The government can read any email or text message you send to your financial advisor or broker, and they do it routinely

TL;DR – Every text message, email, or letter you send to a financial advisor or broker in the United States– and definitely in Washington State– will be collected by a securities regulator once every 1-3 years for no particular reason, and some percentage of what you’ve sent will be read by them.

photography of person peeking
We’re watching you, but it’s for your own good!

Routine violations of client privacy by Big Brother

It came to my attention recently that it is the routine practice for the DFI— Washington State’s financial regulatory authority– to request all ‘written’ client communications to or from a financial advisor (like me) or a broker. The DFI will then comb through them, reading them as they see fit, under any circumstances they choose and at any time, without any good reason whatsoever.

The ‘reason’ in this case is a mandatory, routine audit that in Washington state happens anywhere from annually to once every 3 years or so. No cause for anything suspicious is required, and all client communications are seized from advisors each time the audit is conducted. Advisors that refuse would be terminated and disallowed from working.

If you weren’t prone to protecting privacy as a general principle, you might think “why would communications between a financial advisor be worth keeping private?” Let me tell you: consider how many sensitive issues come up during financial advising: divorce, aging parents, special needs children, fights with families over money, job losses, or even just the simple hopes and dreams that I would bet your average person wouldn’t want made public to strangers.

This is a client privacy issue, not so much an advisor/broker privacy issue

I have (almost) no problem with my own ‘half’ of communications to clients that are strictly about ‘boring’ financial matters being shared with regulators. I have a HUGE problem with my clients’ end of those conversations being shared. In case you’re wondering, yes, the language of the regulators is broad enough that anything simply ‘related’ to the business of advising must be handed over to regulators en masse for any reason and at any time.

Failure to comply would presumably result in the suspense of the advisor and the killing of their livelihood. Even if some communications of a strictly personal nature could be theoretically excluded, it would be infeasible for someone like me to separate those out ahead of time before handing over 3 years’-worth of client emails & texts to regulators upon their request.

Of course, I too resent my often informal communications with clients over email and text being exposed to regulators, but frankly, I’m not the one typically sharing intimate personal information with clients. It’s clients sharing these intimate details with me because they are absolutely vital to the financial planning process. I.e.: I often need to know–and clients routinely tell me unprompted– and record when clients are facing divorce, foreclosure, layoffs, estrangement from family, special needs considerations for a child, receiving mental health therapy, admitting to substance dependence, or any other myriad issues that entangle private life with money.

Do you trust the guv’ment to be responsible with your private conversations?

The only ‘good news’ for clients and honest businesspeople is that these communications aren’t subject to public record. I.e.: ‘only’ an unidentified bunch of government bureaucrats will snoop through all your emails & texts with your advisor or broker. These messages won’t be made available for everyone in the world to read.

Unless of course there’s a data breach, which fortunately never happens to government agencies. Ok, that was sarcasm: according to a study done by Verizon, there were “there were 3,236 public sector data breaches between 2020 and 2021“. Emphasis mine.

Supposedly the state will delete unused communications later, and only retain ones relating to an investigation or evidence of wrong-doing (which could be anything from something completely benign or actual malfeasance on the advisor or broker’s part.) However, I was given no details from the (very nice) man from the DFI whom I asked about how rigorous the DFI was about deleting unneeded client conversations or what standards, timelines, storage methods, and other cybersecurity details they adhere to.

Ironically, these same agencies have stringent cybersecurity guidelines for the firms they audit. Which of course they should, but, ya know, so should the agencies since they have access to all communications from all clients of all firms!

The problem goes all the way to the top

FINRA, the SEC, and Washington State’s DFI are apparently united on invading your privacy, and when I pushed back on this requirement with a letter to Washington state’s Governor’s office, our elected officials simply handed me back to the DFI which brushed off my concerns in an email reply saying “examinations conducted by the Securities Division are consistent with those conducted by the Securities & Exchange Commission, FINRA and other state securities regulators, which include the review of [client] communications, including electronic communications, as part of their examinations.”

I.e.: since the Feds see fit to violate your privacy without any suspected malfeasance on the part of you or your advisor/broker, so do we.

What can you do as a client of a financial firm to protect your privacy?

Unfortunately, your only option is to communicate anything you don’t want exposed to any regulatory snooper in-person or over the phone (whether digital/VOIP/video chat or telephone.) Audio communications are NOT subject to seizure per today’s guidelines as I understand them. You should assume that literally everything written in email, text, or physical letter will 100% be obtained every 1-3 years by a regulator, and than some percentage of those communications will be read by them.

As I read the rules, writing over an encrypted channel doesn’t help you because the government will require the advisor not to use any method of communication that can’t be turned over to them (in cleartext.) Your only option to safeguarding anything you want to keep private is to communicate orally with your advisor.

Regulations become too strict as electronic written communications became the norm

It seems obvious to me that the rise of electronic written communications becoming the new casual method of conversation–replacing the telephone– is the reason the rules worked at one time, but are so obviously flawed today. When writing a letter was the only thing an advisor or broker would’ve turned over, and letters were infrequent and probably of a professional nature with few client personal details, handing over all ‘written communications’ was both reasonable and not a big deal. Everything personal, and much that wasn’t like placing trades or discussing investment strategy, would’ve been handled over the phone or in-person even as recently as the 1990s, and really before the smart phone was commonplace in the 2010s.

Today, the world is different, and text messages and to a lesser extent, email, have replaced the phone. And all that conversation is being grabbed by regulators.

Contact your elected officials and complain

I would encourage you to do as I’ve done and complain about this practice to the DFI (dfi@dfi.wa.gov) and–more importantly– your elected official(s). Start with the Governor’s office (Washington State here), since– at least in Washington state– they control the securities regulators.

Feel free to also complain to the SEC/FINRA, since they control the rules for the big advisors (like the bad guys) and set the standard for the state regulators that control the little guys (like me.)

I’d love to know if you are as taken aback by this as I was, or if you think it’s reasonable and not-undesirable for client’s to have all of their written communications shared with government regulators, so please leave a comment with your thoughts.

Intro to REITs (aka easy index funds for real estate!)

A Real Estate Investment Trust (REIT) is a trust that makes money from income-generating real estate. You can think of it as the real estate version of a mutual fund. There are also index funds of REITs that allow you to own a low-fee, broadly-diversified portfolio of REITs (and therefore of real estate) similar to the way you can own stocks or bonds via index funds. Vanguard’s VNQ is an example of a REIT index fund.

high angle shot of suburban neighborhood

How do REITs work?

You can read more here, but in short, REITs finance, lease, or own real estate, and distribute any profits as dividends to investors. Many REITs trade like stocks or (when bundled together) like mutual funds. They essentially have to pay out the bulk (90%) of their income each year to shareholders, hence why their income generation is high relative to investments like stocks that are not required to distribute income.

How are REITs taxed?

REIT dividends are taxed at regular income rates

One negative aspect of REITs is that instead of their dividends being ‘qualified’ for long-term capital gains rates on shares held for a while (like stock funds), the income is taxed at regular income tax rates (same as for bond funds, or bank interest.)

Per the Tax Cuts and Jobs Act of 2017, you might get some of that back in the form of the 20% QBI deduction. Say your tax bracket is 24%. 20% off that equals an effective rate on REIT dividends of 21.6%, which is still higher than the 15% long-term capital gains/qualified dividend bracket that you’d be in for stocks you’ve held for over 60 days.

Because of the higher income generation of REITs vs stocks combined with the dividends being taxed at regular rates, you probably want to have REITs in your retirement/tax-advantaged accounts, and have more stocks in your taxable funds to balance out whatever asset allocation you’re going for.

Other forms of (non-dividend) REIT income

You can also have capital gains (long-term or short-term) from REITs that are taxed the same way as capital gains generally (e.g.: for stocks), as well as ‘return of capital’ distributions which would lower your cost basis at the time of sale. These forms of income seem to be rare for most publicly-traded REITs.

How have REITs performed vs stocks or bonds?

Trying to use past returns to predict the future is often a fool’s errand for financial markets, but the longer back you look at broad asset classes the more helpful it probably is.

For Vanguard’s REIT fund (our proxy for the REIT sector), the results are not very favorable compared to the total US stock market (light blue line below) or even an overall US bond fund (Vanguard’s BND, the yellow line) given that the bond fund was MUCH less volatile compared to the REIT fund, despite price appreciation that was only slightly less over the ~16 year period that I could get data for (when all 3 funds were in existence together.)

I should note that this chart from Yahoo! Finance understates the total returns for both the bond fund and the REIT relative to the stock fund (VTI) since the dividends in those funds were likely higher than those from the stock fund, and reinvested dividends aren’t shown in this chart, just the total (capital gain) return.

I’d take US stocks for the long run.

Even so, I doubt it would make enough difference to change the conclusions: Y-charts shows 5-year total returns of 35% for VNQ vs 13% shown over the same 5-year period in Yahoo! Finance due just to price movement, so any extra ~4-5% per year isn’t shown. VTI probably had dividends of about 1.5-2% per year during the past 10 years, so REITs’ should have an extra ~30-40% of absolute return tacked on relative to VTI.

Yahoo has 3-year trailing total returns (as of 1/12/2023), and these showed 0.60% per year for VNQ (REITs), 7.40% for VTI, and -2.33% for BND (the negative returns were due to interest rates rising somewhat dramatically– compared to recent history of very low interest rates– in the past year or two.)

Should I have REITs in my portfolio?

I don’t see any reason to. No past data of returns & risk/volatility will ever be ‘conclusive’, but the long-run returns of real estate vs stocks helps cement my belief that individual investors can prudently ignore REITs and just use a mix of stock and bond index funds (with cash for needs in the next year) for their portfolios.

You have real estate exposure already

Most investors already have significant exposure to real estate in the form of a personal residence, which is another reason to skip REITs. (Yes, I know, your single residential property isn’t the same thing as a basket of many commercial properties, but you’ll still be impacted by national real estate trends on top of local market conditions.)

Businesses like those owned via the total US stock market also have commercial real estate in the form of office, retail, and manufacturing space, so you have some exposure to commercial real estate already through stocks.

Conclusions

Keep it simple and skip REITs. Stick to my recommendation of just bonds & stocks in the form of low-fee, diversified index funds. But, if you really want to own real estate as part of your financial portfolio, use a low-fee REIT index fund like those from Vanguard.

How to retire way earlier in 10 minutes

This is the first post in a series of easy steps I’m writing for the New Year that will dramatically improve your financial security in 15 minutes or less.

Retire way earlier by boosting your retirement contributions in 10 minutes

Option #1 – Up your contribution by 2% now or in the future

Log into your 401k or other workplace retirement plan right now and boost your contribution amount by 2%. (Look for something that says ‘Change contributions’ or ‘contribution amount’.)

Screenshot of a Fidelity 401k

Opt in for future 2% increases

After upping your contribution– or even if you feel like you can’t boost your savings rate today– set up annual future increases of 2% if your plan offers an automatic increase function (many plans, including Fidelity & Vanguard, do.) Set up future annual increases of 2% per year until you get to 20% (or the max IRS contribution limit.) You’ll usually find this option in the same place where you edit your current contributions.

Consider setting the annual increase date to be just after your company’s annual raise period so that you don’t see a decrease in your take-home pay when the extra 401k contributions kick in since your pay will likely be higher then.

Option #2 – Save 20%, or max it out

Log into your employer’s retirement plan (e.g.: 401k/403b) and increase your contribution to 20%.

If you make more than ~$110,000 a year, or if you’re just an excellent saver and make less but still want to max out, divide the IRS limit– $22,500 in 2023 for those under 50, $30,000 if you’re 50+– by your salary, round up, and use that percentage. For example, if you make $140,000, $22,500 / $140,000 = 16.1%, and rounding up = 17% for the year to max out.

Get all employer matching no matter what

No matter how much you decide to contribute, definitely put in enough to get all of any employer matching your company offers. That’s free money you can’t afford to pass up.

Why boost your retirement contributions?

If you’re at all hesitant here, the first thing to remember is that this change is completely reversible. You can go in anytime– even minutes after you make the change– to your 401k and change your contribution rate back down. Lean in here and just do it for your future self. It’s not a one way door!

Tax savings and more wealth

In addition to saving thousands a year in taxes, boosting your 401k contribution from 10% to 15% per year over your working career means you will have 50% more money at retirement in your account.

Yes, that’s right, for the price of only a ~3.5% decrease in stuff-you-could-buy-that-you-didn’t-need-anyway, your income in your golden years will go up by 50%! Even a mere 2% boost from 10 to 12% ups your retirement income by 20%, so at least do that much.

I’d take this deal any day; wouldn’t you…?

Imagine future you

If you’re still not convinced that saving for your future is something you must do now, picture yourself in your 60s or 70s: grey hair– or white, if yours is already grey–, (more) wrinkles, a slower step, and someone wiser, quieter, but a little more lonely and less lively than you are now. Don’t you want that person– you— to be financially comfortable, maybe even relatively wealthy, even if it means a small sacrifice on the younger you?

Any reason NOT to do this?

There’s really only one reason to not do this, and that’s if you have high-interest debt like a credit card balance or a personal loan charging greater than 8% or so. Pay that off FIRST before increasing your 401k contributions beyond the minimum required to get all your employer matching. Read this to learn how to free up cash to pay down debt.

Should you choose Roth or regular (pre-tax) 401k contributions?

Many employers offer Roth 401k contributions, although generally employer matching will always go into the pre-tax account. If you expect to be in a lower tax bracket in retirement vs now, choose pre-tax. Otherwise, choose Roth. Generally, younger folks just starting out in their careers should do Roth, and older folks (30s-50s) in their peak earning years should do pre-tax 401k contributions.

Roth if you make less money, regular if you make more

Another rule of thumb of mine is if your tax bracket is less than 22% (i.e.: 12% in 2023), i.e.: you make about $55 K or less Single or $110,000 K or less as a Married couple– do 100% Roth contributions. If you make more than that, 100% pre-tax is probably your best bet, but you can always reach out to a financial advisor to discuss more.

There’s no bad way to save though, so just make your best guess and move on. The key thing is to save the money, not agonize other Roth vs pre-tax and what future tax rates will be.

Increase your contributions right now, before you read any further!

Log into your workplace’s retirement account, which for most people is either a 401k or 403b plan. Search your company’s benefits site if you don’t know where to go, or if you know they use Vanguard or Fidelity, head straight there and login (create an online login if you’ve never logged in before.)

Click on your 401k or 403b account if you have multiple accounts, and then look for something that says ‘contributions’ like ‘change my contributions’. Click that, and find your current contribution, usually expressed as a percentage of your base salary. Enter the new number that you decided upon above, and save your work. You should get some kind of confirmation screen.

Great work! Keep reading. You need to do one more thing while you’re logged in.

Optimize your investments with a few more button clicks

Switch both your current investments as well as your future contributions to a low-fee Target Retirement fund like those offered by Vanguard or the Fidelity Freedom funds. Choose the year closest to your 75th birthday (e.g.: if you were born in 1980, choose the 2065 fund.) You should see some option like ‘change investments’ and might have to do this once for future contributions and once for the money already invested in your account.

For bonus points, double-check your ‘beneficiaries’, or set them up if you haven’t before. You want to make sure your assets are sent to the people or charities you want to get them if something untimely happened to you.

Don’t have an employer retirement account? Use an IRA instead

If your employer doesn’t have a retirement account, or you freelance and don’t want to set up a self-employed IRA, open a Roth IRA at Vanguard instead, then set up automatic monthly deposits with this link after you’re logged in. The maximum yearly contribution in 2023 if you’re under 50 is $6,500/year, and $7,500 if you’re 50+. Max out if you can. (If you work for yourself, consider opening a small business retirement plan.)

I’m assuming a Roth is best for you since I’m predicting you’re at or under the 22% tax bracket. If your marginal rate is 24% or more and would rather save on taxes now, use the Traditional IRA instead, but ONLY if you or your spouse don’t have a 401k at work, since that generally prevents you from making pre-tax contributions to a Traditional IRA.

You’re now retiring earlier, or more luxuriously, or both!

Boom! You just secured your age 60+ retirement in the time it takes to make a cup of coffee. Pat your self on the back, take a lap and hit the showers.

Next up, make this simple change to your direct deposit and never worry about spending too much again.

If you want to retire ever earlier, read this too.

Share in the comments how much you bumped up your contribution, and whether you changed your investments or beneficiaries!

ABLE accounts for those living with disabilities and the people who care for them

* WARNING *

This is a DRAFT/fragment article that may contain incomplete information or spelling errors. Use it with caution and double-check things! I’m publishing it ‘early’ before I have the time to polish it to get the info available to certain clients.

Key points on ABLE accounts

ABLE accounts allow the disabled to have assets up to $100,000 that don’t count against the $2,000 resource limit test used to determine eligibility for state & federal aid programs like SSI (cash assistance from social security), SNAP (food stamps), and Medicaid (health insurance for the poor.)

The ABLE National Resource Center has a lot of great detailed info to help you through the process of application & selecting the best ABLE plan for you. In general, if you pay state income tax, you’ll be best off picking your state’s plan since you can deduct your contributions from your state (but not federal) taxes.

Who is eligible for and can manage ABLE accounts?

People who developed a disability–including blindness– prior to their 26th birthday that is expected to last indefinitely or has already lasted for a year are eligible for ABLE Savings accounts, and they are also the account owners and beneficiaries. However, “authorized agents” for the disabled person can be the person actually opening, funding, and managing the account on behalf of the disabled beneficiary. This is typically a parent or guardian, but many states allow for multiple authorized agents with varying levels of access.

In general, individuals are eligible for an ABLE account if they are already receiving benefits under Supplemental Security Income (SSI) and/or Social Security Disability Insurance (SSDI). If not, they may still be eligible if they certify that they are blind or disabled and have a written diagnosis of their condition by a licensed physician. Under all circumstances, the onset of the disability must have begun prior to age 26.”

Until very recently, disabled individuals found themselves in a delicate situation when it came to their long-term financial security. The same often applied to families raising children with disabilities. While they might qualify for state and federal aid programs, such as Supplemental Security Income (SSI), Supplemental Nutrition Assistance Program (SNAP), and Medicaid, they could only receive the full benefits of each if their assets were less than $2,000. Since these programs often fund access to assisted living technologies and services, healthcare, and transportation, disabled individuals were essentially forced to remain poor or lose their benefits.

Luckily, this antiquated approach is slowly changing, thanks in large part to the Achieving a Better Life Experience (ABLE) Act. The ABLE Act amended parts of the federal tax code beginning in 2015, allowing states to establish tax-advantaged savings programs for individuals with disabilities and their families. Importantly, the assets don’t count against the $2,000 resource limit for SSI until they total $100,000.

https://www.fool.com/investing/2018/07/05/what-are-able-savings-accounts-5-things-you-should.aspx

Advantages of ABLE accounts

Money up to $100,000 ($100,000 is the limit in Washington state, but in some states, it’s higher.) can be shielded from the limits imposed by Social Security for determining SSI payments. Investments in the account grow tax-free and are tax-free upon withdrawal if spent on ‘qualified disability expenses’, similar to how a 529 plan works. In fact, you can transfer assets from a 529 plan into an ABLE account, with some restrictions.

In Washington state and generally (double-check with your state just to make sure), there’s no limit on ABLE funds for eligibility for Medicaid, which is awesome.

What can you spend ABLE money on?

You must spend ABLE money on “qualified disability expenses” (QDE) which broadly include any expense related to the disability or blindness of the beneficiary. In practice this includes:

  • Living expenses
  • educational expenses from preschool through college, and includes tuition, books, and supplies.
  • transportation, like bus passes, moving expenses, or the purchase of a vehicle
  • job-related training expenses
  • Almost any medical expense, including insurance costs, long-term support, nutrition management, communication services & devices, and more.
  • Assistive support expenses like a computer for a child with autism.
  • Various miscellaneous expenses like legal fees and funeral expenses.
  • Housing like rent or a home purchase can be considered qualified, but keep in mind they might impact SSI eligibility, so do your homework there.

Many state plans offer debit cards that can be used to spend directly from the account. Washington state charges a small monthly fee per debit card iisued of $1.25/month (no transactions fees when using the card, however.)

Who can contribute to an ABLE account, and how much?

Anyone can contribute to an ABLE account, but the total for all contributions from all people– including any 529 plan rollovers– combined for a single beneficiary can’t exceed $16,000 in 2022, with some exceptions for those below the federal poverty limit for 1-person households. If you pay state income taxes in the same state that the ABLE account was established in, you can deduct your contributions from your state (but NOT federal!) income taxes. Washington state has no income tax, and California’s plan does NOT allow state income tax deductions, but the funds do accumulate tax-free and if spent on qualified expenses, are distributed state (and federal, like all ABLE plans) tax-free.

Also, note that you can only have one ABLE account per disabled beneficiary. In Washington state, only one Authorized Legal Representative is allowed (other states might allow more than one authorized agent.)

From https://www.finra.org/investors/learn-to-invest/types-investments/saving-for-education/able-accounts-529-savings-plans :

  • The disabled ABLE account beneficiary can also contribute their employment income to their ABLE accounts in excess of the annual contribution limit, up to the prior year’s individual federal poverty level. For 2022, that was a max of $12,880 in 2022.
  • Designated ABLE account beneficiaries may now be eligible to claim the Saver’s Credit.

What state’s ABLE plan should I choose?

Try this comparison tool to look at 3 state plans together. Include your home state. Some states, including Washington state, only allow residents to open plans there. Oregon & California, for example, each have plans open to all US residents.

What investments should I choose within my ABLE account?

Choose low-fee index funds like those offered by Vanguard if your plan has them (Washington state’s does), preferably in the form of a ‘target date’ option that automatically adjusts– or at least rebalances– between stocks and bonds. I assume here that the beneficiary expects the funds in their ABLE account to last over their lifetime. If instead they planned to use all the ABLE money in just a few years, a more conservative investment option should be used.

For Washington state plan participants, I recommend the ‘ABLE Aggressive’ option which is a mix of 84% stocks and 16% bonds for young-ish beneficiaries, like those under 40 or 50. For those 40 – 50 or older, the 50-50 ‘ABLE Moderate’ portfolio is a good one.

For those 70 or older with very limited risk tolerance, the ‘ABLE Conservative’ 80% bonds – 20% stock plan can be used, or for those that expect to exhaust all the ABLE funds in a few years and aren’t planning on using it for life.

For California ABLE plans, the … are good.

Note that you can only make changes to your ABLE investment choices twice a year, the same as for 529 plans.

Can an ABLE account or 529 plan be rolled over to another ABLE account?

Yes, you can roll one ABLE plan over to another as long as the authorized person stays the same, and the beneficiary either stays the same OR is in the eligible family members list. These are the exact rules for Washington state ABLE rollovers. Other states might vary:

  • “An eligible Beneficiary can only have one ABLE account open at any
    time, except for the 60-day grace period for closing an ABLE account
    following a rollover to a new ABLE account.
  • If there is an Authorized Legal Representative (ALR) on the old ABLE
    account, they must be the same on the new account. If you would
    like to change the ALR, please do so on the old ABLE account before
    completing this form.
  • The Beneficiary of the new Washington State ABLE account must
    remain the same as the beneficiary of the old ABLE account or be an
    eligible “Member of the Family” (brother, sister, stepbrother, stepsister)
    of the beneficiary of the old ABLE account.
  • A rollover from one ABLE account to another qualified ABLE account
    for the same beneficiary can only occur once every 12 months.”

Also, 529 plans started for education purposes of even a different beneficiary– say, you, or a child without a disability– can generally be rolled into an ABLE account per the ‘family member’ rules (unless the 529 plan was funded with a UTMA/UGMA gift to a minor, in which case the beneficiary can’t change.) This is subject to the ABLE plan contribution limits however, so if you have a large balance in your 529 plan, you may have to do the rollover in pieces ($16,000 at a time for the 2022 ABLE contribution limit.)

What happens to any unused ABLE funds when the beneficiary dies?

Unused funds pay Medicaid. If the account owner dies with funds in an ABLE account, those funds must be used (in this order), to pay any outstanding qualified disability bills including funeral expenses, to provide payback to Medicaid for all Medicaid benefits received, and then to be distributed to the account holders legal beneficiaries.”

This means in practice that if the ABLE beneficiary received a fair amount of Medicaid services, there might not be much if anything left for beneficiaries, so keep that in mind for estate planning purposes.

Other kinds of accounts for disabled people

A Special Needs Trust is often used as well, but that generally requires legal fees to set up, whereas an ABLE account can be funded for as little as $25 with minimal annual fees ($35/year in Washington state.)