach or reach those maximum ages but not necessarily living longer than the maximum age).

Shape And Scale Effects

This distinction is important because people often talk about rising life expectancy as though it goes hand-in-hand with increasing maximum age, but that’s not necessarily the case. In fact, when we look at how survival curves have shifted over time, changes have been attributable to both the shape effect (i.e., living closer to maximum age) and the scale effect (i.e., increasing the maximum age) at varying rates.

Historical Changes In Survival Curves

The graphic above shows experienced and projected survival curves from 1851 through 2031. The trends over time reveal one of the more interesting changes humans are experiencing in survival rates: while there has been some increase in the maximum ages, most of the change over time appears to be a “squaring-of-the-survival-curve” (which is also known as “rectangularization”). Squaring-the-survival-curve refers to the change in shape that results from people living closer to their maximum age without an equivalent increase in their maximum age. In a perfectly squared survival curve, nearly 100% of a population would survive to the maximum human lifespan and then suddenly pass away, forming a “curve” that takes the shape of a right angle (hence, “squaring-the-curve”).

The Impact Of Shape And Scale Effects On Historical Changes In Survival Curves

Current Changes In Survival Curves

Survival curves are constantly evolving and subject to significant variation globally. A 2012 study published in Nature found evidence of variations in scale effects and shape effects even among relatively similar, wealthy capitalist societies. Though variations exist among societies, the long-term trends over the past several hundred years have shown both increases in maximum age attained and increases in the percentage of the population living closer to their maximum age, as noted in the chart above.

However, it’s possible humans in developed nations have recently reached a pivotal point in the evolution of our mortality. A 2016 study in Nature found evidence that the lifespan was increasing up until 1990, but has not increased since. In fact, the trend since 1990 has actually been a slight decrease in lifespan.

There is disagreement among researchers regarding whether a true maximum human lifespan exists, and exactly what that lifespan might be, but the same 2016 study in Nature found evidence that the human lifespan has plateaued around 115 years. This doesn’t mean no one will live beyond 115—Jeanne Calment was the oldest documented human at an age of 122 and few other exceptions have joined her living past 115—but the maximum age for all but truly the rarest exceptions appears to be stabilizing at 115, despite continued advancements in medical science.


It’s important to note that researchers are dealing with a relatively small sample when evaluating those approaching a maximum lifespan, so it is possible we are currently just experiencing some noisy data and lifespan will continue to increase in the future. Still, what we do know is that since 1990, almost all of the gains in life expectancy have been due to people living closer to their maximum age, rather than increases in maximum age. In other words, squaring-the-survival-curve now seems to be the sole driver of increasing life expectancies in developed nations.

The crucial insight from the phenomenon of squaring-of-the-survival curve is that increasing life expectancy does not necessarily mean increasing lifespans. At some point, we may see many (perhaps even the most!) people living beyond age 100, yet the likelihood of living to 125 may still essentially be zero! That’s not to say that we won’t encounter dramatic breakthroughs that fundamentally change these dynamics—for instance, technology that literally reverses aging—but barring any such technological breakthroughs, there is currently little foreseeable reason to forecast life expectancies beyond 115, even with ongoing medical advances. In other words, rising life expectancies don’t necessarily mean we’re likely eventually be living to age 150 and beyond… it may just be that we’re increasingly likely to all make it right up to a “maximum” age around 115!

One potentially concerning behavioral consideration is the role that theavailability bias may play in influencing longevity forecasts. Many clients forecast their own life expectancy based on the longevity of family members. While it appears that genetics play a significant role in longevity and it’s reasonable to take family health history into consideration, ironically, squaring-the-curve may mean that individuals with the lowest longevity expectations are actually the most prone to significantly outlive their expectations!

The reason is that people with longevity in their family already tend to die of old age, whereas families with without longevity often die of other health conditions. Yet, if squaring-the-curve results in increasing survival rates without a corresponding increase in maximum age, then the bulk of the gains in survival rates will go to those who aren’t dying of the same ailments that claimed the lives of previous generations. In other words, someone who has a family history of living into their 90s of 100s may have a good reason to believe they will also live that long, but there isn’t a huge risk they will live significantly longer. However, someone without longevity in their family who believes they will die in their 70s likely has the biggest “risk” of living 20-30 years beyond their expectations.

Individuals should also understand that average trends may not apply to them if their demographics make them significantly different from average. A recent report from the National Center of Health Statistics found that overall U.S. life expectancy dropped in 2015 for the first time since 1993. While it’s still possible this was just some statistical noise (and there’s some evidence that may be the case), it’s important to acknowledge that not every demographic experienced a decline in 2015. People seem relatively aware that differences exist among factors like gender, but it’s important to remember that race, education, wealth, income, and occupation are all important factors as well. Given the “typical” client of a financial advisor, these factors tend to be associated with more favorable life expectancies (relative to the average).

How Squaring-The-Curve Changes Retirement Planning

If we aren’t on a trajectory to live to 150, but instead, we’re on a path towards more and more people living into their 90s and 100s (and perhaps just a decade beyond), then this has some important retirement planning considerations. Most obvious, if we’re all dead by 115 but almost certain to be alive into our 90s or 100s, then (assuming norms surrounding retirement age don’t change) this will have the practical effect of increasing the length of the distribution phase of retirement, and, as a result, the assets needed for those entering retirement.

However, the good news is that for anyone who is already planning in accordance with distribution phase best practices, material changes to a plan may not be needed (at least not yet!). Most distribution research has historically used an assumption of a 30-year time horizon in retirement. Assuming a retirement age of 65, this still runs projections out until age 95, and for an average couple who has attained age 65, current joint mortality tables suggest that even just one of them living to age 95 or longer is only a 1-in-5 chance . And even with some continued squaring-of-the-curve, this assumption may be reasonably conservative for some time to come, particularly in light of how conservative the assumptions are that underlie the safe withdrawal rate, and the high likelihood that money withdrawn under the 4% rule will last more than 30 years anyway.

The more direct impact of increasing longevity will likely be on spending patterns throughout retirement. Just as we are starting to get a better grip on actual declining spending patterns of individuals in retirement, continued change among lifestyle factors may change these spending patterns further.

Notably, though, there are competing viewpoints on what these changes may look like. Some predict that squaring-the-curve will come from the ability to merely keep people alive (albeit possibly in a minimally-conscious and highly sedentary state). Under this scenario, life expectancies would be extended and healthcare expenses would increase, but it’s likely annual spending would decrease significantly within these final years of life.

More optimistic viewpoints see the extension of life coupled with more years of healthy life. In fact, gerontologists speak of different form of “squaring-the-curve” that comes from plotting quality of life over time – with an ideal of maintaining a high-quality lifestyle right up until death. Under this scenario, the decrease in retirement spending that is currently seen over time would be diminished. Not only would retirees live longer, but they would live longer with more years of higher levels of spending.

Of course, the optimistic and pessimistic views of squaring-the-curve are not mutually exclusive. It’s also possible—and perhaps, more realistic—that we’ll see a combination of longer time spent in good health and increased possibilities for extending life in poor health. Rather than the more gradual decline commonly seen in spending now, there may be an increased prevalence of steep declines in spending as the result of quicker and more dramatic lifestyle changes that coincide with rarer but more dramatic changes in health (that still can’t be overcome by future medical science).

Another consideration is that if lifestyles become healthier and more active in old age, perhaps people will “retire” less—instead opting for“semi-retirement” consisting of scaled-back or different forms of work—and the nature of the need for income in retirement will begin to change. After all, retirement originated as something for people who were too old to work and became “obsolete” as workers. Its use as a time of leisure is a recent phenomenon.

It’s likely the meaning and conceptions of retirement will continue to change as well. When a retiree’s 60s and 70s are no longer their twilight years, will retirement itself become a less relevant milestone? Will new careers, civic engagement, or philanthropic work become even more prevalent in these stages of life? Will retirement become an even more popular transition as healthier retirees have even more to look forward to? Will the prospects of a longer, but perhaps less stressful career be more enticing than trying to save up enough to not work for many decades? Cultural shifts are hard to predict, but afforded the assurance that one is likely to live into their 90s or beyond (particularly in good health), it’s hard to imagine that cultural views on retirement wouldn’t change.

Farther Reaching Consequences Of Squaring-The-Survival-Curve

While squaring-the-survival-curve has many practical implications that affect the assumptions and practice of retirement planning, there are also some farther-reaching consequences that could influence the financial services industry more broadly, and are worthy of consideration.


One of the key benefits of annuitization is the ability to earn mortality credits. Mortality credits serve as a way to pool and spread out risk. However, in a world with a perfectly squared mortality curve, there would be no way to earn mortality credits. Everyone would live to their forecasted maximum age and then immediately pass away. Of course, this is an extreme example we are unlikely to see for a very long time (if ever!), but the general principle remains. As the distribution of age at death becomes more concentrated and uncertainty surrounding life expectancy is reduced, the conditions that make it possible to earn mortality credits are reduced as well. This may mean it’s a good idea to lock in mortality credit pricing in annuities today, but it may also mean that credit quality of the insurer is even more important, as low-quality annuity providers could be financially threatened if there is a dramatic squaring-of-the-curve with future medical breakthroughs!

Of course, the flip side of this is that as life expectancy becomes more predictable, the need to hedge against longevity is also reduced. If at some point in the future 95% of people are surviving to, and then dying between, the ages of 95-105, then retirement planning will have become a lot easier (at least from the perspective of dealing with one of the biggest planning contingencies of an unknown time horizon until death). It’s possible that future generations will look back and have as hard of a time fathoming our current mid-life mortality rates as we have looking back and fathoming maternal and infant mortality rates from as recently as the early 1900s.


Squaring-the-curve could have a tremendous impact on long-term care insurance, but the impact it has will ultimately depend on whether the optimistic or pessimistic perspectives on squaring-the-curve end up being more accurate.

If squaring-the-curve happens among both mortality and quality of life, then long-term care insurance could become largely obsolete. In fact, this may be what today’s still-struggling-to-be-profitable long-term care insurers are betting on (medical breakthroughs that turn their existing unprofitable policies into more profitable ones as claims decline)!

Alternatively, scenarios short of curve-squaring perfection could greatly enhance the risk characteristics of long-term care from a risk-transfer perspective. Ideally, insurable risks are high severity and low probability occurrences. With the expectation that 1-in-3 retirees will need some type of long-term care, the current characteristics actually aren’t great for creating products for the pooling and transfer of risk. However, with a healthier aging population and reduced need for long-term care services, long-term care insurance could significantly decrease in cost and begin to look much more like life or disability insurance does today – primarily used to address low frequency but high severity risks.


While living to 95 or 100 isn’t necessarily disastrous for the assumptions that go into current retirement distribution best practices, the reality remains that many Americans are simply not financially prepared for this type of longevity. As a result, squaring-the-curve will likely increase the amount of stress that already exists on social safety nets, such as extending and increasing the duration and amount of claims from Social Security and Medicare, not to mention the potential need to rely on Medicaid.

Of course, squaring-the-curve may have other effects that influence social safety nets as well. People in better health living more vibrant and active retirements may opt to delay retirement or engage in more work during retirement. Additionally, people may retain the ability to go back to work, even in “old” age. Particularly if the quality of life curve is squared as well, a retiree in their 90s may be much better equipped to re-enter the workforce in the event that they run out of money. Less extensive health care needs could reduce stress on certain social safety nets that provide health care as well.


Squaring-the-curve will likely influence generational family dynamics. Families with three, four, and possibly even five living generations will become more common. As families play an increased role as financial or personal caregivers across more generations, family relationships and support systems may become more complex.

Beyond pooling resources between generations, these changes could influence housing, caregiving, and child rearing. Multi-generational homesteads could become more common, and housing may need to adapt to provide the balance of independence and cohabitation families may desire. Adult children may continue to take a more active role in caring for elderly parents or grandparents, but at the same time, more active grandparents and great grandparents may play a larger role in raising and caring for children as well.

Generational transfers of wealth may also begin to change – not only because people are living longer, spending down their assets, and bequeathing less, but because of the greater need for assets to transfer up a generation or for inheritances to skip past generations (perhaps because children may commonly be in their 60s or 70s when their parents die and grandchildren or great grandchildren will be at a stage where they have greater needs for the inheritance). Or perhaps the ability to work longer will diminish the need for generational transfers as people can remain financially independent longer.


Few people today would seriously consider the possibility of going to medical school at age 50, but what would happen if they were relatively confident they would live to age 90? Four years of medical school and four years of residency may not seem so daunting to a 50-year old if they have a dream to be a doctor and the potential to still have a 20-year career with 10+ years in “retirement”.

In fact, a severe career reboot may be helpful in not only helping people pursue careers once they have a better idea of “who they are” and “what they want to do with their life” (i.e., they aren’t young adults with still developing frontal lobes), but also help facilitate a more efficient allocation of human capital. The effects of a higher willingness to re-invest in human capital mid-career likely wouldn’t be isolated to older adults either. The increased prevalence of older adults (even those in their 30s or 40s) pursuing entry-level positions in new fields or going back to school would likely result in competition that directly affects younger adults’ abilities to pursue these same economic opportunities.

The fact that life expectancy is rising is common knowledge, but the nuances behind that change are not. People are, on average, living longer, but that change isn’t necessarily the result of increasing lifespans. Rather, it is now the result of successfully living to our potential maximum lifespan and avoiding premature death.

That trend appears likely to continue, but if people are going to live healthy lifestyles into their 70s, 80s, and even 90s, there are implications for all areas of financial planning. Whether it’s our patterns of saving and dissaving across our life cycle, the financial products we use to achieve our goals, our living arrangements and family dynamics, or even our conceptions of work and retirement itself – squaring-the-survival-curve has profound implications to our clients’ finances and the goals we help them achieve.