understanding gift tax

What is a Fiduciary?

Fi – du – ci – ar – y

Wikipedia defines fiduciary as, “A fiduciary is a person who holds a legal or ethical relationship of trust with one or more other parties. Typically, a fiduciary prudently takes care of money or other assets for another person.”

A fiduciary holds the highest legal duty of care.

You can see why you would want a fiduciary when dealing with topics of money and the managing of your life savings.

There are a lot of “professionals” out there that are willing and eager to help you take care of your money. As experience has probably already showed you, not everyone is created equal.

A fiduciary is tasked to look out for your best interest instead of their own.

Suitability Standard

When not bound by the fiduciary standard, many financial professionals will be tied to the suitability standard. The suitability standard dictates that the professional can only recommend investments that are suitable for their clients. That may seem like a good thing but the there is an asterisk around suitable.

Suitable simply means that it will fit your needs, not that it is the best thing for you. Imagine walking into a suit shop needing a new suit for your party tonight. The salesperson comes up and ask if you need help. You describe the suit you would like and ask if they have any in your size for your party tonight. Unfortunately, the salesperson responds, we don’t have any in your exact size, but here is one that is slightly bigger. Even though the fit isn’t perfect, and it looks a little baggy on you, you would rather not go to the party in your pajamas. You take the suit and go on your way, not looking your best. That is what is considered suitable.

If you walked into that same shop that was run by the fiduciary standard, it would go a different way. After the salesperson informed you that they currently don’t have your size, they would recommend you try this other suit shop right down the road because they believe that they will have this suit in your size. They even go out of their way to call the other suit shop to confirm that they do have the right suit and size.

Even though the fiduciary standard salesperson didn’t get the commission from selling you a suit, they did help you find what was best for you.

Now imagine that scenario in the financial industry. You talk with your advisor about investing in some index funds in your retirement account. The advisor decides to recommend some funds that give his firm a kick-back and him a nice commission. Unfortunately, these funds carry a higher expense ratio (fee) than comparable funds. You don’t know any better, so you go ahead with it. Was this in your best interest or their own?

Did the insurance salesperson recommend you get life insurance because they think it is the best thing for you right now, or was it because they make a large commission from the sale of life insurance policies?

Fiduciary Standard

The SEC has defined fiduciary duty as, “An adviser’s fiduciary duty “[ ] means the adviser must, at all times, serve the best interest of its client and not subordinate its client’s interest to its own. In other words, the investment adviser cannot place its own interests ahead of the interests of its client. This combination of care and loyalty obligations has been characterized as requiring the investment adviser to act in the ‘best interest’ of its client at all times.[] In our view, an investment adviser’s obligation to act in the best interest of its client is an overarching principle that encompasses both the duty of care and the duty of loyalty.””

The SEC has also concluded that a departure from the fiduciary standard by a fiduciary represents fraud upon the clients. This could result in the loss of the firm’s or investment advisor’s registration.

A fiduciary must undergo a prudent process to determine that their recommendation is right for you. This doesn’t mean that they can’t put you into products that pay commissions or recommend insurance products to you, but they need to have a definite reason for making such recommendations.

How Do I Know Who is a Fiduciary

Not all financial advisors are fiduciaries. All investment advisors registered with their state boards or SEC must act as a fiduciary. Brokers-dealers, brokers, and insurance agents are not required to follow fiduciary standards.

Certified Financial Planners™ are required to be fiduciaries when they are within the scope of financial planning. If your CFP is not the one giving the financial planning advise, they are not required to be a fiduciary at that time. If they are giving advice about retirement, tax, insurance, or investments, they are required to act as a fiduciary.

There are also voluntary fiduciary registrations. If an advisor is registered with National Association of Personal Financial Advisors (NAPFA), Garrett Planning Network, or XY Planning Network, they are required to take the fiduciary standard.

Conclusion

Should you only work with a fiduciary?

No, you shouldn’t. But you should always understand the driving factors behind the people you are working with, especially when it comes to people working with your money.

Insurance agents and brokers cannot be fiduciaries, but they are needed. You cannot go around without any insurance just because you don’t want to work with non-fiduciaries. Understand the fee structure behind the professionals you are working with, can give better insight to how they make recommendations and why.

Fiduciaries are held to the highest standard of care when working with you. They must make recommendations that are you in your best interest, not just what is suitable for you.

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