In an effort to attract top talent in a highly competitive industry, some firms have escalated the recruiting packages to an unprecedented level. These lucrative—and some may say inflated—transition bonuses in the form of upfront money have also caught the attention of regulating bodies including FINRA.
Historically, to help offset many of the costs of making a move to a new affiliation as well as provide signing incentives, firms developed transition packages.
Although the hard dollar cost of transition really hasn't increased over the past 15 years, the upfront money some firms are offering has.
On face value, more upfront money may seem great from an adviser's point of view. However, there a few truths the adviser should be aware of.
Truth: Upfront money is a taxable event to the financial adviser. Over the term of the loan, a portion of the note is “forgiven” and “taxed” annually.
The upfront money an adviser receives to change affiliations is compensation. Firms typically wrap the offering into a promissory note detailing how the loan will be forgiven over a three, five, seven or nine-year period. Once the financial adviser moves, the “upfront” portion of the loan is provided. In the wirehouse or regional channel, a financial adviser could receive “cash up front.” (Sometimes as much as 100%-140% of the trailing 12-month revenue.)
Each month, an amortized portion of the loan is “forgiven” and becomes taxable income. Employee firms (wirehouses, regionals) will automatically withhold and escrow the estimated taxes due on the income. Independent firms will 1099 the financial adviser each year.
Advisers should request a hypothetical illustration detailing the transaction and tax implications. While receiving the money upfront could create a cash high, advisers will have a future tax liability. In the case of the employee adviser, monthly taxes are withheld on the amortized income from the upfront money in addition to the taxes withheld on their monthly production.
Truth: As a recruit of the firm, large upfront money is attractive, but as a practicing adviser of the firm your view may change.
As a practicing adviser you will likely hope your firm is continually investing in areas designed to help you grow your business and serve your clients—integrated compliance, innovative technology, dynamic marketing and ample staff support.
If a firm's philosophy leans too heavily on recruiting new advisers, you may be disappointed with the amount invested to serve existing advisers. This is especially true if firms are using working capital to overly incentivize future advisers.
Bottomline: Most financial advisers will change firms during the tenure of their career for a variety of reasons. Ultimately, the decision to change firms should create added value to the adviser's clients and foster business growth. The advisers most pleased with their decisions to move are those who determined the “cost of staying” far out-weighed the cost of change.
Tom Daley is the founder and CEO of The Advisor Center, a strategic partner to InvestmentNews.