My friend Joe, an ER doc in Colorado asked me how he should save for his daughter’s college education. The answer was simple, I told him to enroll in a 529 Plan directly through the State of Colorado. When you put money into a 529, you protect your money from federal and state taxes, and you can take tax-free distributions when paying for qualified education expenses. Some plans offer special tax incentives to state residents, and some allow sales professionals to sign up consumers and charge hefty commissions. At the time, Vanguard had a very solid no-load, low-cost plan, so I suggested Joe funded this one. “Well,” he said, “I don’t have a Colorado Vanguard Plan, my advisor told me to get a Blackrock Plan!” “He did?” I said. “Well, that makes no sense because in Colorado you can deduct up to $400,000 of contributions at your state tax rate and the plan is virtually free!”
The reason for this mishap is the structure and nature of the salesmen’s business who advised my friend. For advisors that work on commission, they are incentivized to sell a specific plan or product that has a sales commission as high as 5.75%. Let’s walk through the potential damage caused by the advisor.
Joe Earns $300,000 Per Year and Deposits $25,000 into the 529. At the 4.63% Colorado marginal tax rate, we have $1157.50 of state tax savings. If Joe paid the sales load cost of 5.75% x $25,000 = $1437.50 this would have been a cumulative hit of $2595 that this advisor would have cost Joe.
Do you know how your advisor is compensated and what his incentives are?
I recently came across a “college savings plan” that was built around a life insurance vehicle. A prospective client of mine told me he is funding a plan where he gets a death benefit in the event of premature death, his cash is protected by creditors, he gets a guaranteed return, AND he can borrow from his own money whenever he wants (for college)! This seems brilliant, right? The problem is that life is busy, and we just take people’s word for it. This plan came from a salesman who cannot use 529 plans and instead promotes the product he/she can sell. What the clients do not know, is that there are far more efficient ways to protect against premature death and build college savings.
Here are five “must ask” questions before purchasing any financial products from a sales professional.
- How much will this product cost me?
- What are the alternatives to this product to achieve my goals?
- How difficult is it to pull my money from this product and are there penalties or restrictions?
- What are the tax advantages or disadvantages of this product?
- How can things go wrong with this product?
A lot of this boils down to information asymmetry – where one party has more or better information than the other. The best scenario is for an individual to admit that we lack the proper knowledge in a field that we do not work in every day and rely on a professional. Therefore brokers, financial advisors, financial planners, and life insurance agents have a job. Unfortunately, not ALL financial advice is created equal and it is up to you, the consumer, to ask the tough questions and make sure you do not have to bear the costs and consequences into your future financial years.
Shameless plug coming here – 529 plans are a part of our comprehensive financial life planning and they only cost our clients $110 per $100,000 invested per year paid directly to the investment manager. The best probability of eliminating any future mishaps from financial products is to align yourself with a Fiduciary Advisor because a Fiduciary must do what is in your best interest and give you the most efficient path towards achieving any and all of your goals.
Athanassios Panagiotakopoulos is an Investment Advisor Representative with Dynamic Wealth Advisors dba Life Managed. All investment advisory services are offered through Dynamic Wealth Advisors.
