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How To Solve For Your Remaining Commission Assets?
A common misconception about the RIA model is that you must be 100% fee-only to transition your practice to it. While being 100% fee-only is a path many advisors and teams takes, it is entirely possible to maintain a commission component to your practice. Whether on a short-term basis to work through the transition, or on a long-term basis to continue to provide such solutions to clients. It is a matter of identifying what commission products and solutions you currently use with clients, and how to “solve” for them under an RIA model approach.
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Full Transcript:
How to solve for your remaining commission assets? That is today’s question on the Transition To RIA question and answer series. It is episode #117.
Hi, I’m Brad Wales with Transition To RIA where I help you understand everything there is to know about why and how to transition your practice to the RIA model.
If you’re not already there, head over to TransitionToRIA.com where you’ll find all the resources I make available from this entire series in video format, podcast format. I have articles, I have whitepapers. All kinds of things to help you better understand the model.
Again, TransitionToRIA.com.
On today’s episode we’re going to talk about a misconception advisors often have when considering the model. And even if you understand it’s a misconception, how do you solve for it?
If you are considering the RIA model for your practice, you’ve heard about it, you’ve seen colleagues do it, you’ve been following along on my episodes, then you think to yourself… “I’m not 100% fee-only, so that model is not for me.”
It is a big misconception at times where advisors think they must be 100% fee-only to go to the RIA model. And as we’re going to talk about on today’s episode, that is absolutely not the case.
There are many advisors and teams that perhaps are 100% fee-only, or aspire to be 100% fee only, near term or perhaps long term. But as I’m going to explain, you don’t ever have to be 100% fee-only if you choose not to. So don’t let that be a deterrent for looking into the model.
From experience talking to hundreds of advisors that reach out to me to discuss the RIA model, most are not already 100% fee-only at the time they begin exploring the model. So don’t fall trapped to that misconception.
The second thing I’ll point out here before I dive into the meat of the episode is when I talk about commission assets, I’m not referring to insurance commissions. That’s essentially an entirely different episode. I’ve talked about insurance in the past on some episodes.
What I’m referring to there is if you’re doing mostly non-variable type insurance solutions, perhaps life insurance or fixed annuities, those are insurance only products. Those do not require a broker-dealer. Perhaps you are currently accessing those solutions through your broker-dealer, but they are actually insurance products.
If that’s the extent of what you did from an insurance front is things like a fixed annuity, going forward you do not need a broker-dealer for that. You would just need a way to access those insurance solutions, which is possible with the RIA model.
I’m not going to dive into that here on this episode, but just know what we’re talking about today when I refer to commissions, I’m not referring to insurance solutions.
With those two points of clarification, I want to give examples of the types of assets you might have in a commission arrangement now, a brokerage account now, and how you could potentially solve for them.
Before I get into the specific products, I’ll start by pointing out three options you have that are not necessarily as attractive as some of the other things I’ll get into, but they are options nonetheless.
First, and this option is not overly appealing, but you can always just walk away from those assets. You could say… “I’m moving on, I want to be an entirely fee-only advisor and I’m willing to walk away from this small amount of my practice that remains in commission assets.”
That’s possible, but where that often becomes a challenge is in many cases a client that has a commission solution or product also might have a fee-based account with you. So simply walking away from the commission side of it doesn’t help because you still have this other part of the relationship on the fee-based side.
Now, if the full extent of your relationship with that client, perhaps it’s a very small client, perhaps it’s a client you got early in your career when you were willing to take on everyone, and it’s a very small relationship and it’s solely a commission relationship, if that’s pretty much how all of your commission relationships are, perhaps it is feasible to walk away from it as part of the transition because you’re not jeopardizing any desired long-term client relationships.
So, in theory it’s possible to walk away. But in most instances that is difficult and certainly not appealing to do in many instances.
The next potential solution of the first three, there are some advisors that say… “I want to essentially walk away, but I don’t want to just completely abandon my clients”, or “I have some clients that also have a fee-based relationship with me.”
Some of those advisors reach out to a trusted colleague of theirs at their current firm – could be a different firm, but usually it’s the current firm they’re at – and say…. “Can I give you these client relationships? All I ask in return, you can keep the revenue, just don’t try to steal the rest of the client relationship from me (ex: their fee-based account.”)
Handing such clients off to a trusted colleague is another approach that you can consider.
Sometimes it must happen, such as if you’re in a broker-dealer type relationship and some of those solutions are in proprietary products that cannot be transferred elsewhere, they must stay at that firm. One way you can attempt to solve that is to try to identify someone you can trust and who will service those clients, but who won’t do anything to jeopardize your future path with those clients.
And then the third example, which is related to the one I just mentioned, is as opposed to just giving the clients to a trusted colleague, I have heard of some advisors that work out an arrangement where they effectively sell those commission assets to the trusted colleague.
The selling advisor gets some revenue from it, and the buying advisor – who perhaps has no plans to ever leave that firm, or at least not anytime soon – gains some revenue.
It can be a win-win. The buyer perhaps pays one-times revenue for that, and now they have future revenue for their practice as well.
So those are three quick ways you could try to manage this, but which aren’t as typically used as they have some limitations to them. But I did want to acknowledge them as options.
Ok, now to discuss specific investment products and how to potentially solve for them.
This is a lot of what I help advisors with is…. “Let’s look at what your practice is currently. Let’s look at what it’s comprised of, in this case, on the commission side. Let’s look at how much production you’re generating for each, because that impacts what solutions might be available to use.”
That’s a big part of what I do is dive into that practice, dive into that book of clients that you have and help you understand which of these might work.
The first example, and this heavily depends on the amount of commission assets involved – because there minimums required for this – you in theory can keep everything as-is.
I’ll use simple numbers. If you have a practice that is 90% fee-based and 10% commission-based, as long as that commission base is still producing a reasonable amount of production, there are so-called “RIA friendly broker-dealers” that will say…. “Go start your own RIA for your fee-based assets. We’re not going to take an override on any of that. But we realize you have legacy commission positions that perhaps you would like to keep as-is. That arrangement is working for you. It’s working for your clients. You don’t want to try to convert or exchange (or do the things I’m going to talk about on this episode.) So we, as the RIA friendly broker-dealer, we would be happy to house just that 10% of your practice. We will take an override on it, and we try to stay out of your hair as much as possible on your fee-based assets.”
That solution absolutely exists. The challenge is, because the RIA friendly broker-dealer only takes a scrape on the commission production, most of the solutions, and there’s not many of them out there, they have minimum production requirements. If they’re only going to take a scrape of that minority part of your practice, there needs to be enough meat on the bone to make it worth their while to do this.
That’s something I can help with, is to determine if this solution is even going to be available to you, based on the composition of your practice.
But if there is enough meat on the bone, it is potentially possible to keep everything exactly as-is with your fee-based and commission-based assets.
This also generally works if you join an RIA. I’ve done several episodes on joining an RIA. Most good solutions or platforms that are appealing that you might join, they have procured an RIA friendly broker-dealer solution.
And in that case, the minimums are not as important because you’re basically getting to ride the scale that they already have with that RIA-friendly broker dealer.
You can come in, put your fee-based accounts with the RIA, and your commission accounts with the RIA-friendly broker dealer. And they’ll take you even if you fall below the minimums for if you had your own RIA.
So main takeaway, you don’t necessarily have to change anything as far as your balance between fee-based and commission assets. But again, the devil’s in the details and it is something you need to talk through. Which I’m happy to help you with.
Now, moving on, let’s discuss how you could potentially work to wean down the commission assets if you’re not inclined to use one of the methods I just mentioned. Or perhaps you simply aspire to potentially be 100% fee only at some point, which will make your life easier if you can ever get to that point.
So the question is, how can you solve for these remaining positions you have? I’ll give some examples.
The one I typically see most when I inquire about what an advisor’s commission assets are, are variable annuities.
For starters, I’m referring to commission variable annuities. There are many fee-based versions of variable annuities now. That’s a whole different subject for a different episode.
But in this case, we’re talking about an advisor with legacy (commission) positions, that they used with the client 5, 10, 15 years ago. And there might be reasons the client is still in that product because at the time the interest rates, and the add-ons of the annuity, make sense.
The question is, what can you do with those positions? They’re sitting there, typically kicking off a trail to the advisor. A common example I see is an advisor or team and they have these variable annuities that are kicking off maybe $200,000 a year in trails. That’s meaningful revenue. That’s not something they just want to walk away from. And so, what can you do with that?
There are two main options to consider.
One, there’s an increasing ability to, if it makes sense for the client, to convert some of those positions into the fee-based versions I just mentioned.
The marketplace is rapidly growing with fee-based versions of variable annuities. There are solution providers that will not only help you access fee-based variable annuities, but will analyze your existing commission variable annuities down to every detail and say… “This annuity that was sold at this time period and that has these riders on it and whatever the perks are, hey, advisor, do you realize that with the changes in the marketplace and changes in interest rates, that client is arguably actually better off now in this fee-based version over here?” And typically you can convert it on a non-taxable transaction.
“So advisor, if you want to go to your client, explain this to them, explain how now that the industry has evolved, the product offerings have evolved, that now they’d be better off converting the position to this fee-based version.”
If that sort of transaction makes sense, and you can whittle that down, you’re moving more and more into a fee-based approach. Again, there are service providers that will help you do that analysis for you.
Second, the other main way to address variable annuities, and this is a relatively new solution, is something I’ve heard described as park and advise.
There are solution providers that say… “Maybe you don’t want to convert any of those, or you just want to keep them as is. You don’t want to have to have the conversation with the client, or whatever your motivations are, maybe it doesn’t make sense for the client.
We’re a broker-dealer. We’re going to put those variable annuities with us, we will be the rep of record, we will keep the trail on that. We will promise not to solicit that client – that you likely have a fee-based account with as well – we’re not going to do anything to solicit the client for any of business. We’re a safe space to keep that annuity.
We’re going to keep the trail. But what we are going to do is because most of these variable annuities have sub-accounts that arguably need to be managed – perhaps mutual funds that need to be adjusted at times – we are going to in turn hire you as the RIA to advise us on an ongoing basis what to do with these positions.”
That’s where the “park and advise” comes in. It’s a way to essentially have a safe landing spot for the positions, not having to convert them if you don’t want to, but still potentially have some degree of revenue coming in associated with it.
That’s another example when it comes to variable annuities. There are typically ways you can, as I like to say, “solve” for those positions.
Next, moving on to mutual funds.
When I ask advisors what comprises their commission assets, in addition to variable annuities, there’s also often mutual funds involved. Typically a C-share situation, or an A-share sold years ago for a front-end load and it’s paying a trail.
In most cases those are smaller clients and the firm the advisor is with has a minimum account size for a fee-based account, and the client did not meet that minimum. So instead, the advisor had to put them in an A-share or C-share type situation.
In the RIA world, there are typically not any minimums on account size. Now, if you were to go join a firm that has some minimum account size, you’d have to play along with that. But that’s not too typical.
But if you have your own RIA, you might set your own minimum, but there’s no one that dictates that an account must be, for example, $50,000 to have a fee-based account.
If you have an existing client with perhaps $35,000 in mutual funds (in a commission account), you could open a fee-based account, move the mutual funds into it, convert them into typically institutional class shares – which eliminates the trail you’ve been receiving – but then you could set a commensurate fee on the account.
Which that fee might be quite low if the funds had simply been just sitting there paying an A-share 12b-1 trail. But you could set your fee to basically make the client consistent of… “Here’s what you were effectively paying before in that A-share or C-share situation. You’re not paying any more or any less over here. It’s just a different mechanism for how it’s done.”
So that’s a way to potentially solve for mutual funds, move them into a fee-based account, convert to the lower priced share class, and just put your own fee on top of it.
Next example is concentrated stock positions.
Maybe you have a client that has a million dollars in a taxable account or an IRA or whatever, but it’s in a fee-based account and you’re managing that million dollars for the client. But that client also has a large concentrated stock position, perhaps because they worked for some employer for a long time or they inherited it.
Either way, you’re not actively managing it. It’s in a brokerage account and then once a year or whatever the agreement is with the client, you’ll whittle that down by selling a little, which you then move into the fee-based account which you then manage going forward.
You can essentially solve for that in the RIA space by, if you choose to, putting the concentrated stock position in a fee-based account, but there’s two very important things involved.
First, if it were me, I would keep the position isolated from the client’s other assets, because if you are actively managing those assets on a discretionary basis, you are responsible for those assets.
If you put the concentrated stock position in there, even if you have some verbal understanding with the client that you’re not really managing that part of it, that could create issues down the line if that position tanks and they come back and they say… “You had discretionary authority, why didn’t you sell?”
The way you essentially protect yourself is to open a second fee-based account and do two things with it. First, make it a non-discretionary arrangement with the client for that account. Which by the way, remember, all brokerage accounts are non-discretionary (so that’s what you had before with them with that account.)
So you say… “I’m not going to actively manage this at all on a discretionary basis, it’s just going to sit there. Any time a transaction is done is because either you’re going to ask me to or I’m going to clear it through you first, but I’m not actively managing that.”
And then to the degree you don’t want to charge a fee on it, you don’t have to charge a fee on it. Move it into a fee-based account, mark it as non-discretionary, do not charge a fee. You’ve effectively created the same situation, but now you’ve got that asset out of that brokerage account bucket that you’re trying to solve for.
The next example is somewhat related where some advisors and teams say… “I use this fee-based relationship with the client, but I use a brokerage account for cash management.”
Perhaps the client wants to hold a lot of cash strategically, or for planning purposes, or whatever the case is. And you manage that so they’re getting a good return on that while it’s just sitting there. Perhaps you buy into money market funds and the client doesn’t want to pay an ongoing fee on that.
If that’s important to the client, if that’s important to you, again, you can still do that in a fee-based account. Just don’t charge a fee if you don’t want to.
Now, the reason you might have to charge a fee currently, if you’re at a large broker-dealer type firm, is because they might require a minimum fee be charged on fee-based accounts.
That’s just because that firm is deciding to put in some minimum. There’s not some regulatory requirement that says you must.
If you have, for example, your own RIA, you could move those cash management assets – again, I would do it in a separate account from the main assets you’re managing – and just either charge no fee, or perhaps a very low fee for that cash management service.
So that’s entirely doable as well.
Two final examples, first is 529s.
It seems like most 529s out there are historically still on some sort of commission basis. There’s increasing ways to just convert those in-house with the same provider.
I often hear American Funds as an example where an advisor set up 529s with American Funds that are on a commission basis. There’s a mechanism to convert those into a fee-based version.
So 529s can generally be solved for. They’re usually a very small part of an advisor’s practice. It’s usually not a concern over the revenue, but more so to protect a client relationship where maybe a larger client wants to open a 529 for their grandchild. Due to its size, it almost not worth your hassle, but because of the larger client you want to maintain it somehow. So there’s again ways to potentially convert that into a fee based relationship as well.
And just as a reminder to what I said earlier, if you went the route of some sort of RIA-friendly broker-dealer arrangement, you don’t have to change any of these. You could simply carry them on exactly as-is with the new broker-dealer arrangement.
The final example I’ll give on this episode is I sometimes hear advisors explain they have some clients that simply prefer a commission arrangement. It’s maybe been that way with the client for 20 years. They like it that way. They don’t think the client is going to want to pay an ongoing fee when the commission arrangement has worked with them for 20 years or whatever.
In those cases, what I suggest is go back three years’ worth, four years, five years, whatever, go back historically, look at how much commissions were generated, divide that into the asset total of the account at the time, and then go to the client and explain it to them.
Perhaps that math, because on average we’ve done X number of trades per year, that has generated this amount of commissions and you have this much assets in the account. That math is consistently coming in at (for example) 30 basis points per year.
“If we put you in a fee-based account and we put a 30 basis point fee on it, it’s basically going to be the same fee you’ve been paying all along. But this is a bit cleaner because now you don’t ever need to worry about another transaction running up a commission. I’ve gone back and I’ve done the homework and here is the math. Here is how this has worked out for the past couple years. Again, I’m indicating this is generally going to be pretty similar for you.”
Now, a client still must agree to it, but again, that’s a way to potentially say to those clients… “We can maintain that status quo in a fee-based arrangement. I’ll just set the fee accordingly with respect to that.”
This has not necessarily been an exhaustive list. But these are many of the items that are in that commission bucket when I’m going through this with advisors. This is a very typical conversation I have with advisors and teams after they reach out to me. What does that remaining commission piece of your practice look like? What are we hoping to get to? Are we trying to get to 100% fee-only at some point? Are we content with how it is and you want to keep that as-is scenario?
Basically, really understanding what does your practice look like, what does the composition of the assets look like, and what solutions do we have available to potentially, as I say, “solve” for those assets. I’m happy to have that conversation with you as well.
I’ve explained this at a generic level, but every advisor, every team situation is so unique you really need to understand what your practice would look like and what specific solutions would be available to you based on the mechanics of what your commission assets are.
As I said at the top, my name is Brad Wales with Transition To RIA.
This is a typical conversation I have with advisors all day long. I’m happy to have that conversation with you as well.
First things first though, if you head to TransitionToRIA.com you’ll find all the resources I make available to help you better understand the model. This entire series is available in video format, podcast format. I have articles, I have whitepapers.
At the top of every page is a Contact link. Click on that and you can instantly and easily schedule time to have a one-on-one conversation with me. Whether you want to talk about today’s topic or anything else RIA related, I’m happy to have that conversation with you.
Again, TransitionToRIA.com.
With that, I hope you found value on today’s episode, and I’ll see you on the next one.
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