Our 2 Cents
Do you know whether your financial adviser is legally required to act in your best interest? Many investors may be surprised at the question. Shouldn’t all advisers be required to put their clients’ interests first, try to avoid conflicts of interest, be transparent about the reasons for advising certain financial moves and the fees that might be involved? In our opinion, yes, they should. (Our firm has been a registered investment advisor, RIA, since we opened in 1997, which means that we have always operated under this standard.) However, this is not always the case. A new rule from the Department of Labor (DOL) has shifted the industry in that direction, but the shift is still imperfect and incomplete, as we discuss below.
What Is the New Rule? This month, a new DOL rule targeted at financial advisers went into partial effect. The rule requires that financial advisers giving advice on retirement accounts such as 401(k)’s and IRAs be held to a fiduciary standard of care, meaning that they are legally bound to act in the best interest of their clients—putting clients’ interests above their own financial or other interests. The DOL first proposed this rule in 2010, in part because many investors were unaware that their advisers were held to a much lower standard of care (called the “suitability” standard) and that they were paying a significant amount on commissions and fees. Even earlier this year, a survey by the American College of Financial Services found that 48 percent of respondents working with a financial adviser did not know whether their adviser was a fiduciary or not.
What Does It Mean that the Rule Went into “Partial Effect”? As might be expected, advisers that have operated for years under a lower legal standard have objected to the new fiduciary rule. There has been significant lobbying against it, and its implementation has been delayed multiple times. On June 9th, the rule went into partial effect, meaning that advisers should now act as fiduciaries with respect to retirement accounts, but the rule will not actually be enforced until after it goes into full effect on January 1st. In the meantime, the DOL will continue to solicit public comments on the issue and deliberate whether the rule should be revised prior to full implementation.
This past May, DOL Secretary Alexander Acosta wrote, “Trust in Americans’ ability to decide what is best for them and their families leads us to the conclusion that we should seek public comment on how to revise this rule.” In the words of Washington Post columnist Michelle Singletary, “What malarkey.” Given how difficult it can be for those with limited financial knowledge or experience to decipher the costs and implications of different investment options, we respectfully disagree with Secretary Acosta and think that Americans could use a hand in protecting their savings and investments. Whether this will come to pass, however, is yet to be determined.
Why Is the New Rule Incomplete? In a post last year, we discussed how the final version of the DOL rule includes many exemptions and means by which brokers can continue earning excessive commissions for pushing particular investment products, even ones with notoriously high fees such as variable annuities. The stipulations of the rule may be watered down even further prior to implementation on January 1st. Furthermore, the rule only applies to advice on retirement accounts. If a financial adviser is managing a taxable account (non-retirement investments) for a client, he or she could still only be held to the lower suitability standard, meaning that brokers must simply have a “reasonable basis” for believing that a particular investment they sell is “suitable” for a client, considering a client’s circumstances.
Again, Professional Financial Solutions has already been operating under a fiduciary standard with respect to all of our clients’ investment accounts—retirement and non-retirement—since the year our company was founded, so this new rule does not significantly impact our manner of doing business. We will continue to discuss with clients the pros and cons of any financial moves, promote low-cost investments as the most effective way of building clients’ wealth, and try to operate with complete integrity in how we advise our clients on financial planning and investment issues.
**If you’re interested in learning more about the fiduciary standard and other factors to consider in finding a financial adviser that you can trust, an informative (and fun) place to start is comedian John Oliver’s Last Week Tonight episode on retirement plans.v
After decades of faithfully paying their mortgage, many retirees find themselves in a position in which they have significant equity in their homes, but cash flow is tight due to low retirement income and/or savings. Looking for a source of funds to pay for daily living expenses or perhaps increased medical bills, some turn to the idea of reverse mortgages, thinking that trading some of the equity in their home for a lump sum or an income stream over a number of years could be the answer to their problems. Unfortunately, in some cases, this tactic generates more problems for the borrower, their spouse, and/or their heirs down the road. Before entering into a reverse mortgage agreement, you must make sure that you understand the terms and features of your particular agreement and that you consider carefully the pros and cons, as discussed below.
Features of Reverse Mortgages:
- Borrower must be age 62 or older and must have either no mortgage or a low enough mortgage balance that it can be paid off with loan proceeds.
- Equity in your home is traded in exchange for payments received monthly, as a lump sum, or as needed through a line of credit.
- The loan usually does not have to be repaid until you die, sell your home, or move out.
- There are three types of reverse mortgages: single-purpose (government agencies or nonprofits are the lenders, funds must be used for one purpose such as home repairs or property taxes); proprietary (private companies are the lenders, funds can be used for any purpose); or Home Equity Conversion Mortgages, HECMs (U.S. Department of Housing and Urban Development is the lender, funds can be used for any purpose). A subset of HECM loans, called HECM for Purchase, allow retirees to buy a new home using a reverse mortgage.
- Reverse mortgages are a source of income that still allows you to stay in your home, and loan proceeds are generally tax-free.
- Income from reverse mortgages generally does not impact your Social Security or Medicare payments.
- Most reverse mortgages include a “non-recourse” clause, so that you or your estate cannot owe the lender more than the appraised value of the home when the loan comes due, even if the accrued interest and fees exceeded that amount.
- As a borrower, you will pay significant upfront costs due to the mortgage origination fee, mortgage insurance, and closing costs on the loan. These costs are even higher if you borrow more than 60% of the available proceeds in the first year.
- Going forward, you will continue to pay regular servicing fees, and interest owed on the loan will grow on a monthly basis.
- The interest rate charged on the loan may change over time (most have variable rates).
- Reverse mortgage income may impact your eligibility for Medicaid or Supplemental Security Income benefits.
- Since you keep the title on your home, you are still responsible for home maintenance and repairs, property taxes, insurance, etc. If you neglect any of these, the lender may require the loan to be repaid.
- A spouse or other family member living in the house could be forced out when you die or move out (such as if you needed to move into assisted living), unless they can afford to repay the loan. Even if spouses are allowed to stay in the home (e.g. in the case of some HECMs), they will not continue to receive payments from the lender if they were not part of the initial loan agreement.
There are many reasons to hesitate before taking out a reverse mortgage, but it still may be a sensible option in some cases, especially if you are in the later stages of retirement and can have some assurance that you will be able to stay in your home until life expectancy. However, if a spouse, adult children, or other family members are living in the house, they must be part of the discussion and understand how they may be impacted if a reverse mortgage becomes due. Furthermore, as Nick Clements of Forbes warns, “Don’t underestimate how quickly a reverse mortgage’s compounding interest erodes your equity.” Consider whether downsizing your home; obtaining a home equity loan, line of credit, or cash-out refinance; or finding some other source of income may be a better solution—not just for you, but for your heirs as well.