Do retainers beat AUM-based fees under fiduciary rule?

New paper makes the case for advisers to charge clients flat fees versus fees based on assets given the approaching DOL regulation

Sep 7, 2016 @ 11:53 am

By Liz Skinner

The Labor Department's best-interests rule for retirement advice is poised to move more financial advisers toward providing counsel for a fee as opposed to accruing commissions. But the best method for how to charge fees is now under debate.

The most popular current method among fee-only advisers is to charge an annual percentage of client assets the adviser oversees. Often that is about 1% to 2%, usually declining as client assets increase above certain thresholds.

But some planners contend it will be in the best interests of financial advisers under the new world of widening fiduciary requirements to charge clients a monthly or annual flat fee known in the industry as a retainer. It would be set for several years and is often based on clients' net worth and income.

There are fewer feasible conflicts with this approach, and the model would qualify advisers for the less onerous “level-fee” rule exemption when providing retirement advice, a new white paper written by two financial advisers said. The paper — by Jake Kuebler, a partner at Bluestem Financial Advisors, and Ken Robinson, president of Practical Financial Planning — is being released Monday.

“The whole intention of the fiduciary rule is putting clients' interests first, and under the AUM model there are more conflicts that present themselves than with the retainer model,” Mr. Kuebler said. “AUM is really a model that's meant for investment management.”

(More: Adviser explains why and how to move to a retainer model)

It harder to show that a recommendation is in the client's best interest when the adviser's fee will depend on whether it's acted upon, he said.

An example often used to illustrate the possible conflict with the popular AUM-based model is whether an adviser will be hesitant to recommend a client pay down his mortgage or make a large charitable contribution when keeping the client's funds invested in their account benefits the adviser.

One of the stickiest issues when the DOL fiduciary rule begins to be implemented in April will be how advisers show a recommendation to a client to roll over funds from a workplace retirement account to an individual retirement account overseen by an adviser is in that client's best interest.

(More: Advisers shift away from AUM fees to better serve clients)

For advisers charging an AUM-based fee, whether the client makes such a move directly impacts his or her fee, Mr. Kuebler said. But for advisers charging a retainer, the fee isn't based on where the money is held, so there's no financial incentive to roll over a client's account.

The decision whether to stay in the 401(k) plan, therefore, will come down to whether the current plan has good investment choices and is low cost. In other words, it will come down to what's in the client's best interest, he said.

A retainer fee also would stamp out regulator concerns about advisers charging varying fees based on how money is invested, Mr. Kuebler said.

Some advisers charge more for managing equities than for bonds or cash. Regulators have expressed concern that an adviser who charges clients less for managing cash might recommend moving into investments that would pay the adviser more, even if the client would be best served by keeping the cash reserve.


Advisers who charge clients based on AUM, however, contend that their model is easier for clients to understand and it aligns the goals of the financial adviser and investors.

“It puts the adviser and the client on the same page because both of us have an incentive to make the money grow,” said Arie Korving, chairman of Korving & Co.

Charging clients a flat fee would seem to be against the best interest of a client who has a small amount of assets to manage, who would pay much more each year under a typical retainer model than they would if they were charged a percentage of assets, he said.

With regard to rollovers, Mr. Korving said his firm recently changed their standard advisory agreement in light of the pending DOL rule. It now informs people that they can roll over their 401(k) assets themselves for free. By signing the agreement, clients acknowledge and recognize that they are paying for the firm's advice and management of those rollover dollars, he said.

“We are making sure they are aware that they could do it themselves,” Mr. Korving said.

Jamie Twining, founder of advisory firm Financial Plan Inc., said he reduces a potential conflict by charging an AUM-based fee on all manageable assets, even if they are held by different financial institutions.

(More: A comprehensive, searchable database of advisers' fiduciary FAQs)

“We are completely agnostic as to where the assets are held,” he said.

Since the firm includes assets held in a 401(k) in its AUM-based fee, there's no conflict whether they recommend a client rolls out of their company plan or not, Mr. Twining said.

He added that AUM-based fees also will qualify for the “level-fee” exemption under the DOL's fiduciary rule as long as certain fiduciary disclosures are made.

That path, designed to be easier than having to abide by a more comprehensive best-interest contract exemption under the DOL rule, is designed for advisers who don't accept commissions, 12b-1 fees and other product payments, he said.


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