Consumers are often confused about the difference between estate and financial planning, and for good reason. Even professionals in these fields may use these terms interchangeably and sometimes financial planners and investment companies will purport to do estate planning. Strictly speaking, financial planning concerns your money – savings, investments, spending, insurance – and estate planning involves your legal rights – appointment of agents, creation of trusts, directions as to who ultimately will receive your property.

Financial planning also gets confused with retirement planning because a financial planner should help you determine how much money you will need to retire and how you will get from here to there by maximizing savings, limiting spending, and investing appropriately. He will advise on the types of insurance – life, disability, long-term care, umbrella – that can protect you and your family. He should be able to help you make decisions about when you can comfortably retire or whether it makes sense to keep working a few more years, at least part-time, and when you should begin taking your Social Security benefits. Your estate planning attorney may advise on these issues as well, but more likely, based simply on past experience rather than actually crunching the numbers as the financial planner should do.

Financial planners are compensated in one or more of three methods, each with their pros and cons:

Fee only

Some financial planners, like some lawyers, simply charge for their time by the hour or a flat fee for various projects. This is often the least expensive approach, though it might not feel like it since you’re writing a check or passing over your credit card. It avoids potential conflicts of interest inherent in other approaches. However, problems can arise if you’re reluctant to contact the planner with questions because you’re concerned about the cost or the planner is unaware of developments because you’re not in as close touch as you might be with other approaches.

Money Under Management

Many planners take responsibility for all of your financial life and charge a fee based on the size of the estate, often 1% per year. So, if your investable assets totaled $1 million, the annual fee would be $10,000. There are several advantages to this approach. The financial planner has responsibility to stay on top of your financial life and can monitor changes in investments or spending habits. This can be very important for older clients who may stop paying bills or become the victims of financial fraud. This approach also means that there’s no additional charge for calling the planner and asking questions, so you’re more likely to develop a closer relationship with your planner. Having the fee relate to your level of assets aligns your interests with the financial planner’s, at least to some extent, since her fee will increase along with your level of assets.

Commission

The third way financial planners get compensated is through commissions for selling insurance and brokerage products, such as life insurance, long-term care insurance, annuities and some mutual funds. This may feel like the least expensive approach because you don’t have to write a check, but it can end up being the most expensive if you end up spending money on products you don’t need or that don’t produce the same investment results as less expensive products. With the broker’s compensation only coming if you purchase an insurance or investment product, the incentives can cause them to push sales that are not always in your best interest.

I don’t mean to cast aspersions on all insurance brokers here. Insurance and the right annuities are hedges against various risk that can be important parts of virtually every financial plan. There’s nothing wrong with your financial planner receiving a commission for helping you choose the right insurance product for you and your situation. And if the insurance company is willing to pay the broker rather than your doing so, that’s great. I’m just concerned that the incentive structure leads to poor results for many consumers. The best protection against this occurring is to make sure that you always get a second opinion before purchasing any insurance or investment product.

Some financial planners adopt a combination of the above compensation systems, charging a flat fee for the initial plan and then either charging a percentage fee if you hire them to manage your finances or collecting a commission if the plan entails purchasing insurance.

Most financial planners encourage their clients to complete their estate plans and often play an instrumental role in aligning the investments with the plan, making sure that the beneficiary designations on life insurance policies and retirement plans are properly stated and helping title investments in trusts, if necessary.

A last word with respect to the fees financial planners charge: they are well-earned. Financial planners help their clients navigate our increasingly complicated financial world, much of which seems designed to fleece consumers of their hard-earned dollars. It’s not difficult for good financial planners to save their clients multiples of what they charge, whether it’s 1% per year or an hourly fee.

 

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