The conflicts your financial advisers don’t want you to know about

In the past decade, people have moved trillions of dollars to advisers who charge fees rather than commissions. These advisers typically charge clients annual fees, often between 0.75% and 1.25% of an investment portfolio.

The fee-based financial planners are a hit with regulators and consumer advocates, in part because they often don’t earn commissions, a practice that has encouraged some brokers to push expensive financial products or recommend potentially costly moves, including frequent trading.

Still, the fee-based structure can tempt advisers to make recommendations that maximize a portfolio balance, even when doing so isn’t in a client’s best interest, according to academics and researchers. In one example, people who pay advisers portfolio-based fees claim Social Security earlier than what is often considered ideal, and at the same age as those who aren’t getting any advice at all.

“Fee-based compensation is generally considered less prone to abuse than commissions, but we’re seeing some behaviors among fee-only advisers that also represent clear conflicts of interest," said Michael Finke, a professor at the American College of Financial Services.

Claiming Social Security

David Blanchett, head of retirement research at PGIM DC Solutions, an affiliate of Prudential Financial, co-wrote a study that found that people who used fee-based advisers took their Social Security benefits at 65, on average.

Though people can claim Social Security as early as age 62, holding off until later guarantees them a higher monthly check. It is often optimal for the spouse with higher earnings to delay claiming until age 70.

But advisers stand to earn more fees when their clients claim Social Security soon after retiring, because clients don’t take as much from their portfolios.

“I would have thought people with an adviser would claim later, since advisers should be aware of the benefits," Blanchett said. He concluded that the way advisers are paid is likely influencing their claiming recommendations.

Those with fee-based advisers drew Social Security later than people with brokers, who took benefits at age 64, according to the study. Both tapped their benefits earlier than people who paid advisers an hourly fee, no matter the size of the portfolio. They claimed at age 66, on average.

The study examined 260 households with $500,000 or more in assets that the Federal Reserve surveyed in 2019.

Consider a man who retires at 65 with $2 million and spends $7,500 a month. If he has a choice between taking $3,400 a month in Social Security at 65, or $5,000 a month starting at age 70, he will maximize his lifetime benefits by waiting until 70, provided that he or his spouse lives to about 83, said Blanchett.

If he waits until age 70, he would need to withdraw $450,000 from his investment accounts to support himself between 65 and 70. If he instead claims at 65, he would only need to withdraw $246,000, since his $3,400 Social Security check would cover some of his living expenses.

Paying off a mortgage

Eliminating debt was once considered a key part of preparing for retirement. As interest rates fell over the past decade, holding on to a mortgage later in life became more common. Advisers have a financial motive to agree with the strategy.

Consider someone with a $500,000 mortgage and a $1 million portfolio, who pays his or her adviser a 1% annual fee, or $10,000.

If the client withdraws $500,000 from the portfolio to eliminate the mortgage, the account balance and adviser’s pay halve.

In recent years, the percentage of households age 65 or older with mortgages has risen, from around 15% in 1989 to 29% in 2019, according to Boston College’s Center for Retirement Research.

One reason: “There’s a remarkable comfort among the adviser community with keeping mortgages in retirement," said Michael Kitces, co-founder of the XY Planning Network, whose 1,800 advisers charge fees.

Advisers argue that their clients have a better chance of earning higher returns by leaving their money in the stock market than they would get by selling their investments to eliminate a mortgage.

Recent history has proved them right: Over the past five years, the S&P 500 has gained an annualized 14.7%, according to FactSet, far exceeding the carrying cost of a mortgage refinanced when the 30-year rate fell below 3% a few years ago. Some people might also get a tax deduction for paying mortgage interest.

But not everyone is comfortable using debt to bet on the stock market, said Alan Moore, chief executive of the XY Planning Network.

“Whether an adviser chooses to recommend the right thing for the client or not, it would be naive to think their own pay doesn’t enter their mind," Moore added.

Buying an annuity

Some fee-based advisers shy away from annuities, including a type some economists recommend.

An immediate annuity requires a retiree to pay a lump sum to an insurance company in return for a fixed income for life, often an irrevocable move. Currently, a 65-year-old man who wants $3,000 a month for life would pay about $480,000.

Annuities have critics, partly because many varieties have high fees. But some economists like immediate annuities in part because they remove the possibility of going broke in old age and typically have commissions of around 3%.

Advisers don’t generally share in economists’ enthusiasm, said Finke, perhaps because buying an annuity generally means moving money out of an investment account.

“They are so seldom used by advisers that one would have to question whether conflicts of interest are preventing advisers from presenting a solution that will likely make clients better off," he said.

For example, Fisher Investments, which manages $265 billion for fees of up to 1.25% of assets annually, has a website that says: “Our founder, Ken Fisher, is fond of saying, ‘I hate annuities,’ because he believes anything you can do with an annuity can be done better with other investment vehicles."

What Fisher doesn’t say is that his firm earns more by steering clients away from annuities, said Finke. “If he recommends taking 25% of a client’s assets and purchasing an annuity, he loses 25% of his fees."

A spokesman for Fisher said the firm always works in its clients’ best interest. “While we don’t sell annuities, if they make sense for a client after our evaluation we tell them so," the spokesman said.

Write to Anne Tergesen at anne.tergesen@wsj.com