Make it essential to find out how a financial advisor is paid before hiring them. While some are fee-only advisors, others may receive commissions. Additionally, you’ll probably pay an advisor a percentage of your investments in addition to fixed and hourly fees for financial planning services. There are a number of variables at play when selecting an advisor that is paid on commission.
Financial Advisor Commissions: An Overview
While some financial advisors receive fees just by opening an account for a client, others do so by persuading you to buy a particular financial product. In that situation, the business that produces the product, such as an insurance company, pays the advisor.
An advisor may receive their compensation in a variety of formats. These can include up-front sales commissions, loading on mutual funds, commissions from annuities or other insurance products, surrender fees for annuities, and trailing commissions, where a client is charged for each year they hold an investment.
Financial advisors are required to abide by regulations and standards in order to protect consumers. An advisor is probably a licensed fiduciary if they are registered with the SEC or another state regulating body. In this situation, they are required by law to put your needs ahead of their own and steer clear of any conflicts of interest when recommending items.
Similar to this, registered advisors who adhere to the appropriateness standard are subject to a lower standard by the Financial Industry Regulatory Authority (FINRA), a nonprofit organization. Although they must provide financial products that meet a client’s needs, they are not required to be the finest products available. In other words, an advisor can offer you whatever product they want, even if they get paid by the firm hawking it, as long as they have a “reasonable basis to believe” that doing so is in your best interest.
What Are the Sources of Commissions for Financial Advisors?
A variety of investment products offer commissions to financial planners. These commissions typically take the shape of a percentage of the product’s sale price. Because commission-based agreements frequently depend on a relationship an advisor has with a corporation, conflicts of interest can occasionally arise.
Here is a summary of some typical sectors in the financial services sector where commissions are encountered:
Insurance products: Selling insurance products may come with significant financial rewards. Some consultants could receive commissions as high as 70% of the premium for the first year. As long as the policy is in effect, they could then get an additional 3% to 5% of the premium each year.
Mutual funds: Advisors who sell mutual funds typically receive payment in the form of a trailer fee. This commission might be between 0.25 and 1 percent of the assets placed in the fund each year. As long as the investment is held in a mutual fund, the advisor is eligible to receive this fee.
Annuities: Commissions for annuities are typically included in the contract’s pricing. Depending on the annuity type, commissions typically range from 1% to 10% of the total contract amount. For instance, fixed-indexed annuities often result in a 4% commission for planners.
How Agents Are Paid by Annuities
Agents frequently make even more money when they market annuities because more life insurance firms are now offering a wide range of financial solutions. The industry’s mainstay continues to be the fixed annuity, which pays the owner a predetermined sum each year. However, a lot of reps offer more complicated items, which frequently have much bigger commissions.
A variable annuity, as an illustration, provides a cash-balance function, where the payout is partially based on the performance of various stocks, bonds, and mutual funds chosen by the owner. The carrier and the selling agent may each receive a commission of 5% of the amount invested in these policies.
The equity-indexed annuity is another very sophisticated financial product. These annuities’ returns are determined by how well a benchmark, such the S&P 500, performs. These products have drawn criticism for being fairly sophisticated as well as for paying agents excessively. Every time they sell one, sellers often get commissions of over 5%.
This is not to say that most life insurance agents earn enormous sums of money. The Bureau of Labor Statistics reports that the median pay for insurance brokers in 2021 was $49,840.
The most recent year that can be used is 2021. Building a consumer base might be particularly difficult during the initial years. However, experts claim that comprehending the industry’s compensation structure might help consumers understand why some agents might have a preference for some products over others.
The Case Against Advisors Paid on Commission
Working with a commission-based financial advisor has a few drawbacks. For starters, there’s always the concern that they would suggest you buy a product just because it’s profitable for them. For instance, it might not be appropriate for your financial objectives or risk tolerance. Your best interests could be at risk if your financial advisor only earns money through commissions.
These consultants might not provide the same level of long-term care for your finances as you might expect because they just get paid once for the transaction. Therefore, unless you’re purchasing a product that doesn’t require recurring transactions, you might want to look for a financial advisor who is open to having ongoing conversations with you.
Another thing to keep in mind is that financial counselors who work for investment brokers or insurance companies sometimes prioritize sales. Therefore, even if they may follow the appropriateness or even fiduciary standard, they can have their employer’s bottom line as their only allegiance.
However, it’s important to keep in mind that many qualified financial advisors earn compensation in addition to commissions. In addition, an adviser may have a different fee schedule if they have a certification or designation. Additionally, SEC- or state-registered advisors are bound by a fiduciary duty that requires them to put your interests first at all times.
Do your homework before choosing a financial advisor, just like you would with any other financial decision. You might be okay with that if all you’re doing is purchasing a single annuity product from a commission-based advisor. However, a fee-only advisor might be your best bet if you’re seeking for a comprehensive financial advisory service that will stick by you over the long haul.
How Should a Typical Insurance Sales Commission Be Calculated?
On the sale of a policy, agents or brokers often keep more than half of the first year’s premium. Depending on the size of the insurance, that might come to hundreds or even thousands of dollars. Additionally, they frequently get renewal commissions, which can be up to 7.5% of your premiums for the following nine years that you keep the policy. In addition, some plans pay the agent a nominal “persistency” charge (sometimes called a residual) once a year.
What Are the Inherent Challenges of an Insurance Sales Position?
Because of the pressure to produce a minimum number of sales, agents are claimed to frequently burn out within a year. Due to the lack of a requirement for a college degree, the field may also be saturated. Also, it can be challenging to identify qualified clients. These could be a factor in why agents receive hefty commissions.
What Qualities Should Purchasers Look for in Annuities?
Commissions from annuities are often higher than those from other insurance products. Although the fixed annuity continues to be the industry standard, many representatives market plans that are trickier and frequently have significantly higher commissions. In the case of a variable annuity, the carrier and the selling agent might each receive commissions of 5% of the invested amount.