Whether you do some research online, or ask a friend, you may find it difficult to fully understand what working with a financial planner actually entails. There are some great online resources that provide a general description of services; however, I find it amusing that many of these articles are rarely written by an actual planner.
Within this search, you may find that some just provide financial planning services, others just handle the investments or simply sell insurance products. But not to be forgotten, there is a subsect of the planner world that assists their clients in making sense of and advising on the entirety of their situation.
In my opinion, the most talented and well-rounded financial planners are the ones who connect the dots for their clients. I do not believe it is a coincidence that their planners also seem to have satisfied and happy clients.
While everyone’s situation is different across incomes, net worth, goals, etc. each client that I work with goes through the same process. Within this engagement we may spend more time on a few particular topics than others if we identify a greater need or priority, but regardless, we always make sure to touch upon each aspect of their situation. As you may come to find out – they are all important and effect one another!
With that said, today I will walk through the process I take every single client through when they enter into a financial planning engagement. The hope is to provide a better understanding of what this type of arrangement looks like, and why it is important to loop in every aspect of financial planning.
1. Identify your goals & understanding your why
It is extremely difficult to develop a proper life and financial plan without first understanding where you’d like to land, and why you want to land there. In my opinion, this is a very important step that works to ‘go beyond the numbers’ to uncover what it would all mean to reach the end of this goal, and make some sacrifices in the meantime, to get there.
Clients can typically answer what their goals are pretty easily, but when I ask why they want to achieve these specific things, they often are silent. Rightfully so, this is a very hard question to answer – my wife and I refine our personal ‘why’ at each stage of life – and I always remind clients that these goals and this why are not set in stone. Having said that, in my experience, when clients are able to formulate some definition of their why, the financial decisions required to get them there often complete themselves.
So, in this initial first step we work to understand where we are, where we’d like to go and why - then we begin to lean into what steps we need to take to get there. If you can provide yourself some clarity here, it is that much easier to put an action plan in place that has the capacity to provide a great level of choice and flexibility from a lifestyle perspective.
2. Financial Snapshot – balance sheet, income sources, expenses, retirement picture
Once we establish our why, we will want to dig more into the numbers. This is where we begin by putting together a balance sheet detailing all financial assets and liabilities – bank accounts, investment & retirement accounts, HSA’s, primary residence value, rental property value, mortgage balance(s), personal loans, student loans, car loans etc. This simple exercise confirms that we are accounting for all relevant line items and gives us a quick snapshot of the net worth figure (assets – liabilities = net worth) to gauge current financial strength.
Next, we will review paystubs, tax returns, debt statements to build a model of the client’s cash flow. This may seem like a simple task, but cash flow is the backbone of our financial engines. You may earn $300,000 of income, but if you subtract out taxes, debt payments, living expenses, and nothing is remaining for savings, investments, retirement accounts, cash reserve, etc. – it is going to be difficult to truly build the wealth required to get you to your why with flexibility and choice.
I always tell clients, it does not matter how much income you earn, you always need to have a good handle of your cash flow to understand how much you are actually keeping.
A good starting point is to understand how much you earn on a gross level, how much you take home, how much you are contributing (if any) to retirement, how much you are spending monthly on discretionary means and debt payments, and finally, what level of surplus you have (if any). Once we have an idea of these figures, we are able to identify where adjustments need to be made and come up with a plan to make these changes as smoothly as possible – efficiency is key here.
The above also helps us paint a picture of the long term – i.e. how on track (or off track) we are to retiring at age 55, purchasing the covet beach house, fully funding children’s education.
Moreover, some of these changes we identify could be to allocate more dollars to specific debt payment as a result of their interest rate, pay off a debt in cash, increase the amount going into retirement accounts for current and future tax purposes (more on this later), allocate more funds to non-retirement accounts, or work on building up your cash reserve (emergency / slush fund). Additionally, depending on the level of expenses you have, a good rule of thumb is to have 4-6 of expenses in something liquid for emergencies. If you are a business owner, this should be more in the range of 9-12 months.
3. Tax Planning
In my experience, this is an area where clients seem to be extremely underserved and can potentially make an improvement. When I ask new clients (who sometimes transition from another advisor) how the previous advisor handled tax planning, they mention that it was never discussed. Or, if it was, the advisor would mention that it is not something they assist with, and to go talk to their CPA.
While CPAs are awesome and do a phenomenal job for clients, I find that many of them only help with ‘cleaning up what happened last year’, instead of making planning adjustments for the year ahead to avoid a surprise at tax filing (owing a large amount), or facing a tax bomb during a client’s retirement / withdrawal years.
To be clear, I am not a CPA, but I do aim to assist clients with identify tax planning opportunities, then confirming with their CPA that we are thinking about it the right way prior to making any decisions.
So, on the high level I review the following with clients as we navigate tax planning:
- Understanding what level of taxes they are paying today
- W2 employee – being aware of the amount they are withholding and if adjustments need to be made
- If self-employed how much they could owe and plan around it using quarterly estimates
- Reviewing a client’s past few years of tax returns allows us to understand the marginal tax bracket they are in now, and what this bracket could be in retirement under current tax laws.
- This leads to decisions concerning:
- Pre-tax vs. ROTH retirement account contributions (401k, 403b)
- For business owners
- SEP IRA
- Solo 401k
- For business owners
- Maximizing the Qualified Business Income Deduction (QBI)
- Understanding and planning for self-employment taxes
- Determining if it makes sense to be an LLC filing as an S Corp depending on size, revenue, employees, etc.
- Individual ROTH Contributions
- Back door ROTH
- HSA contributions
- Contributions into a non-retirement account for current and future flexibility from a liquidity and favorable tax rate perspective (capital gains rate vs. ordinary income)
- Charitable Contributions (if inclined)
- Donor-advised fund
- Direct cash contribution
- If you own real estate and are planning an exit
- Understanding the level of capital gains taxes and depreciation recapture taxes you could face upon the sale
- For business owners
- Pre-tax vs. ROTH retirement account contributions (401k, 403b)
- This leads to decisions concerning:
The above are just a few examples of the opportunity’s clients have to make smart tax planning decisions – sometimes even years ahead.
When we run the analysis out comparing their current situation vs. making these adjustments, we sometimes find that the changes can reduce their lifetime tax bill.
Informed decision making concerning one’s tax planning can be a great asset for the present time and the future!
4. Investment Planning
A client’s investment planning can take on many forms depending on their stage of life.
In essence, our goal here is to understand how the client is allocated, their thoughts, feelings, and education on their current holdings, and what adjustments need to be made. The goal is diversification, simplicity, and efficiency.
When we put all of the client’s accounts together to form an overall allocation plan, the results can be surprising – some clients are not aware how they were invested. Here, I always state that looking at how one account is allocated does not tell the whole story. Furthermore, even if an account is allocated to 80% equity & 20% fixed-income, what is actually owed in each sub asset class can drastically effect the efficiency, return, and tax treatment of the account.
This is why we utilize a specific software to run performance reports on every client’s accounts – 401ks, 403b, IRA’s taxable accounts – to confirm they are acting as intended. We compare each account to the appropriate benchmark – i.e. a 60% equity & 40% fixed-income portfolio is compared to a 60 / 40 benchmark. Sometimes, we find that accounts are underperforming their benchmark, again, not all allocations are created equal as a result of the underlying holdings.
This type of discovery can help us in the adjustment of allocations. Moreover, in taxable accounts we often find that the underlying holdings are not very tax efficient – and the account is kicking off unnecessary capital gain distributions or dividends. Again, another opportunity for improvement.
The above recommendations are all completed in the planning process without actually taking over management of the account. However, in full disclosure, some clients may ask for additional help in managing the account, and this is an engagement that can be discussed outside the scope of the planning relationship.
5. Protection Planning (Insurances)
An extremely important topic to be looped into the planning process as understanding and talking through a client’s protection options allows us to connect the dots to investments, cash flow, balance sheet, etc.
As client’s continue to do great things and increase their net worth (and as a result their flexibility), they are more in need of protecting their assets in the worst case type of scenario:
- Premature death
- Disability event
- Car accident
- Damage to their home
- Being sued
Even though we all may believe one of the above will not happen to us, these events unfortunately affect families every day. Therefore, we make it a point to account for all insurance clients have in place and determine if improvements are warranted.
This involves:
- Life Insurance
- Disability Insurance
- Home & Auto Insurance
- Liability Protection (Umbrella Policy)
- Business Insurances (if self-employed)
For many of these, I make sure my clients are connected with the appropriate trusted professionals who can properly assist them with their coverage needs. The goal is to review what they have, understand what gaps there are, and take the required steps to protect what they have built!
6. Estate Planning
It does not matter how old the client is, if they have children, or the level of their net worth, every single client that engages with me needs to be thinking about their estate plan.
Many will say they do not need it because they do not have enough assets, their situation is too simple, or because taking action in this area is very expensive. When in reality, the cost of not doing anything can far outweigh the upfront cost to execute these documents if something were to transpire. In addition, some of the options in this area actually protect families while they are living, versus being perceived as only useful if someone passes away.
While, I am not an attorney, nor do I claim to be one, within the planning process we review with clients the meaning and purpose of Wills, Medical Directives (healthcare proxies) and Powers of Attorney (financial powers). In the worst-case scenario, these types of documents elect who will make financial or medical decisions on your behalf, who will have guardianship of your children if both spouses pass away, and how the estate will be distributed.
Many clients often ask about Revocable Living Trusts and their purposes both while living, and when one passes away. This type of entity could make sense if more privacy is preferred, aiming to avoid probate, or if clients would like to have ‘control from beyond the grave’ in regards to who receives assets and when they receive them. In higher level cases, proper estate planning can be crucial to reduce state or federal estate taxes. Which also affects one’s investment, tax and protection planning today!
We always instruct clients to meet with a qualified estate planning attorney to walk through and execute these documents. With this, I aim to work closely with the client’s attorney to be sure they have all the information they need to assist folks in implementing these strategies.
Tying it all together
I am cognizant of the fact that the above is a lot of information to digest. However, understanding what goes into forming and maintaining an efficient financial lifestyle is crucial to make adjustments to your own situation.
For example, you may have a sound investment strategy during your accumulation years, but if you did not properly plan taxwise, there could be a tax bomb waiting to explode once you take withdrawals. The growth you positioned yourself for over the years may be going more into Uncle Sam’s pocket, then into your own pocket.
And as I tell clients, the initial plan is just a point in time, as your situation changes the numbers portion needs to be nimble to accommodate these changes and make further improvements.
If you need assistance on your financial planning journey, make an effort to connect with a CFP® to ensure you are receiving unbiased advice. Of course, all CFP®’s are not created equal, but this is always a good place to start.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give tax or legal advice.
Some IRA’s have contribution limitations and tax consequences for early withdrawals. For complete details, consult your tax advisor or attorney. Distributions from traditional IRA’s and employer sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching age 59 ½, may be subject to an additional 10% IRS tax penalty. Converting from a traditional IRA to a Roth IRA is a taxable event.
Asset allocation is an investment strategy that will not guarantee a profit or protect you from loss.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.
The use of trusts involves a complex web of tax rules and regulations. You should consider the counsel of an experienced estate planning professional before implementing such strategies.