How To Protect Client’s Wealth and Your Business in an Aging World

As Tom West, creator of LCAP and Senior Partner at SEIA, settled into his office in Tyson’s Corner, Virginia, a distraught woman urgently requested his help. She had just attended an eye-opening financial planning session and was deeply concerned about her family's future.

The woman's husband, a once-successful CPA in suburban Washington DC, had unknowingly experienced cognitive decline. This led to significant errors on his clients' tax returns, attracting the IRS's attention and eventually triggering legal action from affected clients. The downward spiral resulted in his CPA firm's closure, and now the couple faced a dire situation.

The sudden turn of events had thrust the 70-year-old woman into a state of desperation. Previously uninvolved in managing the family's finances, which had always been her husband's responsibility, she now found herself in an overwhelming position. With the urgent need to sell their family home, tackle mounting financial challenges, and secure proper healthcare for her ailing husband, she faced an uncertain future with little time to spare.

“The family was understandably panicked, because no one saw this coming, including the two adult children or his former financial advisor,” says West. “Fortunately, we’ve worked with clients before who have dealt with the crushing reality of diminished capacity. For this client, we went into financial planning triage mode. We reconfigured the couple’s entire portfolio in a way that created more income to help turn around the negative cash flow situation,” he explains.

The decline of financial decision-making as we age

For many advisors like West, the average age of a financial planning client is 64 and rising. “We are living longer, but our brains often do not hold up as well as the rest of our bodies,” he explains.

A major Brooking Institute study concluded that the “peak age” of financial decision-making is 53 – so the overwhelming majority of wealth clients are already past their financial decision-making prime.

“But here’s the really hard thing,” says West. “Many of these clients will live for another 30 years or more—and there’s no major advancement in treating dementia on the horizon.”

According to West, bad family decision-making related to diminished capacity are often the result of misunderstandings of the current situation (such as denial) or an inability to agree on priorities. “Advisors should rely on clinicians with dementia expertise to help define current and likely cognitive realities,” says West.

“Good advisors can take a leading role in gathering family decision-makers to explore and decide on the hierarchy of health, housing, and financial priorities while remaining sensitive to the likelihood that priorities will change with circumstances,” he adds. “For example, ‘staying home’ as the most important thing can change to ‘keeping spouses together’ when a care setting is no longer suitable.”

 5 key risks to financial advisory businesses

Diminished capacity poses risks not just for individual clients, but for all wealth management firms. According to Steve Gresham, a wealth management industry consultant and founder of Next Chapter, there are 5 major risks associated with managing clients with diminished capacity.

1. Loss of the primary account holder’s assets

The inability to successfully identify and manage diminished capacity can result in the loss of some or all of a client’s current assets under management. Financial exploitation and/or impulsive decision-making left unchecked can lead directly to substantial account outflows and/or significant declines in overall portfolio value.

The perceived inability to adequately address diminished capacity issues can further result in declining client satisfaction and loyalty. An estimated 58% of high net worth (HNW) investors have switched financial advisors within their lifetime, with 23% having done so within the past five years, according Cerulli Associates, a Boston-based research and consulting firm.

In a McKinsey & Co survey, 20% of wealth management clients indicated that are “likely or somewhat likely to switch financial advisors in the next 12 months”. This figure rises to 40% for clients who do not view their advisor as being “proactive”.

“One key way advisors can be more proactive would be to take a holistic view of the family’s wealth and engage the next generation in financial strategies and important family money decisions” advises Gresham.

2. Loss of opportunity to consolidate held away assets

Wealth advisors are sometimes measured on how much of one’s total wealth they manage. It’s known as “share of wallet” and most firms estimate they hold between 40-50% of available wealth.

Most wealth managers see aging as an asset consolidation process, as they advise clients to simplify their financial accounts as they get older. This may present risks to the wealth management firms, especially if it controls less than 100% of a client’s total assets, like most do.

According to Gresham, “money in motion” -- money that is in transition, up for grabs, or that hasn't yet found a purpose-- is now up 350% over the normal rate and twice the rate it was following the financial crisis of 2008-09.

“More and more, clients of financial advisors are increasingly willing to part ways with a current advisor and move their money to a firm where they feel they are most effectively served,” says Gresham. He continues, “Bottom line: Firms that are not helping their clients more effectively identify and mitigate age-associated financial risks – like those presented by diminished capacity – are in danger of losing 25-50% of client assets to competitors who are.”

According to West, ‘money in motion’ requires advisors to execute transfers of funds and oftentimes tax information to beneficiaries, and the transfers present opportunities to educate recipients of best practices of managing wealth—and retain assets.

“I’m fond of forwarding the non-threatening questionnaire from the CPFB (Consumer Protection Financial Board) about financial well-being is a place to start. Next, we follow up with a communication that defines the fiduciary standard and then we recommend that the wealth recipients consider advisors that meet that standard,” he explains.

3. NextGen: Loss of assets inherited by heirs

Many sons and daughter know they are poised to inherit a lot of money. This phenomenon is known as “wealth transfer”, but the vast majority of the Next Generation don’t know when – or how much. It is estimated that some 40% of High Net Worth (HNW) clients are currently considering leaving an advisor whom they do not view as sufficiently “proactive”.

The aging of the Baby Boom generation is largely responsible for the massive transfer of personal wealth that is now underway. Cerulli Associates projects that roughly 45 million US households will transfer a total of $84.4 trillion to heirs and charity over the next 25 years, with $72.6 trillion in assets being transferred and $11.9 trillion being donated to charities.

But what will the heirs do with their inherited money? Probably not keep it with their parent’s advisor. According to Cerulli’s research, an estimated 87% of heirs fire their parent’s financial advisor either to manage the money themselves or move it to a rival investment firm. This unprecedented transfer of wealth presents another major opportunity, and risk, for the firm.

Taboo subject? Yes, diminished capacity is unfailingly a highly sensitive subject within families. “It’s a hard conversation to have,” says West. “If an advisor has a good relationship with the client’s children, and if they can demonstrate that they did everything they could to protect the parent(s) from health-related risks like diminished capacity, the advisor will have a better chance of holding on to the assets of a deceased client.”

4. Exposure to regulatory risks

Diminished capacity cases expose firms to mounting regulatory risks. There are increasing sanctions for misconduct. During the last five years, FINRA, the financial services industry regulator, has implemented a number of rules focused on senior investors. Rule 2165 permits brokers to place a temporary hold on a disbursement of funds or securities from ‘specified adults’ when financial exploitation is suspected. These adults include those who appear to have a mental impairment that renders them unable to protect their interests.

Firms must collect “trusted contact” information under Rule 4512, and FINRA recently revised its guidance to explicitly include the age and vulnerability of victims as factors in setting sanctions for misconduct.

Individual states too have their own reporting rules. While each of the states’ regulatory rules relating to reporting is unique, most address exploitation of victims who have reached a certain age or who are vulnerable for reasons relating to diminished mental capacity, or both.

Cognitive decline can often lead to elder fraud, now estimated to cost Americans over $27 billion a year, according to the Financial Crimes Enforcement Network (FinCEN), a division of the U.S. Department of the Treasury. According to West, if advisors have been trained to look for signs of financial exploitation, they have immunity under the Senior Safe Act when reporting suspected financial abuse of clients.

“Advisors should pre-plan for a crisis, because you’re not going to get a lot of warning if an aging client does have a problem,” West says. “Cognitive issues can happen almost overnight, and advisors need to be looking at ways to be holistic and get in front of these problems.”

5. Exposure to reputational risks

Cases involving diminished capacity are typically messy and often emotional. As a result, any publicity accompanying diminished capacity issues poses additional reputational risks. “Sometimes people threaten to go to the press to tell a story or how Mom or Dad lost money. This kind of extortion rarely succeeds, but smaller advisors may be at greater risk if this negative word-of-mouth spreads in their community,” says Gresham.

“No matter how many assets you have under management, you need strong risk management program for your firm,” says Gresham. “When the stock market is performing well people tend to gloss over minor account changes in an up market. Say the account jumped by $20,000 last quarter. A $5,000 loss attributed to an individual’s impaired actions are harder to notice.”

The Role of the Family and Friends

Hiding symptoms of cognitive decline from family and from advisors is common for both individuals and spouses who might instinctively be defensive about perceptions of lessened ability, says West.  Another predictable mistake is the hesitation on the part of the family to ask for help or perspective until circumstances force the issue. “Early interventions and accommodations to cognitive decline are almost always better for the client, both psychologically and financially,” he adds.

According to the experts interviewed for this article, the following are action steps that friends and family should consider:

  • Update health care directives and financial Power of Attorney (POA) documents

  • Consider hiring a patient advocate to help guide the loved one through complicated medical conditions like cancer

  • Look for a physical, cognitive, and behavioral changes in the person

  • Pay more attention to their finances and look for changes in spending patterns

  • Ask if there are any new companions who are frequently spending time with the loved one

  • Consider a bill pay service to streamline recordkeeping and save time

Engaging the Next Generation

Many adult children no longer live near their parents, so advisors can help play the eyes the ears and be on the lookout for cognitive challenges. “Advisors need to clue into the signs, symptoms and frequency of cognitive decline to protect their clients, says Suzanne Schmitt, Managing Director at Next Chapter.

Schmitt advocates that the next generation (G2) needs to be proactively engaged in their family conversations and begin to explore how to manage money for their aging loved ones. “It shouldn’t be a nice-to-have; but rather these family conversations should be a “best practices” standard operating procedure for a client’s annual review.”

Detecting cognitive declines takes a village, according to Schmitt and early warning signals can include:

  • Lapses in memory

  • Duplicated bills being paid

  • Inability to manage daily household chores

  • Difficulty in figuring a tip or how to pay a bill at a restaurant

  • Suspicious package deliveries

  • Trouble with movement balance, or coordination

  • Changes in mood or personality

  • Making poor decisions, especially related to finances, health, or personal safety

  • Exhibiting inappropriate behavior, paranoia, or hallucinations

Lastly, Schmitt underscores the importance of getting to know the neighbors. “You can’t underestimate the value of having a neighbor to call to get the real intel on Mom or Dad, like the five deliveries from Amazon this week or number of times the ambulance was called that Mom or Dad just ‘forget to mention’.”

Advisors taking on more ownership of the problem

According to Gresham, clients will need to receive more proactive notifications and more targeted educational content concerning the growing proliferation of financial products and services and their benefits. “These technology upgrades and business re-organizations will take time and cost money. But failure to make necessary adjustments will increase a firm’s risk of losing some or all of their managed assets,” say Gresham.

“If you’re a financial advisor, you have to see this coming,” warns West. “To date, the wealth management industry had decided that it’s not our job because no one gets paid for preventative action. The same goes for those that think that dealing with diminished capacity is the job of the client’s doctor or lawyer or family.”

Looking forward, West sees the industry evolving and even embracing ways to help clients successfully navigate cognitive decline. “It’s up to us as fiduciaries and advisors. Today, most everyone is playing defense and looking the other way. That has to change. We need to put the right technology and operational protocols in place. Simply, we need to now play offense and start working harder for our clients,” West says.

Financial Advisor Cognitive Decline Playbook in 3 Easy Steps

Facilitate a series of important family conversations

  • Communicate frequently, especially around major life events. (e.g., a serious illness or divorce).
  • Get to know the spouse, children, and other family members.
  • Have conversations about what you should do if you are worried about your client’s ability to make good financial decisions.

Get it in writing

  • Record the names and contact information of (multiple) “trusted contacts.”
  • Draft a “diminished capacity” letter spelling out what your client would like you to do if you have concerns about their decision-making capacity.
  • Make sure your client has a will, durable power of attorney, a trust (if warranted), a medical power of attorney/health care proxy, a living will and/or other advance directives [e.g., a do not resuscitate (DNR) order].

Put monitor systems in place and seek professional support

  • Always be on the lookout for behavioral changes, especially around major life events like a divorce, job loss, or death of a spouse.
  • Use account monitoring software, such as Eversafe, and other applicable technologies, designed to help evaluate client behaviors.
  • Consider setting up alerts that notify trusted contacts when your client attempts to execute specific transactions (e.g., a stock purchase of more than $10,000).
  • Provide referrals to local mental, behavioral, and geriatric care specialists along with psychiatrists, Alzheimer’s support groups, and elder law attorneys.

Related: Helping Clients Maximize Inherited IRAs