Vonnegut: A Bonus, Then a ‘Bagel Paycheck’
WEALTH ADVISER – Wall Street Journal December 1, 2014
Vonnegut: A Bonus, Then a ‘Bagel Paycheck’
By Norb Vonnegut
You’re pinching yourself. Hoping it’s not a dream. A branch manager from the evil empire just offered you $1.4 million to join his wirehouse. It gets better. If you hit Darth Vader’s annual revenue targets, you’ll earn additional bonuses of $500,000 in each of the first three years. He’s pitching you $2.9 million in potential upside.
All that money is a beautiful thing, like the new S-Class Mercedes you’ve now got your eye on. What can possibly be wrong with $2.9 million in cold, hard…Employee Forgivable Loans?
“Bagel paychecks,” for one, says Paul Spitzer, CEO of Advanced Practice Advisors, Registered Investment Adviser with $330 million in assets under management.
Brokers should be prepared for worst-case scenarios. The upfront money is deceptive, warns Mr. Spitzer. As principal and interest are forgiven on an EFL, they generate ordinary income. And the ensuing taxes can reduce your take-home pay to zero.
Like a big, fat bagel.
Let’s say you’re a $1 million-a-year producer who says yes to that offer. You sign a $1.4 million EFL, at 5% interest, amortized over 10 years. Then–uh oh–assets are slow to follow, and so you generate only $500,000 in your first year at the new shop. Uh-oh is right. Your after-tax income goes negative. I’m making some more assumptions here, including a 40% payout on revenue and a 50% total in federal and estate income tax on that payout—not unreasonable rates for lots of advisers.
So let’s look at the numbers:
Forgiven interest adds up to $70,000 and forgiven loan principal to $140,000, so you get $210,000 in noncash income. Add $200,000 from the payout and you get $410,000 in total income. Taxes on that total come to $205,000. That’s $5,000 more than you’ve gotten in pay for the year. That’s a bagel paycheck.
Mr. Spitzer, who once took a signing bonus to change broker-dealers, says the take-home situation is worse when you factor in Alternative Minimum Taxes, overhead charges or reduced payouts on, say, small accounts or discounted trades.
He calls EFLs “a 10-year sentence with no parole.”
Yes, you did get the $1.4 million signing bonus upfront. And that is a lot of money.
But let’s compare what a $1 million-a-year producer-adviser would earn over 10 years by staying put versus taking a check and moving to a different wirehouse. I’m assuming no difference in payouts between firms, and that the breakaway adviser keeps 75% of pre- move production but never hits Darth Vader’s targets. Consequently, there are no bonuses beyond the initial $1.4 million.
You know the old saying. Hope for the best. Prepare for the worst.
I wanted to understand the economics of a disappointing move. After all, it’s advisers who put their careers on the line when they change firms, not the shops that hire them. My initial conclusion: Take the check but forget the Mercedes. Even if you’re “bageling” and find it necessary to eat into that signing bonus, you may come out ahead.
Wealth-management businesses are leaky buckets. Advisers lose important clients all the time, so an upfront payment is like a put option against the future loss of clients. Saying “yes” to the signing bonus is one way to share business risk with somebody else.
Then again, career decisions aren’t just about the money. Danny Sarch, president of a recruiting firm that specializes in adviser transitions, notes that during 2014, “less than half of the advisers who leave wirehouses will move to another wirehouse.”
“They’re tired of being told what to do,” he explains.
Many big producers are moving to independent broker dealers like HighTower Advisors or LPL Financial , in part because they can. Their client loyalty, Mr. Sarch says, “is much stronger than ever before.” Can advisers control their destinies at independent broker dealers any more than they can at wirehouses?
Not according to Spitzer. To obtain true freedom, he believes financial advisers must go off the W-2 grid. That means owning their own shop, taking advantage of the many tax advantages that accrue to owners, and finding a solution for the administrative back office. What if you’re not ready to take that risk? Should you take the check from the wirehouse, stay put, go indie, or flee to an RIA? It depends.
If you’re at the start of your career, stay put. Moving a business from one shop to another is a grisly, exhausting experience that eats time and limits your ability to grow. In your shoes I’d play the long game, tell Darth Vader to get lost, and throw all my energy into finding new clients rather than running what-if scenarios about greener pastures. But let’s say you’re a well-established veteran, all your new business comes from referrals and retirement’s not too far away. It might be time to crunch the numbers, to think long and hard about that put option.
Norb Vonnegut built his wealth-management practice in New York City, and now writes thrillers about financial malfeasance.
Write to Norb Vonnegut at email@example.com