This book (available here on Amazon) of several dozen two to four page mini-stories, is a disparate random collection with many messages:
- cautionary tale about the single-minded unforgiving nature of the CRA bureaucracy and the dangers of disobeying tax laws, deliberately or accidentally (as he says, there is “no compassion in a crocodile brain”)
- cautionary tale about citizens who don’t pay the taxes they should, some of them due to reasons we can be sympathetic to, and others who are just plain cheats – he has met all types
- how the insider game works in politics and business deals where who you know makes a big difference
- self-promotion and self-congratulation of the tax services of the author
- memories of personal holiday and work adventures, (I’d guess all of which were arranged to legitimately be tax-deductible as business expense though he never utters a word about his own tax affairs)
- how sometimes innocent people get caught up in the CRA idiotically and harshly using its power
- how sometimes very guilty people get away with lots of cheating by hiring a good lawyer
Last week, the CBC published on its website an article by James Fitz-Morris provocatively titled TFSAs will lead to ‘welfare’ for the wealthy, government warned. This week, the Financial Post followed up with a sky-is-falling article by Jonathan Chevreau, How the Guaranteed Income Supplement is on a collision course with TFSAs. Take a valium people. I disagree.
Guaranteed Income Supplement (GIS) is not the same as Old Age Security Pension (OAS)
The first step in toning down the rhetoric (since confounding the two and adding the numbers together makes the problem look bigger than it really is) is to distinguish these two sets of federal government payments with completely different purposes and different eligibility requirements. In this discussion I’ll stick to figures for a single person. Quoting figures for couples makes them look bigger, without helping to address whether abusive use of a TFSA will take place. It’s simpler and more direct to deal with an individual.
GIS (per the official Service Canada website description) is the true low income benefit, the only payment that qualifies in any sense of the word “welfare” (which incidentally is not used officially by any Canadian government).
The maximum GIS payment for an individual in 2014 is $747.86 per month / $8974 per year. GIS starts being clawed back at the rate of 50 cents per dollar of income (other than OAS and GIS itself, which do not count as income for GIS-eligibility testing). GIS is completely clawed back and recaptured by the CRA when taxable income, which includes amounts withdrawn from an RRSP, from CPP, from dividends, interest and gains in taxable accounts plus any pension received, reaches a mere $16,728 in 2014 (TaxTips has details). GIS really is for retirees who little or no other income.
OAS (see Service Canada page) on the other hand is a payment merely for being an old citizen and having lived in Canada for a long time. Anyone 65 or over who has legally parked his/her butt in Canada for ten years or more, and is not in prison now can get it.
OAS currently pays $6765 per year to a single person. OAS is NOT for low income retirees, it’s for everybody except really high income retirees. OAS only starts being clawed back through income taxes when a person’s income reaches $71,592 and it is only all reclaimed by the government when income reaches about $116,700. That’s hardly low income, not even middle income. Low income people do get OAS, but whether or not TFSAs are involved, OAS is clearly not intended for low income people only. So please, CBC, stop referring to OAS when using the term “welfare”.
The problem only happens in a brief window, the three years between age 67 and 70. Both OAS and GIS are only for people 65 and over at the moment but in 2023 the age eligibility will begin rising gradually over the following six years to 67. TFSAs will need to have existed a lot longer than till 2029 to grow large enough to generate enough income to support a high-income lifestyle. At age 70, CPP must start (or you miss out, it’s not paid retroactively). A rich person would likely have worked in a high-income job and likely therefore to get maximum CPP, which would be 42% more than at age 65, or $17,693, which is more than enough income (CPP counts as income when calculating the GIS clawback) to wipe out the GIS. At age 71, forced withdrawals from registered plans would easily (especially for rich people who would almost surely also have saved lots in such plans) take care of GIS.
TFSA accounts allow the tax-free accumulation of any type of investment earnings like dividends, interest and capital gains. The flat contribution limit is currently $5500 annually, starting at age 18, and carries over and accumulates through any years where no contribution is made. There is no tax refund like RRSPs give for contributions i.e. TFSA contributions are made with after-tax dollars. TFSA withdrawals are completely tax-free, not included in income on an annual tax return. There is no tracking or attribution of contributions vs income/profits in a withdrawal.
If the TFSA is thought to be the problem because it holds a large tax-free balance then it is not the problem. To be large enough to support a high income lifestyle for three years, wealthy people would have had to save / contribute the maximum $5500 every year. Over 35 years from age 32 to 67 that would total $192,500. For three years from 67 to 70, the wealthy steady saver could spend those contributions to support $64,000 in annual spending – tax-free, of course, because it’s their own after-tax contributions. It’s not income and no further income taxes are due and they could keep all their GIS. No tax-free income from the TFSA is needed for rich people to unfairly grab the GIS. Similarly, a rich person could well have large bank savings or a non-registered account, which could be converted for few years into low- or non-interest cash accounts to have plenty of tax-free assets generating no taxable income to spend. Blaming the TFSA as the threat to GIS is a red herring.
The tax-free earnings within a TFSA would help more middle income people implement a GIS-grab strategy since they would not need to contribute as much to the TFSA. Re-invested growth within the TFSA could be combined with the contribution capital to achieve a similar balance e.g. contributing $2500 annually for 35 years from age 32 (an age where more people start to be in a position to save) at 3.5% compound return produces a balance of $172,500 at age 67. As the FinAid calculator shows with those inputs, half the balance is the investor’s own after-tax accumulated contributions and half is income.
Using unlikely assumptions to trump up the argument – It is only by using improbable figures that the CBC article’s Kesselman puts together an argument that someone could live entirely off tax-free TFSA income. A 6% sustained return on a balanced portfolio that generates a $1 million portfolio? Not very likely! Historically, Stingy Investor’s Asset Mixer tell us a real returns from 1980 to 2013 were 6.1% geometric (compound) for a 50-50 bonds-Canadian equity portfolio. Sounds right …. except those are index returns before fees. Select the Global Alpha Assumption of “Average Fund” for typical mutual fund fees that the Canadian investor faces and returns are down to 4.6%. As the famous Dalbar studies have repeatedly shown, investors on average do far worse than their funds by bad timing of buying and selling. Compound 4.6% for 35 years of $5500 annual contributions and the portfolio total is only $478,500, of which only $286,000 is accumulated income, the rest being the investor’s own after-tax contributions. It is only by assuming that the rich investor would have been able from age 18 to contribute an unlikely $5500 per year for 49 years that a 4.6% return would produce a portfolio worth $1,008,000 by age 67, when they could achieve their goal in life of taking $9k of GIS by living off tax-free TFSA income for the next three years.
Is the historic average 6% return likely for the future? Um, no! – But let us suppose that rich investors have become so by being smarter than the average. They will buy and hold with mechanical (no gut-feel!) rebalancing low-fee index ETFs and so lose only 0.1% or so return per year off the index. What return can they reasonably expect?
The future return environment is nowhere near as rosy as the halcyon decades of the 1980s and 1990s when stocks were going gangbusters and bonds benefited hugely from continually declining interest rates. Today’s reality – Stocks in future might return 3 to 5% while bonds look set for 2% returns. A portfolio combined 3 to 4% is more reasonable. We’ll use 3.5%. That has a big effect. TFSA contribution room accumulates and never expires, but most of the growth in a portfolio comes from long term compounding. Starting an investor at age 30, giving 37 years of savings and growth at 3.5% return, gives a TFSA portfolio of only $418,000. At that stage taking out a 3.5% return as tax-free income would provide only $14,600, hardly enough to sustain a wealthy lifestyle. The investor would need to withdraw some $45,400 of the accumulated capital and past income (each of which constitutes about half the portfolio total) to reach Kesselman’s $60k of tax-free spending.
In short, a few investors may be lucky or skilled enough to accumulate huge TFSA balances that will enable them to live entirely off tax-free income while collecting GIS for a few years but they aren’t likely to be numerous. Is it worth turning the tax system upside down, such as testing for assets instead of income, or drastically changing the TFSA by making some of the income taxable?
The TFSA exemption for GIS (and OAS) eligibility is not a flaw or a “loophole”, it is fundamental design feature and deliberate rule to benefit large numbers of modest income retirees.
The government itself explicitly touts the feature as an advantage. The TFSA was designed to especially help, and various analyses comparing the TFSA to the RRSP (including my own), show that it is most attractive to people with low income. So CBC should stop pejoratively describing this as a loophole and people like John Stapleton quoted in the Financial Post should stop calling it a “policy flaw”.
Are the rich likely to try grabbing GIS, even though they could do it? Too many other factors mean likely few will.
Future very well-off retired people will have lots of assets. They probably will have maxed out their TFSA and their RRSP, be entitled to maximum CPP and maybe even have non-registered assets too. Assuming that rich people want to stay rich and have no moral qualms (which might deter a few) about possibly claiming GIS, it will be one of the factors in the mix. Staying rich means considering more than the short period from 67 to 70, it means taking account of the whole of remaining lifetime. It may not be worthwhile taking GIS if that means pushing up into higher tax brackets later and paying more tax in total with less disposable after-tax income. Taking GIS is not a single dominant no-brainer must-do. Sophisticated retirement planning tools like RRIFmetic that figure out the best withdrawal strategies depend on many assumptions and factors.
Is there likely to be a problem with public finances? Nope, according to the Chief Actuary at the Office of the Superintendent of Financial Institutions in this latest 2014 report on the Old Age Security Program. Note that the conclusions quoted below are about the entire expected effect of the TFSA, including especially the mass of lower income Canadians using TFSA tax-free income to get GIS as intended, and not just rich people abusively using the GIS-gambit.
- “The GIS recipient rate is projected to slowly increase from its current level of 32% to 34% by 2030 due to the impact of TFSAs. The GIS recipient rate is subsequently projected to reduce to 31% by 2050.” i.e. in the major impact in 2030 is when TFSA have been in existence only 21 years and have not yet grown to large amounts, then it tails off … is this an ominous problem?
- “… the fact that individuals are also assumed to invest in TFSAs results in GIS and Allowance recipient rates increasing slightly over time. Ultimately, however, the fact that benefits are indexed to inflation as opposed to wages drive the cost of the OAS Program relative to the GDP down over the long term, with the result that annual expenditures are expected to fall to 2.4% of GDP by 2050.” Doesn’t sound like the sky is forecast to fall does it?
A much more sensible reaction than the hyperbolic media reports is found in the comments of a Department of Finance official reported in the Financial Post
- “… he thinks this [suppressing all taxable income to claim GIS] would rarely be possible. Most high-income individuals have other income sources and would inevitably render them ineligible for GIS. And since TFSAs have only been around five years and so remain mostly small, “this might be too hypothetical to comment on, given that the purported optimal scenario is decades away,” he said.“
Leave the TFSA alone, except to double the annual contribution limit as the government has promised.
Regardless of what “size of government” you believe is appropriate (large government vs. small government), I think we can all agree that government needs to be as efficient as possible in utilizing our tax dollars. And, if investments can be made which do not raise our tax dollars now, and promise lower taxes for us all in the future, such investments deserve to be rapidly undertaken.
Here’s how it works, in simple terms. If I loan you $1,000,000 at 3% interest, with a payback over 10 years, in equal installments, your annual loan payments (paid monthly) would total about $105,000, or 10.5%. But what if taking out the loan results in energy efficiency improvements for you that: (1) save $105,000 to $200,000 in electricity costs each year, for 20 years (varies, depending upon electricity cost per Kwh and installation costs); (2) in some communities, effect a slight drop in crime in your area; (3) save on greenhouse gas emissions; and (4) creates well-paying jobs for members of your community – installers and domestic manufacturers of LED lighting.
Sounds too good to be true? It isn’t.
While I’m no expert in LED street lights nor their installation, from reading several articles about past and planned installations of LED street lights (which are said to last for 20 years or more, resulting in lower future maintenance costs as well compared to traditional street lighting), as well as reading articles about how rapidly LED light fixture prices have declined over the past few years, it seems apparent that dramatic cost savings are possible for municipalities where street lighting is widely employed. All that is needed is capital.
What’s the solution for municipalities to acquire capital to make these infrastructure improvements? Here are three alternatives:
(1) The first would be the issuance of general revenue municipal bonds. But, such bond issuance has its (often substantial) underwriting costs, and interest rates for many municipalities (due to shaky finances) might be much higher.
(2) A better solution, in my view, is for Congress to authorize a government loan program under which the federal government (U.S. Treasury) issues 10-year government bonds (yields as of 2.8.15 – about 2%), and then loans funds to municipalities at 3%. The spread would easily cover the costs of administering the programs and the costs of any defaults. If administrative and default costs are lower, then perhaps rebates to municipalities could take place. Debt could also be staggered, with the U.S. Treasury authorized to issue 1-year, 2-year, 3-year, 4-year, etc. securities, and loaning to municipalities with principal paybacks over time. (This would lower effective borrowing costs for municipalities even more, and
(3) For those desiring to keep the government’s balance sheet smaller, the U.S. government could guarantee municipal loans (thereby ensuring a very high rating), adopt legislation for a shorter prospectus (given the guarantee), and thereby result in possibly lower borrowing costs via 10-year municipal loan obligations (AA-rated 10-year municipal debt yields, as of 2.8.15, are about 1.8%). The federal government could charge 1.0% per year on outstanding debt to the municipalities, to cover the costs of any loan defaults and the costs of administering the program. Again, if the administrative and default costs are lower, then perhaps rebates to municipalities could take place.
Want to make a huge dent? Authorize tens of billions of such loans or loan guarantees to be undertaken, over the next three years.
Of course, interest rates could rise. Then again, costs of LED street lighting could fall over time. Even if interest rates rise moderately, cash flow savings would still likely result over the first 10 years, at least for the vast majority of municipalities. And even if loan repayment amounts rise slightly and equal energy savings over the first 10-year period, the real savings result in years 11-20, when the huge energy cost savings result flow to the bottom line of muncipalities, after the loans are repaid in full.
Other avenues exist for direct loan programs or government loan guarantee programs, for promoting energy efficiency for federal, state and local governments – such as improving energy efficiencies within office and other government buildings (including, as well, the halls in our colleges and universities). Payback times vary, however, and need to be more thoroughly examined to ensure savings actually take place.
Some federal government intiatives in this area already take place, as well as some state programs. What I suggest is that these iniatives be greatly expanded through Congressional authorization. Let’s … PUT AMERICA BACK TO WORK … and … SAVE ON OUR OWN FUTURE TAX BURDENS. And let’s do it in A BIG WAY.
The future of America is bright. Innovations in materials sciences, health sciences, renewable energy, robotics, and computer applications continue – and the pace of such innovations is even accelerating. Let’s together – act smart – and enable our own future prosperity.
Ron A. Rhoades, JD, CFP(r) is an Asst. Professor of Business at Alfred State College, Alfred, NY. This blog post reflects his personal views only, and not those of any organization with which he may be associated. Prof. Rhoades may be contacted at: RhoadeRA@AlfredState.edu.
I was an Armor officer for the first six years of my professional career. One of the key components of the schoolhouse Army decision making process focuses on risk management. The way the Army and other large organizations think about risk is in two parts: what’s the likelihood of an event happening, and what are the consequences. Creating a process of evaluating risks and determining what risks are suitable and what risks are not is at the core of leadership, particularly when people’s lives are on the line.
The Guardian came out today with a fantastic visualization of a similar risk management matrix that reminded me of the Army’s process, but with respect to infectious disease. On the X-axis you see the infectiousness of the disease (ability for it to reproduce, in units of likely human propagation), and the Y-axis the fatality rate. Note where Ebola stands – a 70% fatality rate combined with a propagation rate of 2.5. Really only Tuberculosis and HIV have a similar combination of fatality and pervasiveness.
The data source for the spreadsheet can be found here.
An attendee at a recent conference stated that financial literacy is not “rocket science.” I almost fell off my chair. There was a group of speakers presenting at that moment, and I could not comment or ask for clarification right away. While sitting silently on the edge of my chair I realized that, unfortunately, this is how financial literacy is often perceived, in particular among practitioners. Some people think that financial literacy is a set of good practices that, if you try a few times or long enough, you eventually master, like basic woodworking or cooking. Others think that financial literacy is a bunch of rules—such as “live within your means”—that should guide behavior.
In my view, we have to equip people with the knowledge and skills necessary to make decisions. Let me be specific and provide an example of what I mean. Here is a situation we can face (it is taken from my Financial Decision Making course):
Whose advice can you trust? It’s complex and confusing but you cannot wash your hands of getting an idea of whom to trust because a mistake can be extremely costly, as in having your retirement savings wiped out.
There are titles galore in the financial and investment industry that we individual investors must deal with. Some titles mean something, others are just fluff to impress us.
The key idea is that only a few select people we might deal with are obliged to act first and foremost in our best interest, what is called behaving according to fiduciary duty. Most are held to a much lower standard, such as suitability, for instance in the Mutual Fund Dealers Association Member Regulation Notice on Suitability. That allows the industry professionals to behave with great latitude and often in their own best interest, mostly as salespeople, as long as their “advice” is not outright fraudulent or misleading.
Two documents from official regulatory sources provide a means to narrow things down to a list that has substance:
1) Canadian Securities Administrators Understanding Registration, a one-page list of all the types of people and firms that can sell or offer advice on securities (mutual funds, ETFs, stocks, bonds). Acknowledgement to the Small Investor Protection Association, where I found this link.
2) Canadian Securities Administrators Consultation Paper 33-403, The Standard of Conduct for Advisers and Dealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty when Advice is Provided to Retail Clients, a 37-page legalistic, technical document (why is it that such important consumer information is only to be found buried in such a user-unfriendly place?). Page 9 of the pdf contains the following chart; most of the entries in the fiduciary duty columns have a No, few a Yes and several It Depends.
What is your firm’s and your personal registration category? This is the first question to ask. Check the registration here. If the answer is “not registered”, run for the hills!
Only three categories of individuals matter.
Ninety percent of people who call themselves financial advisor, investment advisor, financial planner, wealth advisor or some variation of such are Dealing Representatives, which as we see from the charts, are actually salespeople selling mutual funds. Caveat emptor! Assume they will not necessarily provide recommendations or plans that are best for you (except in Quebec where they are obliged by law to always act in a client’s best interest).
Advising Representatives and Associate Advising Representatives almost all work for Investment Dealers or Portfolio Managers. If they have explicit authorization to buy and sell in your account i.e. a Discretionary account, they have a clear responsibility to act in your best interest (the Yes entries in the second table). Of course, that does not negate human nature and some bad apples might still do lots of trades to generate extra commission income for themselves.
The “It Depends” situations are very problematic for the individual investor. You have a Non-Discretionary account and still have final say on buying and selling. But you may be reliant on the advice given, which may mean you can or cannot count on that advice being in your best interest, depending on how the five determining factors (vulnerability, trust, reliance, discretion, professional rules or codes of conduct) cited in the CSA consultation paper pan out. In the case of dispute, usually when it’s too late and and bad things have happened to the investor, the only way to find out for sure is to go to court at great cost of money, time and effort. The ambiguity, which usually works to the benefit of exploitative abusive firms and investment professionals, is a big reason for the long-standing but so far unsuccessful push to have a much broader best interest fiduciary standard imposed on the investment management and advice industry. Therefore, as a pre-cautionary rule of thumb, assume the “It Depends” will not necessarily provide recommendations or plans that are best for you.
For all my dislike of the provincially-partitioned investment regulation in this country, I wish the other provinces and the CSA would do what Quebec has done and clear up the ambiguity by statutory imposition of the best interest fiduciary standard.
A source of much un-necessary confusion is the proliferation of so-called financial certifications and designations, some much flimsier than others. Even for the more substantial ones amongst those listed here on the IIROC site, there is a wide range of best-interest related clauses in the codes of ethics or conduct. Trolling through any one of them to know the exact legal ramifications of each code is time-consuming and of uncertain value. Therefore, ignore designations and stick to the above basic approach.
That says who you should be able to trust, legally speaking. But even then, there are a few bad apples, so it is of course necessary to keep a watchful eye and be aware of a gut instinct that says something may be wrong.
As for me, I know where I stand. The Discount brokerage entries show a clear No in both columns. I know I’m on my own. If I mess up my investments, it’s all my fault.
You can’t deduct grooming – haircuts, tanning, manicures, makeup/beauty products – under most circumstances, even if these items are required as a condition of employment (yes, even for military, police officers, firefighters, nurses, and construction workers).
Yet people try to do so all the time. Creating a fraudulent deduction is one of the more common ways that people cheat the tax code – unintentionally, and intentionally. In contrast to those who run a business or are self-employed, creating a false deduction is probably the only way to go for folks who receive their income primarily through wages, which are reported directly to the IRS by their employer.
To combat this kind of fraud, tax regulations require taxpayers to keep substantial records, and place the burden of producing them during an audit squarely on the taxpayer. Rules are published which, to me at least, are very clear.
In most cases, the tax code is pretty specific as to what is a valid and substantiated deduction and what isn’t. The deduction must be substantiated, with documentary evidence, such as a cancelled check. It must have a clear business purpose. And it must be both ordinary and necessary. That covers the majority of how tax deductible expenses are defined, although items that exist at the margins are debated endlessly in tax court.
However, there are some items defined within the tax code which are declared and/or the tax courts have ruled are non-deductible. Wrist watches are a good example of a personal expense. Here’s what a typical ruling looks like when a taxpayer tries to deduct a wrist watch, from a medical researcher who claimed about $100,000 of deductions over two years for expenses clearly unrelated to any business:
IRC § 262 is the section of the US tax code that states that personal expenses aren’t deductible. The wrist watch provision has been challenged many times on the grounds that for certain occupations are allowed as ordinary and necessary under IRC § 162. For certain jobs, this is certainly the case. But that’s not the end of the story.
The tax courts have consistently applied that wrist watches are not deductible even if they are allowed in 162, because they are considered personal expenses under IRC § 262. Thus, personal items defined in 262 supercede items defined as ordinary and necessary in 162. End of story.
Grooming also falls into this category. They are considered personal expenses, even if required for work, even if the grooming is a condition of employment, such as this example of an airline flight attendant:
Note that it clearly doesn’t matter if your employer requires you to maintain a certain appearance. Haircuts and personal grooming expenses aren’t deductible.
This extends even to uniformed personnel, such as US Army service members, which goes into some detail:
The tax courts have ruled very consistently on this manner. It’s not enough that your employer require these expenses.
It’s not just grooming. Any clothing item that can be adapted to personal use is considered personal in nature. So a t-shirt or a polo shirt with a company logo purchased cannot be deducted as a uniform expense, same as a suit or dress or shoes purchased only for work.
What can be considered deductible are uniforms that can’t be adapted to personal use. A police or military uniform is a good example, as this clothing is generally not appropriate for casual usage. The same applies to protective or safety clothing, or a costume for performances, provided these items meet the ordinary, necessary, and substantiation requirements discussed above.
Yet grooming and uniform deductions are some of the more common erroneous deductions that I come across on tax returns.
From IRS Publication 529, here are some more example of non-deductible expenses:
Adoption expenses, broker’s commissions, burial or funeral expenses, including the cost of a cemetery lot, campaign expenses, capital expenses, check-writing fees, club dues, commuting expenses, fees and licenses, such as car licenses, marriage licenses, and dog tags, fines and penalties, such as parking tickets, health spa expenses, home repairs, insurance, and rent, home security system, illegal bribes and kickbacks, investment-related seminars, life insurance premiums paid by the insured, lobbying expenses, losses from the sale of your home, furniture, personal car, etc, lost or misplaced cash or property, lunches with co-workers, meals while working late, medical expenses as business expenses other than medical examinations required by your employer, personal disability insurance premiums, personal legal expenses, personal, living, or family expenses, political contributions, professional accreditation fees, professional reputation, expenses to improve, relief fund contributions, residential telephone line, stockholders’ meeting, expenses of attending, tax-exempt income, expenses of earning or collecting, value of wages never received or lost vacation time, travel expenses for another individual, and voluntary unemployment benefit fund contributions, wristwatches.
Reporter Andy Kiersz at Business Insider has been pouring through the US Census Bureau’s American Community Survey database. The ACS is a Census-like measure of demographic information about the USA that is published once a year, and the 2013 data just became available.
His post today caught my attention, which was the youngest median population town or village in each state. The winner for the entire United States is right in our backyard: Kiryas Joel, New York.
Kiryas Joel is a village whose residents are primarily Satmar Hasidic, a sect of Orthodox Judaism who seem to generally reject modern, secular culture. Anecdotally, marriages seem to happen relatively young, and families tend to be large, with an average household size of 5.7 twice as high as the New York State average of 2.6, which is the cause of the low median age.
The effect that Kiryas Joel has on the region, particularly with regard to social services, is profound. According to a 2013 report, a full 93% of the village’s population either receives Medicaid or the Medicaid-funded Family Health Plus. Due to the high birth rate, the village continues to grow exponentially as well, with the population expanding at a rate of about 3-4% per year.
Much of the developed world, meanwhile, is experiencing a slowing birth rate, as wealthier and more educated populations tend to produce less children at a young age. This has a very serious economic impact in the extreme cases (see Japan, China).
Thus, as much as Kiryas Joel skews demographics today, it looks like it will yield a greater influence going forward as its population continues to grow, particular in relation to slowing trends elsewhere in Orange County and New York.
COURT DISCUSSES MUTUAL FUND FEES. “[P]articipants’ retirement benefits are limited to the value of their own individual investment accounts, which is determined by the market performance of employee and employer contributions, less expenses. Expenses, such as management or administrative fees, can sometimes significantly reduce the value of an account in a defined-contribution plan.”
As seen above, the Supreme Court noted that mutual fund expenses “can sometimes” significantly reduce the value of investment accounts. This statement can be read several different ways.
The Supreme Court noted these facts in the case: “Petitioners contend that respondents breached the duty of prudence by offering higher priced retail-class mutual funds when the same investments were available as lower priced institutional-class mutual funds.” However, the Supreme Court did not opine on this aspect of the case, nor upon the trial court’s finding that the plan sponsor “had ‘not offered any credible explanation’ for offering retail-class, i.e., higher priced mutual funds that ‘cost the Plan participants wholly unnecessary [administrative] fees,’ and [the trial court] concluded that, with respect to those mutual funds, [the plan sponsor] had failed to exercise ‘the care, skill, prudence and diligence under the circumstances’ that ERISA demands of fiduciaries.”
Nevertheless, given the clear duty of due care of an ERISA fiduciary to justify higher-cost funds, the burden is very heavy upon an ERISA fiduciary to recommend higher-cost investments when lower-cost investments are available which are substantially similar in terms of their composition, risks, and expected returns. One of the key issues for analysis of the “Best Interests Contract Exemption” is whether higher fees and costs incurred – that results in additional compensation to the broker-dealer firm or insurance company – can ever be justified under ERISA, and if so, what this justification would look like. What is the evidentiary standard for such justification to withstand scrutiny? The Supreme Court’s decision does not directly address these issues, but it is clear that justification must be credible.
COURT DISCUSSES THE ERISA FIDUCIARY’S DUTY OF DUE CARE. “An ERISA fiduciary must discharge his responsibility ‘with the care, skill, prudence, and diligence’ that a prudent person ‘acting in a like capacity and familiar with such matters’ would use.”
This statement of the ERISA fiduciary’s duty of due care follows many prior decisions.
Note that the U.S. Supreme Court did not discuss the ERISA fiduciary’s duty of loyalty, nor did the Court discuss procedures to be followed under ERISA when a fiduciary possesses a conflict of interest.
COURT DISCUSSES THE ONGOING DUTY OF THE FIDUCIARY TO MONITOR INVESTMENTS. “[U]nder trust law [from which an ERISA fiduciary’s duties are derived] a fiduciary is required to conduct a regular review of its investment with the nature and timing of the review contingent on the circumstances.” The Uniform Prudent Investor Act confirms that “[m]anaging embraces monitoring” and that a trustee has “continuing responsibility for oversight of the suitability of the investments already made.” §2, Comment, 7B U. L. A. 21 (1995) (internal quotation marks omitted). Scott on Trusts implies as much by stating that, “[w]hen the trust estate includes assets that are inappropriate as trust investments, the trustee is ordinarily under a duty to dispose of them within a reasonable time.”
“Under trust law, a trustee has a continuing duty to monitor trust investments and remove imprudent ones. This continuing duty exists separate and apart from the trustee’s duty to exercise prudence in selecting investments at the outset. The Bogert treatise states that ‘[t]he trustee cannot assume that if investments are legal and proper for retention at the beginning of the trust, or when purchased, they will remain so indefinitely’ … Rather, the trustee must “systematic[ally] conside[r] all the investments of the trust at regular intervals” to ensure that they are appropriate … The Uniform Prudent Investor Act confirms that “[m]anaging embraces monitoring” and that a trustee has “continuing responsibility for oversight of the suitability of the investments already made.” §2, Comment, 7B U. L. A. 21 (1995) (internal quotation marks omitted). Scott on Trusts implies as much by stating that, “[w]hen the trust estate includes assets that are inappropriate as trust investments, the trustee is ordinarily under a duty to dispose of them within a reasonable time.”
This lengthy discussion of the scope of the ERISA fiduciary’s duty to monitor addresses the key, albeit narrow, issue in the Tibble v. Edison case, which involved when action occurs which is actionable (i.e., when action occurs which tolls the statute of limitations, within which time a claim must be brought).
This aspect of the decision reminds us that ERISA fiduciaries – firms and their representatives – possess an ongoing duty to update their due diligence as to investments previously recommended to a client, at least where the client remains a client of the firm.
IN SUMMARY. Only a small amount of guidance can be inferred from the Court’s Tibble vs. Edison decision. Yet, the Court’s decision can serve as a reminder of the high level of due diligence required in the selection of investments. Moreover, the Court’s acknowledgement of the significant role played in mutual fund expenses in a plan participant’s retirement account value will likely result in a strong focus on the type of justification required to recommend higher-cost investments, especially where higher cost investments result in greater compensation to the ERISA fiduciary (as proposed to be permitted under BICE).
As we approach 2015, I share with my “wish list’ for the DOL, SEC, state securities regulators, and the various voluntary professional associations.
And I encourage YOU to undertake simple act, involving just a few minutes of your time, which may well serve to put us back on the path toward a true profession.
financial/investment advisors. Who will lead? Who will merely follow? Which organizations will embrace bona fide fiduciary standards of conduct for its members? Which organizations will be “fiduciary pretenders” without such a commitment?
- The DOL should apply fiduciary duties upon all who provide advice to all retirement plan sponsors and plan participants. Exemptions from the “sole interests” standard should be limited and used only where plan sponsors and participants are truly benefitted by the exemption.
- The SEC should apply nonwaivable fiduciary duties to all registered investment advisers, even dual registrants.
- When any investment advisory account exists for a client, or when fiduciary duties otherwise attach to the relationship, these fiduciary duties should extend to the entirety of the relationship, and any fiduciary-client relationship should not be capable of being switched to an arms-length relationship.
- In order to prevent actual fraud (i.e., “bait-and-switch”) and to eliminate widespread consumer confusion, dual registrants who utilize titles denoting relationships of trust and confidence, such as “financial advisor,” “financial consultant,” “financial planner,” “wealth manager,” or “estate planner,” or who use designations which incorporate such terms, should be held to the fiduciary standard at all times, for all clients.
- The SEC should also apply fiduciary duties to all providers of personalized investment and financial advice, regardless of registration of the advisor, when a relationship of trust and confidence exists between the advisor and the client.
- In so doing, the SEC is merely restoring the principle – followed by the SEC and even the NASD (precursor to FINRA) prior to the 1970’s.
- The various states should then follow the SEC’s lead, modifying state statutes and regulations to apply fiduciary duties to all providers of personalized investment and financial advice, regardless of registration of the advisor, when a relationship of trust and confidence exists between the advisor and the client, and providing individual investors the right to bring claims under state law.
- “Advice” should be broadly defined to include any circumstance in which the advisor states whether an investment strategy or investment product is recommended to a client. Mere descriptions of an investment product should not, without more, trigger application of the fiduciary standard; i.e.,product seller-customer arms-length relationships should still exist under the law, provided that the arms-length nature of the relationship is laid bare and not obscured.
Apply the Fiduciary Standard to Reduce the Number of Regulations, the Size of Government, and the Need for Wall Street Oversight and Proposed Professional Standards of Conduct for the Delivery of Personalized Investment Advice.
- Understand the substantial public policy reasons which support the broad application of fiduciary principles to the delivery of personalized investment advice. If you don’t understand the rationale, you’ll never understand the fiduciary duties themselves, nor how they should be applied and enforced.
- As alluded to above, don’t permit fiduciary duties to be “waived” by clients, as often inappropriately occurs (just look at the Form ADV, Part 2A, and client services agreements, of many dual registrant firms). Realize that estoppel plays a much more limited role in fiduciary law than it does in arms-length relationships.
- Correct the inappropriate rule in which “portfolio turnover” is reported by mutual funds as the lower of purchases or sales of securities, relative to net assets of the fund, rather than their average.
- Eliminate 12b-1 fees, for all the reasons I have previously written about.
- Eliminate sharing of securities lending revenue by mutual funds and ETFs. Securities lending revenue belongs to fund shareholders. If the investment adviser to the fund desires additional compensation for undertaking revenue sharing activities, this should be reflected in the funds’ management fees. If affliates are utilized to effect securities lending, then benchmarking of the fees of those affiliates should be utilized, with compensation paid to affiliates not to exceed average levels.
- As mentioned above, ensure that those who promote themselves with the use of titles or designations which denote a relationship of trust and confidence don’t then seek to absolve themselves of their fiduciary obligations. Compelling reasons exist for the distinctions to be made.
- Don’t permit any securities firm to use client testimonials. Or permit them all to. Just be consistent (and fair) about the rule. Of course, continue to prohibit misleading ads.
- Repeal the “two hats” and “switching hats” temporary rule of Sept. 2007. Don’t condone consumer confusion, nor encourage misrepresentation and fraud, via SEC rules.
- Don’t permit any securities firm to state “we act in the best interests of our client” or “we provide objective advice” (in any communication, including its Code of Ethics unless the firm and its advisors are willing to practice as bona fide fiduciaries to each and every client, at all times. Otherwise, bait-and-switch (via intentional misrepresentations) occur. And don’t permit language which couches such obligations with language such as “we seek to” or “our advisors aspire to” act objectively and/or in the best interests of clients – as the fine distinction between actually doing vs. aspiring to are the source of much client confusion about broker’s obligations to the client. As the SEC alluded to long ago, arms-length relationships should never be disguised.
- Don’t permit FINRA to state that all brokers and their registered representatives are required to act in their client’s “best interests” unless all of these brokers and registered representatives are willing to accept bona fide fiduciary duties at all times. Otherwise, FINRA just continue to obfuscate by attempting to re-define “best interests,” the common expression of the fiduciary duty of loyalty, as something less than what it means. This just creates more confusion for consumers, as well. Require FINRA to modify its previous statement (in “guidance” provided to its members), in this regard.
- Further restrict soft dollar compensation. Inspect soft dollar arrangements, to ensure that any payments for research are comparable to the cost of research which could be obtained through other means, and ensure that the research is actually utilized.
- Eliminate payments for shelf space and other revenue-sharing.
- Eliminate payment for order flow. You can’t achieve true best execution when such huge economic levers exist in opposition to the requirement for best execution.
- Investigate proprietary mutual funds when used by institutions (banks, investment advisory firms). Are all management fees and 12b-1 fees being rebated to the client of the fiduciary, to avoid double dipping? Are the administrative fees of the fund artificially high (seen in some banks’ proprietary funds, when management fees are rebated but administrative fees are not).
- Eliminate any and all “secrecy” clauses with regard to settlements; require public disclosure of all settlements through regulatory filings for same
- When arbitration is agreed to by a client, require all arbitration in securities matters to be undertaken in independent (non-FINRA) forums. It is extremely important that tribunals be perceived by the public to be fair; as long as they exist under FINRA, that perception will not exist.
- End the “revolving door” between the SEC and Wall Street (and the law firms that serve Wall Street firms). Ban any compensation bonuses to Wall Street executives that go to work for the SEC. Ban SEC staffers from any direct contact with SEC commissioners and staff for three years after they leave.
- Eliminate inspections of custody arrangements by private auditors. Seek “inspection fees” or “examination fees” from Congress for taking these inspections in-house. A more focused fee, the amount of which is statutorily determined and which is tied to assets under advisement for which custody is assumed, would likely be more palatable to Congress than broad “user fees.”) Properly undertaken, government inspections (whether by SEC or state securities examiners) are far more effective in uncovering fraud than private audits will ever be. Firms that don’t possess custody would remain exempt from such fees.
- Become again what the SEC once was – one of the most respected agencies of government.
- Let the SEC once again steer our capital markets system to become the grease for the wheels of capitalism, not the sludge it is currently in which a major portion of corporate profits are siphoned off and never reach the hands of individual investors.
I encourage state securities regulators to clearly state that disclosure of a conflict of interest does not “cure” same, and that much more is required of a fiduciary providing personalized investment advice. Disclosure of all material facts, affirmatively made, and client understanding subjectively assured by the advisor. Informed consent – and with the realization that no client would consent to be harmed. And even then, the transaction proposed must be substantively fair to the client.
I encourage state securities regulators to compel all fiduciary advisors to adopt a fiduciary professional code of conduct, similar to the one I have previously suggested. This will guide the advisors on their fiduciary obligations, as well as provide insights for clients of advisors and examiners.
[I wonder if the CFP Board’s long-standing cry of “one designation, one profession” as a means of advancing the CFP certification among financial planners might turn into “one designation, one non-profession (trade group).”]
- Would the organization be willing to have all of their members be required to sign a non-waivable, always-applicable “Fiduciary Oath”; and
- Would the organization be willing to adopt, for its members, these bona fide fiduciary principles as suggested in these Standards of Professional Conduct.
Why this test? It has always struck me that many organizations say they support a true fiduciary standard. In reality this is may be a marketing ploy for the organization, an attempt to punt the issue to a later time, or a wholly different view of what the fiduciary standard is all about. It’s time we know where each organization really stands. Let them state what principles they agree with, and let them state with particularity principles with which they disagree (or are unwilling to adopt), so that we know where each organization really stands.