Individuals make woefully poor financial decisions. Whether that is a result of inadequate financial education, the wiring of the human brain or the undue power of financial services providers — or some combination thereof — is difficult to say.
The Consumer Financial Protection Bureau, a creation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, is designed to remedy the situation by protecting consumers. But protect them from what?
Consumer advocates respond that chaining the financial wolves — bankers, investment managers and Wall Street alchemists — is necessary to safeguard the innocents. No doubt there are predators who deserve such a fate. But placing restraints on predators only confirms that there are prey.
What if something could be done to make the public less like prey and thus less susceptible to financial predators?
Short of mandating that individuals have a financial plan, I believe that Congress can go a long way toward improving the financial well-being of Americans by legislating a tax deduction for financial planning.
Such a move would save far more than it costs in lost tax revenue.
Much of the CFPB's mandate is to make disclosures, terms and contracts more understandable, but more words and pages won't protect individuals from wandering into an alluring wilderness called consumerism. In this wilderness, many predators exist, and while some of them are now restrained, many have yet to emerge.
That is the problem with legislation of this type: It reacts to the excesses of the past without having much insight into what may emerge in the future.
For example, while we locked down the partnership scams of the 1980s, we did little to prevent the Internet IPO bubble of the "90s. Nor did the shuttering of the heated IPO market keep a real estate bubble from emerging that escaped the gaze of private- and public-sector experts the world over.
We are left, then, with the presumed “protections” of the financial-reform legislation, yet with the nagging worry that we will be as unprepared for the next crisis as we have been for those in the past.
As every financial adviser knows, financial products are sold, not bought. Because of this truism, financial-product wolves forever will be knocking at the door with some new sales pitch.
For investors, the most effective deterrent and protection against financial predators comes from having a financial plan. Just as an annual checkup helps detect emerging disease, a financial plan serves consumers with a protective umbrella of filters, methods and procedures designed to impose thoughtfulness instead of irrational urges.
If given the chance, I suspect that few people would not welcome an opportunity to start the past decade over with a protective financial plan.
All too many investors made poor decisions as a result of inadequate due diligence, mismatched cash flows, inefficient execution and skewed allocations — all of which could have been eliminated or mitigated by a financial plan.
In addition to the personal cost, the societal cost of faulty financial decision making is enormous. As a nation, we will be paying billions of dollars over many years for our accumulated failures to plan and handle our financial affairs prudently.
Since we use our tax code to encourage behavior deemed beneficial for society as a whole, it would make sense to include financial planning as one of those positive behaviors worthy of encouragement. But with all the deductions available in the tax code, an explicit deduction for financial planning does not exist. According to current regulations, should an individual want to deduct a financial planning fee on Schedule A of the 1040 Form, he or she would lump the fee under the broad category of “miscellaneous expenses” and, specifically, the subcategory of “other expenses.” Then, only the excess amount greater than 2% of adjusted gross income applies.
Ironically — and absurdly — while U.S. tax policy does not encourage financial planning, it encourages gambling.
Losses from gambling merit an explicit deduction and are not subject to the 2% limit. More than $21 billion of gambling losses were deducted from individual tax returns in 2007, representing about 88% of the entire amount of miscellaneous expenses. What does this say to Americans, who are being exhorted to act responsibly, yet are helped at tax time if they are reckless?
Had a tax-policy endorsement of financial planning been in place since, say, 2005 and was of equal size to the gambling deduction amount in 2007, imagine the reduced demands on the Treasury in light of the millions of home foreclosures and personal bankruptcies that have occurred in that time.
Who pays for all these personal financial catastrophes in the end? We all do.
Since tax deductions are intended to promote positive behaviors (charitable giving, homeownership, raising a family and energy efficiency, for example) and to soften the blow of unforeseen negative events (casualty/theft losses, excessive medical expenses, etc.), a tax deduction for a financial plan fits soundly within U.S. policy guidelines and precedent.
While no doubt the financial planning profession will benefit from a tax deduction, this tax policy encourages sound financial stewardship designed to protect individuals from ruinous and inefficient decisions. Client by client, planner by planner, our own wallets will be thankful for such a national initiative the next time our economy suffers from a market downturn.
Kirk Loury is the chief executive of Wealth Planning Consulting Inc., a provider of financial planning software technology, and founder of the grass-roots Alliance for a Financial Plan Tax Deduction.