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For decades, I have maintained that anyone seeking a financial advisor is best served by a professional who has a fiduciary responsibility to put clients’ interests ahead of their own. One indicator of a planner’s fiduciary status is how they make their money. The way advisors are compensated can significantly affect the advice they provide.
Ironically, one little-used compensation method is a genuine fiduciary approach, yet an advisor who uses it is barred from joining the largest professional organizations for fee-only fiduciary planners. This is the fee-offset model.
The three common methods of compensation for financial advisors are:
Commission-Based: Planners earn money on the financial products they sell, like insurance policies or investment products. This model can create conflicts of interest. Advisors may have to choose whether to recommend products that provide them with higher revenue or those likely to provide the best investment return to their clients (who are more accurately described as customers).
Fee-Based: This hybrid model involves planners charging clients a fee, often flat or on a percentage of assets under management, as well as receiving commissions on certain recommended products.
Fee-Only: Planners charge a flat fee or a percentage of assets, with no commissions. This model is currently the gold standard for minimizing conflicts of interest. Fee-only planners are held to a fiduciary standard that legally and ethically requires them to act in clients’ best interests.
The fee-offset model doesn’t quite fit any of these categories. A planner using this method sets an annual fixed fee for their services. Then any commissions earned from the sale of products, usually insurance products, are credited back to the client, offsetting and reducing the annual fee by the amount of the commission. This can be particularly beneficial when the best product available for a client includes a commission for the planner.
The fee-offset model aligns well with fiduciary standards. Consider this scenario: your financial plan requires an insurance product. You can either purchase one from a traditional insurance agent, paying the full commission, or you can go through your financial planner, who is licensed to provide the same product but credits any commissions against your fixed financial planning fee.
This approach encourages the planner to recommend the most suitable items without being swayed by potential commissions. In fact, the only real reason for a planner to use this method would be to put clients’ interests first. It benefits clients even as it requires more effort from the planner.
Yet the fee-offset model is not recognized by the CFP (Certified Financial Planner) Board or the National Association of Personal Financial Advisors (NAPFA) as fee-only. Planners who use it do receive commissions, despite those being fully offset.
The reluctance of organizations like the CFP Board and NAPFA to embrace the fee-offset model likely stems from a stringent interpretation of fee-only standards, where any form of commission disqualifies an advisor. However, practically speaking, fee-offset might sometimes align better with client interests than strictly fee-only arrangements, particularly when commission-bearing products are truly in the client’s best interest.
As the financial planning profession evolves, there is a compelling argument for professional organizations to consider including fee-offset approaches in their definitions of fee-only services. This would acknowledge the model’s role in serving clients’ best interests by providing necessary financial products at reduced costs.
An advisor’s compensation model is not the only way to ensure their ethics. This is why I suggest, before engaging a financial planner, you ask for a written, signed statement that their relationship with you is a fiduciary one without material conflicts of interest that come from the sale of financial products.
Rick Kahler, MS, CFP®, CFT-I™, CeFT®, CCIM, is the founder of Kahler Financial Group, a Rapid City, SD-based fee-only Registered Investment Advisor.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
