Wealth Preservation and Those Pesky 401(k)/403(b)/IRA Beneficiary Forms

Everybody hates paperwork. So when employees and investors are asked to fill out all the paperwork associated with 401(k) plans and individual retirement plans (IRAs), most people just enter something without giving it  much thought.

When I was a compliance officer, I would always cringe when I saw that the designated beneficiary was “estate.” Unless there is absolutely no other choice, choosing as the designated beneficiary on a 401(k), 403(b) or IRA is absolutely the worst choice anyone can make, as it effectively prevents the account owner’s heirs from using various options that can be used to maximize the account’s value through the use of “stretch” options and individual inherited accounts. Fortunately, the owner of the 401(k), 403(b) or IRA can always go back and execute a new beneficiary form to address such issues.

Beneficiary forms present other issues for retirement account owners. One often overlooked issue is the question of whether the custodian of the retirement account still has the account owner’s beneficiary form on file. Clients are often surprised when I suggest that they confirm that their custodian can produce their beneficiary and provide the client with a certified copy of the beneficiary form. They are even more surprised when the custodian cannot comply with the request.

With all the mergers and consolidation that has occurred in the financial services industry over the past few years, it is not unusual for a custodian to be unable to produce the retirement account’s beneficiary form. Unfortunately, it is not uncommon for custodian’s to have a policy dictating that in the absence of a beneficiary form, the default beneficiary is the account owner’s estate, regardless of who is at fault for the inability to produce the beneficiary. First year law school – the large print giveth, and the small print taketh away.

I usually handle one or two cases a year involving a custodian’s inability to produce the beneficiary form for an account. The potential implications for the owner’s heirs, both in terms of taxes and honoring the owner’s wishes, can be significant.

By requesting a certified copy of the account’s beneficiary form, the account owner can verify that the custodian has a copy of the account’s beneficiary form and obtain a certified copy of same, ensuring avoidance of the “estate as beneficiary” problem. In the event that the custodian is unable to produce the original beneficiary form, the account owner can execute a new beneficiary form and have the custodian provide them with a certified copy of same.

Owners of retirement accounts often name their spouse as the primary beneficiary of the retirement accounts. Owners should always name a contingent beneficiary or beneficiaries, if possible, so as to avoid the “estate as beneficiary” problem. Owners often name their children as contingent beneficiaries. I strongly recommend that owners wishing to name multiple beneficiaries and/or non-human beneficiaries, e.g., trusts or foundations, consult with counsel experienced in retirement account law, as there are various issues which, if not properly addressed, can prevent the owner’s original wishes from being accomplished.

Banks and other retirement account custodians often refuse to use anything other than their standardized, “cookie cutter” forms. Unfortunately, such standardized form often do not properly address the potential tax and inheritance issues involved with multiple beneficiaries and non-human beneficiaries.

Proper counsel can draft the beneficiary forms needed to protect the account owner and ensure that his wishes are accomplished. Some custodians will work with an owner’s counsel on such issues, others will not. By addressing such issues and identifying difficult custodians who do respect the account owner’s wished, the account owner can find a better custodian for the account.

Account owners should never accept a custodian’s representations regarding retirement account law as the final word on the subject. From experience, both as an attorney and a former compliance director for several broker-dealers, I can tell you that the consistency and accuracy of a custodian’s internal operations staff can vary widely, even day-to-day. Sad, but true.

Retirement accounts are often a major asset in one’s estate. Consequently, retirement account owners need to either take the time to carefully read retirement account documents to retain counsel to read and interpret such documents in order to prevent unwanted tax issues and to ensure that the account owner’s wishes are accomplished.

Retirement account owners should also review the beneficiary forms for such accounts on a regular basis to ensure that they still reflect the owner’s wishes. There are several cases where ex-wives have received the proceeds of their ex-husband’s retirement account because the ex-husband forgot to execute a new beneficiary account form for the account. In the leading case on this issue, Kennedy v. Kennedy, the U.S. Supreme Court ruled that although the ex-husband’s will left the retirement account to his new wife, the beneficiary form on retirement related accounts controls the disposition of the retirement account, not the terms of any will left by the retirement account’s owner.

Posted in Asset Protection, Common Sense, ERISA, Investment Advice, Investment Portfolios, Investor Protection, IRA, Life Advice, pension plans, Retirement, Retirement Distribution Planning, Retirement Plan Participants, Retirement Planning, Wealth Distribution, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , , , , ,

Avoiding Costly “Closet” Index Funds

I am a member of the Paladin Registry, a select group of attorneys and investment advisers dedicated to educate investors so that they can better protect themselves against investment fraud and other questionable activity by the investment industry. You can review some of my articles at http://www.paladinregistry.com.

I just posted a new article discussing the unnecessary costs associated with so-called “closet” index funds, funds that charge fees that are often 3-4x higher than true index funds while providing similar, in some cases lower, returns. You can review the article at http://www.paladinregistry.com/blog/investing-2/avoiding-costly-closet-index-funds/

Posted in Asset Protection, Investment Advice, Investment Advisors, Investment Fraud, Investment Portfolios, Investor Protection, Portfolio Construction, portfolio planning, Portfolio Planning, Retirement, Retirement Plan Participants, Retirement Planning, Uncategorized, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , , , , , , , ,

1 + 1 = 34: The True Impact of Mutual Fund Fees

One of the most common mistakes I see investors make is failing to understand the true cost of investment fees. Many investors dismiss an annual management fee of 1 percent as “just” 1 percent.

Just as investment returns compound over time, so does the impact of investment fees. Over a twenty year period, a fee of “just” 1 percent reduces an investor’s end return by approximately 17 percent. Throw in an advisor’s usual annual advisory fee of 1 percent and an investor has reduced their end return by 34 percent. If an advisor persuaded an investor to purchase a variable annuity, with annual fees of 2 percent or more being the norm, the cumulative fees of 4 percent would reduce an investor’s end return by 68 percent!

Fees for actively managed mutual funds are typically much higher than the stated annual management fee. This is especially true for so-called “closet index” funds. Closet index mutual funds are actively managed mutual funds that closely track a relevant market index.

Closet index funds are actively managed mutual funds that have a high R-squared rating. A fund’s R-squared rating indicates the percentage of an actively managed mutual fund’s performance that can be explained by a relevant market index. An R-squared rating of 90% would indicate that 90% of the fund’s performance could be attributed to the performance of the market index rather than the fund’s active management.

Professor Russ Miller has developed a metric, the Active Expense Ratio, that uses a fund’s R-squared rating to help investors determine the effective fees that investors pay on actively managed mutual funds. His findings are that investors investing in actively managed mutual funds are usually paying effective annual management fees that are four or more times the fund’s stated annual fee.

A final approach to evaluating the true cost of actively managed mutual funds is based on the incremental cost and incremental return of an actively managed mutual funds. This concept was first introduced by Charles Ellis in “Winning the Loser’s Game,” which I consider to be one of the most helpful book for investors. My proprietary metric, the Active Management Value Ratio, used incremental cost and return, as it more accurately reflects the added cost and added benefit, if any, resulting from active management.

Let’s assume that an actively managed mutual fund has an annual return of 22 percent and an annual expense fee of 1 percent. A comparable index mutual fund has an annual return of 20 percent and an annual expense fee of 0.22 percent. The incremental return of the actively managed mutual fund would be 2 percent, or 200 basis points, and the incremental fee would be 0.78 basis, or 78 basis points. (A basis points equals 0.01 percent, so 100 basis points equals.)

Since the public may have trouble understanding the concept of basis points, I like to present an analogy using dollars instead of basis points. One of the keys to successful investing is to avoid unnecessary fees, as fees effectively reduce an investor’s end return. So which option is better for investors, paying $22 for 20 percent return or paying $78 for 2 percent return? Yet another cost efficiency way of looking at the options would be which option an investor considers more prudent – paying $22 dollars for 20 percent annual return , or $100 dollars for 22 percent annual return.

The answer seems obvious, and yet the Investment Company Institute reports that over 80 percent of money invested in mutual funds is invested in actively managed funds, with a large percentage of the investment coming from pension plans.

Costs do matter.

Posted in ERISA, Fiduciary, Investment Advice, Investment Advisors, Investment Portfolios, Investor Protection, pension plans, Portfolio Construction, portfolio planning, Retirement, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , , , , , , , , , ,


While I normally write about investing and strategies that investors can use to improve their chances for success, every now and then I come across a non-investing piece that I think is worth sharing. Over the years I have seen far too many friends dealing with divorce, depression and other personal issues. In some cases, such issues have been the result of a failure to properly align one’s priorities. As I read this piece, I myself decided to take a break and offer this excellent article as a form of lagniappe, a familiar term here in the South which means “a little extra thrown in.”

“A professor stood before his philosophy class and had some items in front of him. When the class began, he wordlessly picked up a very large and empty mayonnaise jar and proceeded to fill it with golf balls. He the asked the students if the jar was full. They agreed that it was. The professor then picked up a box of pebbles and poured them into the jar. He shook the jar lightly. The pebbles rolled in the open areas between the golf balls. He then asked the students again if the jar was full.  They agreed that it was. The professor next picked up a box of sand and poured it into the jar. Of course, the sand filled everything else. He asked once more if the jar was filled. The students responded with a unanimous “yes.” The professor then produced two beers from under the table and poured the entire contents into the jar effectively filling the empty space between the sand. The students laughed. “Now,” said the professor as the laughter subsided, “I want you to recognize that this jar represents your life. The golf balls are the important things – your family, your children, your health, your friends, and your favorite passions – and if everything else was lost and only they remained, your life would still be full. The pebbles are the other things that matter like your job, your house and your car. The sand is everything else – the small stuff. If you put the sand into the jar first, there is no room for the pebbles or the golf balls. The same goes for life. If you spend all of your time and energy on the small stuff you will never have room for the things that are important to you. Pay attention to the things that are critical to your happiness. Spend time with your children. Spend time with your parents. Visit with grandparents. Take your spouse out to dinner. Play another 18. There will always be time to clean the house and mow the lawn. Take care of the golf balls first – The things that really matter. Set your priorities. The rest is just sand.” One of the students raised her hand and asked what the beer represented. The professor smiled and said “I’m glad you asked. The beers just shows you that no matter how full your life may seem, there’s always room for a couple of beers with a friend.”


Posted in Common Sense, Life Advice | Tagged ,

The Power of the Informed Investor

“Your account is a brokerage account and not an advisory account. Our interests may not always be the same as yours. Please ask us questions to make sure you under-stand your rights and our obligations to you, including the extent of our obligations to disclose conflicts of interest and to act in your best interest. We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits and our salesperson’s compensation, may vary by product and over time.”

The referenced disclosure was part of a rule proposed by the Securities and Exchange Commission (“SEC”) in an attempt to resolve a dispute with the Financial Planning Association over the SEC’s refusal to require stockbrokers providing investment advice for a fee to register as investment advisers under the Investment Advisers Act of 1940. The Financial Planning Association eventually sued the SEC and won the case.

The court struck the proposed rule down, effectively removing the requirement for the disclosure. Lost was a meaningful disclosure that alerted investors to the inherent conflict of interests problem regarding stockbrokers, their ability to legally put their own financial interests, e.g., commissions, ahead of their customers’ best interests. The SEC could have revived the required disclosure in order to help protect investors, in accordance with their stated mission, but they did not do so.

The SEC subsequently commissioned a study by the Rand Corporation that included a study of investors’ understanding of the difference of the legal duties that stockbrokers and investment advisers owe to the public. The study found that a majority of investors mistakenly believed that stockbrokers owe a fiduciary duty to act in their customers’ best interests. Investment advisers are held to a fiduciary standard, which means that they must always act in their clients’ best interests. Stockbrokers are held to a duty to only recommend “suitable” investments, a nebulous term that allows stockbrokers to recommend products that are “suitable,” yet provide higher commissions for the stockbroker than other equally “suitable” investment options.

A study by TD Ameritrade, another broker-dealer, resulted in similar findings. Some of the interesting findings of the studies:

  • Only 29 percent of those polled understood that the primary responsibility of stockbrokers is to sell investment products.
  • 90 percent of the investors polled believe that a stockbroker and an investment adviser who provide the same services should be held to the same standard in dealing with the public.
  • 97 percent of investors agreed that financial professionals should be held to a fiduciary standard requiring that they always put clients’ interests first , including a requirement that anyone providing investment advice must disclose all fees and conflicts.

Both studies demonstrated both the public’s confusion on the fiduciary duty issue and the need for some sort of disclosure statement advising the public of the conflict of interests issues regarding stockbrokers. And yet, to date,  the SEC does not require stockbrokers to disclose the conflict of interests issue

There is a familiar saying – “knowledge is power.” Nowhere is that truer than with  regard to investing. The more knowledge an investor has, the greater his or her ability to detect investment fraud and avoid unnecessary financial losses. Thus, the byline on our blog, “the power of the informed investor.”

I started this blog in order to provide the public with information that they could use to manage their financial affairs proactively to better protect their financial security. (See http://investsense.com/2011/07/09/the-power-of-the-proactive-investor-part-one/ and http://investsense.com/2011/07/09/the-power-of-the-proactive-investor-part-two/) Based on the feedback and emails that I have received, people have found the information on the blog useful and informative.

A recent study found that only 22 percent of the public trust the financial services industry The SEC should take strides toward improving trust in the investment industry by requiring greater transparency on fees and more investor-friendly information that helps investors protect their self-interests.

The SEC needs to act in accordance with its mission statement and enact a regulation that alerts investors to the conflict of interests issue regarding stockbrokers and the potential financial harm that can result to investors as a result of the stockbroker’s ability to put the stockbroker’s financial interests ahead of their customer’s best interests. The studies mentioned herein clearly reflect both the need for such disclosure and the benefits that such transparency would provide in leveling the playing field.

How could someone in good faith argue against the benefits of a disclosure that would inform the public of important information that serves to promote honesty and basic, fundamental fairness, a disclosure that would allow investors to better protect their financial security?

I do not expect the SEC to enact a rule requiring broker-dealers and stockbrokers to disclose their conflict of interests. That is why I have written this post, to make the public aware that stockbrokers can legally put their own financial self-interests ahead of a customer’s best interests. Now help your friends and family and pass the information on.

Happy Holidays!

Posted in Fiduciary, Investment Advice, Investment Advisors, Investment Fraud, Investment Portfolios, Investor Protection, Variable Annuities, Variable Annuity Abuse, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , ,

“Hidden” Assets – Potential Liability Implication of the LaRue Decision for Attorneys, Fiduciaries and Their Clients

During a recent deposition of an executor, I asked the executor, a bank trust officer, whether the bank had evaluated the defined contribution plan in which the deceased had participated. The trust officer replied that the funds in deceased’s account had been distributed pursuant to the beneficiary form for the account. When I repeated my original request, the trust officer became upset and his attorney objected to my question, the old “ask and answered’ objection, saying the trust officer had answered my question.

I explained that my question had nothing to do with the distribution of the deceased’s pension account, but rather with whether the executor had evaluated the defined contribution plan in terms of compliance with ERISA’s requirements. The attorney quickly responded that the bank had no duty to perform such an evaluation.

But does an executor and other fiduciaries have such a duty? I would suggest that in certain circumstances the LaRue decision does create a duty upon certain attorneys and other fiduciaries to evaluate a pension plan’s compliance with ERISA. LaRue recognized the right of an individual participant in a plan to sue the plan for losses sustained in an account due to imprudent acts or other wrongdoing.

Legally, the right to sue constitutes a “chose in action, ” a property right and an asset of the individual involved. An executor has a legal duty to collect all of the deceased’s property/assets and properly distribute them in accordance with the law. Given the fact that various ERISA experts have opined that most 404(c) pension plans are not in compliance with the applicable ERISA requirements, the question of whether an executor or other fiduciaries have a duty to evaluate a pension plan with regard to LaRue rights is a legitimate question, not only in terms of losses suffered, but also in terms of possible breaches of the plan’s fiduciary duties due to non-compliance with ERISA, e.g, excessive fees, conflicts of interest.

In discussing this theory with other attorneys, some have claimed that exploring such an action would unnecessarily delay the administration of the estate. That simply is not true. An executor could quickly administer the estate’s assets on hand and simply leave the estate open pending the resolution of the potential LaRue claims. The executor or other fiduciary would simply need to conduct a cost-benefit analysis to evaluate the merits of pursuing a LaRue claim. Given the potential recovery in a LaRue claim it can be argued that the prudent course of action would be for the executor or other fiduciary, at a minimum, to conduct the cost-benefit analysis and meet with the heirs to discuss the situation.

This situation came up shortly after the LaRue decision was handed down. One of the services that I perform is a forensic prudence analysis of investment portfolios and pension plans. A fellow attorney, noting the wide-spread belief that most 404(c) pension plans are not compliant with ERISA, asked me to perform a forensic analysis of a plan for an estate for which he was serving as executor. As a result of my analysis, the attorney and the heirs decided to file a LaRue claim. The case survived a summary judgement, based largely on the “chose in action”/property right issues previously discussed, and is waiting to be tried or settled.

As a wealth preservation attorney, I focus on both proactive strategies to preserve and protect asset and reactive strategies to recover wealth loss due to improper activity, fraud and similar misconduct. Issues such as potential LaRue claims are what I refer to as “hidden” assets, assets that may only be recognized by thinking “outside the box.” They are valid assets which may not be recognized by attorneys and other fiduciaries due to a lack of understanding of or experience with a particular type of assets. LaRue is a perfect example of this, as many simply the decision as an ERISA decision without recognizing the “chose in action”/ property right issues created by the decision.

Forensic analysis of portfolios and/or pension plans can also be useful in connection with other types of litigation. While divorce cases are usually more time sensitive than probate cases, attorneys involved in cases involving high net worth clients may want to consider performing a forensic analysis to determine the potential recovery that may result from pursuing such an asset. Divorce attorneys that I have worked with have reported that a forensic analysis helped them negotiate a better settlement for their clients, both in terms of the potential asset and the leverage provided by the analysis with respect to a possible LaRue claim.

Many professionals that I have spoken with on this issue have stated that they do not know how to evaluate the value of a “chose in action.” My response is that the first issue should be to determine whether there are improprieties justifying liability to support the “chose in action.” If so, then the process of evaluating the potential value of the “chose in action” should be undertaken.

There are numerous factors which may come into play with regard to evaluating the value of a “chose in action.” While the process necessarily involves consideration of both objective and subjective analysis, the goal should always be to avoid “throwing good money after bad.” Each case necessarily depends on its individual set of facts.

The purpose of this post has been to alert attorneys and other fiduciaries, as well as their clients, of the potential “chose in action”/property right issues that LaRue has created and the need to consider same in order to properly gather and administer all of a deceased’s property in order to ensure that the estate is properly administered, that the heirs receive all of the assets due to them,  and that professionals involved in administering the estate avoid unnecessary liability exposure.

Posted in Asset Protection, ERISA, pension plans, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , ,

Pimento Cheese Sandwiches and Investor Protection

Yesterday I was in North Georgia in connection with a possible case. I took the opportunity to have lunch with a high school classmate who now lives in the area. Both the company and the food were excellent, but both gone too soon. Then again, I’ve never met a pimento cheese sandwich I did not like.

I took the opportunity to take the long way back to Atlanta so that I could enjoy the fall foliage. Once I left the mountains and got back to the highway, my phone exploded with all kinds of bells and whistles. I pulled into a fast food restaurant and checked my phone. Twenty-seven voice mails! So much for what had been a good day.

As I checked the voice mails, they were all meant to alert me to the House of Representatives’ decision to vote on a bill to delay the proposed fiduciary standard for pension plan service providers. In effect, the pension plan service providers have led Congress to believe that the financial services industry cannot operate profitably unless the industry is allowed to continue to put their financial interests ahead of the public’s interests. And the House obviously bought it hook, line and sinker, voting to prevent adoption of a fiduciary standard that would protect the investing public by requiring that the financial services industry always put the public’s interests ahead of their own.

I have written several posts and articles about the Active Management Value Ratio™ (AMVR), a proprietary metric that uses simple subtraction and division to allow investors and fiduciaries to perform a cost-benefit analysis on actively managed mutual funds. In most cases, the AMVR shows that the incremental cost of actively managed mutual funds far exceeds the incremental benefit of such funds, often by at least 300-400 percent. The results of calculating a fund’s AMVR often indicates that the fund in question is not a prudent investment decision. And yet, most pension plans choose actively managed mutual funds as the primary, if not only, investment option for plan participants.

The current debate is largely over imposing a fiduciary standard on advice regarding IRA investments, specifically the recommendation to put one’s pension funds in a variable annuity within an IRA . In many cases one’s pension fund is one of the largest assets a person owns.

Variable annuities are one of the most oversold, most abused and least understood investment products sold to the public. The saying in the industry is that “variable annuities are sold, not bought.” I addressed the marketing tricks used to sell these products in a popular white paper, “Variable Annuities: Reading Between the Marketing Lines.” The paper has been used by the Financial Planning Coalition in connection with its lobbying activities before Congress in support of a universal fiduciary standard for the financial services industry. I highly recommend that anyone who owns a variable annuity or is considering purchasing a variable annuity read the article.

The financial service industry want to protect their right to abuse pension plan and IRA owners for one reason, greed. During my compliance days, I would estimate that 90 percent of my objections had to do with recommendations involving variable annuities. The sales assistants would dread bringing me the paperwork, as they knew I would probably reject the trade as presented with my signature mantra – “All God’s children do not need a variable annuity.”

Variable annuities usually pay commissions in the range of 7-8 percent, approximately twice the commissions of mutual funds. Various annuities typically use an equitable method of computing a variable annuities annual fees, producing a significant, albeit unmerited, windfall for the annuity issuer at the annuity owner’s expense.

The typical annual fee runs in the range of 2-2.5 percent a year. Given the fact that each additional 1 percent of fees reduces an investment owner’s end return by 17 percent over a twenty year period, many variable owners are losing a third or more of their returns to variable annuity fees alone. Throw in another 1 percent for an advisor’s fee and the annuity owner has thrown away over half of the investment’s return!

The proposed fiduciary standard generally discussed would not prevent financial services salesmen from selling reasonable investment products or from receiving reasonable commissions from the sale of such products. The only change would be that the sale of such products would have to always be in the customer’s best interests. The financial services industry knows that it is not, and cannot, meet that standard, as evidenced by their continuous objection to the adoption of the proposed fiduciary standard.

Check the voting records of your representative and your Senator. If they voted against providing you with the protections that a fiduciary standard would provide, if they basically told you that they care more about the financial services industry and their money than you and your financial security, I strongly suggest that you consider sending them a message the next time they are up for re-election, a message that you want them to serve and protect you rather than special interest groups.

My five-year-old “agent” just walked into my office. Someone stole her jacket so we are going to “de-stress” and buy her a replacement jacket. Then it’s to our favorite restaurant for pimento cheese sandwiches, Arnold Palmers and probably a sundae with tons of sprinkles. The fiduciary fight will have to wait until tomorrow. After all, there’s more than one way to skin a cat. To quote the unsinkable Molly Brown – “Nothin’ nor nobody wants me down likes I wants me up!”

Posted in Asset Protection, Investment Advice, Investment Advisors, Investment Fraud, Investment Portfolios, Investor Protection, IRA, Portfolio Construction, portfolio planning, Portfolio Planning, Retirement, Retirement Distribution Planning, Retirement Plan Participants, Retirement Planning, Variable Annuities, Variable Annuity Abuse, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , ,