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Seeking financial advice can be a daunting task for federal employees. There are many types of advisors that provide advice and most of them will claim that they are the best kind to work with. Knowing how each professional operates can provide some clarity on who may be the best fit to work with. Understanding their compensation models can provide a lot of information about the advisor and their business.

As a Financial Advisor I have served in multiple roles at different times in my career. I am going to provide some facts on how each type of advisor operates and their compensation structure. I believe that knowing an advisor’s compensation structure is pertinent information for anyone seeking financial advice.

TRUTH

Different types of advisors can provide good advice. There are certainly good and bad apples within each category listed below, but many advisors that fall into the categories below present themselves to the public as ‘Retirement Planners’ and ‘Financial Advisors’ when that simply is not true. We are going to address a few things about each type, how they are paid, how they operate, whether or not they are a fiduciary and if there are any conflicts of interest. To begin, let me define what a fiduciary is. A fiduciary is an individual who has made a promise to always act in the best interest of their clients and make recommendations that benefit the client. Now that we have this established, let’s look at the table below for a brief overview of the most common types of advisors.

The Insurance Agent

This type of advisor is paid one way – by commission. The majority of the commission they receive is up front, meaning no ongoing compensation. They typically sell life insurance and annuities. The life insurance can be term, universal life or whole life. The most common annuities they sell are Equity Indexed Annuities (EIAs), but they can also sell a regular Fixed Annuity (FA).

Insurance agents hold licenses to sell insurance. They do not have the ability to sell investments or give investment advice because they do not have investment licenses.

What is the commission? For life insurance it can be anywhere from 50% to 110% of the first year’s premium. Commissions on indexed annuities can be anywhere from 3-10% of the first-year premium.

Fiduciary? No. Insurance agents are governed by the suitability standard which means they have to sell a suitable product. Suitable does not mean it is the best solution for the person buying it, but it is appropriate. For example: an indexed annuity with a 10-year surrender period and limited earnings potential may be a suitable product for a 70-year-old, but the G fund in your Thrift Savings Plan (TSP) could be much better.

A great example of the suitability standard is a meat butcher. A butcher is going to do one thing - sell you a piece of meat. He may sell you a great piece of meat but there are two things he is not going to do – he won’t tell you that the store down the street sells the same meat for half the price. He also won’t give you advice on the benefits of a balanced diet that would include fish, chicken, fruits and veggies. Selling you a piece of meat is a suitable product, but possibly not the best for you.

Insurance agents are often endorsed by employee associations as retirement advisors. Their advice typically comes down to a recommendation to move money out of your TSP to an Equity Indexed Annuity (EIAs), which is also a common product sold at dinner seminars. This happens to be one of my biggest pet peeves in the industry!

An insurance agent can be a good fit if you are looking for a life insurance policy or an annuity. One thing to be aware of is that the more you pay for your insurance product, the higher the commission the agent receives. DO NOT go to an insurance agent looking for unbiased retirement advice!

Conflicts of interest: Commissions pose a conflict of interest for anyone wanting unbiased advice. If an agent gets paid a large commission when you buy an insurance policy he has an obvious personal interest in a product sale. In addition, if an agent is paid an upfront commission, he has no incentive to provide ongoing advice.

Insurance Company Advisor

This advisor is not much different from the insurance agent except that he can sell mutual funds and variable annuities. He is still compensated with commission for selling products and is not a fiduciary.

The One Stop Shop Advisor

This advisor will typically have insurance licenses, securities (series 7) and investment advisor licensing (series 65 and 6, or 66). The advisor can get paid commissions and/or a fee.

Methods of Compensation

• Commissions on insurance products just like the Insurance Agent
• Commissions for sales of mutual funds, variable annuities and other securities products like REITs (Real Estate Investment Trusts) and BDCs (Business Development Companies)
• Fees for managing assets (can be anywhere from .50% of assets to 2% but the most common is 1%)
• Can also charge a fee for financial planning

Fiduciary? It depends. This type of advisor is not required to act in a fiduciary manner in all parts of a client relationship but is required to act as a fiduciary if he is managing money for a fee. He is a fiduciary when managing money but must adhere to the suitability standard when selling products.

Conflicts of interest: There are plenty here. Anytime products can be sold, and commissions paid there is an obvious conflict of interest. There may also be a conflict with asset management (AUM) fees.

Fee Only Advisor

This type of advisor doesn’t accept commissions and only receives compensation directly from clients. Most fee only advisors will have their CFP® (Certified Financial Planner™) Professional designation and may be a part of an organization like NAPFA (National Association of Personal Financial Advisors) that requires them to sign a fiduciary oath.

Fiduciary? Yes

Business practices – These advisors can be paid in a number of different ways, but the important thing to know is that all fees are clearly disclosed. Fee only advisors can do financial plans, manage money, and/or help with ongoing planning and investment management. Fee only advisors can give advice and recommendations on insurance and annuities, but they don’t sell them. Here are the most common ways they are compensated.

• Assets under management (AUM)
• Fees for planning or giving advice
• Combination of AUM and financial planning fee
• Flat fee for financial planning and asset management
• Fee based on income and net worth.

Conflicts of Interest: An advisor being ‘fee only’ is supposed to remove as many conflicts of interest as possible but that doesn’t mean they don’t exist. An advisor getting paid AUM fees has an obvious incentive to tell clients to move money out of their TSP. In other scenarios like a flat fee arrangement, or a fee based on income and net worth the advisor is paid the same fee regardless of where the assets are held. This essentially removes all conflicts of interest.

Summary and My Journey

Know what you are looking for. The information above should help you decide which type of advisor is right for you. If you just need an insurance policy, an insurance agent is a good fit. If you want to have insurance, investments, and all products with the same person then the one stop shop advisor is a good fit. If you want unbiased advice or investment management from a fiduciary, then a fee only advisor is a good fit.

As for me and my journey through the financial world, I initially started as an investment licensed insurance agent and transitioned to the one stop shop advisor. When I was the one stop shop advisor, I thought that I always did what was best for my clients, however, looking back I can’t honestly say that I was never swayed by commissions. There are times that it probably did have an impact.

The more time I spent in the industry the less I participated in product sales. Seeing the bad side of the industry and hearing about person after person that had been sold an equity index annuity have led me to where I am today – a fee-only advisor.

Why fee-only? Very simple – I think it is the best and most honest way of doing business! I think that people should be able to work with an advisor and receive 100% unbiased advice. If you think the fee only advisor is the best fit for you and would like to talk, you are welcome to schedule an introductory call.

Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.