What Is a Letter of Engagement for Financial Planning?

Working with a money professional requires much more than simply turning over your records to a financial advisor with a Midas touch. Rather, the relationship between a financial advisor and you, the client, is a symbiotic one based on accountability, transparency and trust.

Finding an advisor you like is one thing. Working with that person to achieve your financial goals requires a clear agreement that outlines the roles, responsibilities and expectations incumbent upon both you and the advisor. That’s where the letter of engagement comes in.

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Clients may receive a letter of engagement from a professional who’s providing financial planning services or financial advice. The professional could be a certified financial planner, called a CFP, or another financial expert with whom they work directly.

Here’s what clients should know about signing a letter of engagement.

What Is a Letter of Engagement?

The letter of engagement for financial planning is a written, legally binding contract that outlines, in clear terms, the business relationship between the client and financial planner. It sets expectations for the partnership. It’s a brief but accurate summation of the scope of the relationship, its terms and how the advisor will be financially compensated for his or her services.

“Financial planning is such a comprehensive process that clients need to understand what the expectations are for them to be involved, and also the expectations for the advisor’s involvement,” says Katie Burke, a CFP and founder of Method Financial Planning, based outside Philadelphia.

How the Process Works

Once you’ve had your first meeting with a financial advisor to discuss your goals and objectives, as well as what services the professional can offer, the advisor will draft legal documents and the letter of engagement. The document will outline the scope of the work to be done, the terms and conditions of the business relationship, the number of meetings scheduled per year, and the advisor’s compensation. This letter of engagement is signed before work begins.

“Engagement letters help CFP professionals effectively communicate to clients the information required by the CFP Board’s Code of Ethics and Standards of Conduct when providing financial advice, financial planning or updating information,” says John Loper, CFP and managing director of professional practice at the CFP Board.

[Read: Are You Overpaying for Your Financial Advisor?]

Because each client’s needs are unique, no two letters of engagement are the same. Here are common sections a sample letter may include:

— A list of the services and products the advisor will provide to the client, along with an explanation of the advisor’s approach to financial planning.

— How the client will pay for services and products, including how often the client will need to pay the advisory fee (quarterly, semiannually, annually).

— How the advisor will be paid. Often, the client will pay the advisor’s firm and the advisor, who’s salaried, will get part of the fee that the firm receives.

— Any potential conflicts of interest of the advisor or the firm.

— The client’s responsibilities, which include the need to update and disclose personal and financial circumstances.

— The timing of the engagement between client and advisor.

— Privacy policy on protecting the client’s nonpublic personal information.

— Any public disciplinary and bankruptcy history disclosures by the advisor.

[SEE: 6 Pros and Cons of Choosing a Fee-Only Financial Advisor.]

What You Need to Know Before You Sign a Letter of Engagement

The letter of engagement is beneficial to both client and advisor on many levels. For one thing, it acts as a form of insurance, whereby each side knows what the other’s roles and responsibilities are, protecting both from the risk of being complacent or not knowing who’s responsible for doing what tasks. It also acts as a checklist, itemizing the services that will be provided, how those services will be carried out and by whom, and enables both the client and advisor to be on the same page. What’s more, the letter helps clients become more engaged in planning for their financial future.

Although the letter of engagement is necessary before getting down to business with a financial professional, there are several things to keep in mind before you sign on the dotted line:

It doesn’t replace other legally binding documents.“It’s important for clients to know that engagement letters don’t replace the CFP firm’s contracts, agreements or other legal documents or regulatory documents,” Loper says. A letter of engagement typically runs about eight pages in length, and although it provides a clear and concise overview of the business relationship between the advisor and the client, it’s by no means meant to be the only legally binding document requiring your signature. It certainly doesn’t replace or supersede other legal documents generated by your advisor, such as Form ADV, Form CRS or any others required by federal or state regulators or the Financial Industry Regulatory Authority, according to the CFP Board.

Read the letter thoroughly and ask questions. Yes, the letter of engagement is designed to provide a high-level overview of the relationship between the advisor and client, but it also provides details of the terms of the relationship that, if not fully understood, could lead to unnecessary confusion by the client. If, for example, you think you are being charged to meet your advisor once a year, but the letter states you’re to meet quarterly (and be charged per quarter), this misunderstanding could be costly and ultimately lead to a breakdown in communication and trust. “The last thing you want to do is set false expectations,” Burke says. Read through the letter carefully and ask questions about the details of the terms outlined.

To learn more about what information must be provided to clients in all engagements of financial advisory services, see the CFP Board’s reference guide, Financial Planning Engagements Disclosure Guide.

Make sure all necessary items are disclosed. The top three questions the letter of engagment should clearly answer include these: What services are you getting? How will the advisor be paid? How often will you meet with your advisor?

Understand the expectations your advisor has of you. The letter of engagement must clearly state who’s responsible for each task and what information is needed to help the advisor do his job. “You want everything to be clear before work starts,” Burke says. “It’s important for a client to understand the expectations the planner has on them because we need so much information from the client to do our job.” Burke notes an issue she has come across is that some clients think the financial plan is specific to one facet of their financial portfolio and are reticent to provide financial information that’s not specific to that plan. “It’s hard to give a client the financial advice they need without getting access to all of their financial information,” Burke says. “We need to have the full picture.”

Financial planning is different from financial advice. An engagement letter for financial planning is different from one for financial advice, so clients should know the difference between the two and fully understand what type of engagement they are signing up for. A financial advice letter of engagement may deal with the details of a more transactional business relationship — the recommendation and buying of specific financial products — while a financial planning letter of engagement could spell out the specifics of a more holistic approach to the client’s finances.

It’s a long-term relationship, so be prepared for changes. In many cases, working with a financial advisor is a long-term relationship, and during that time, financial and life circumstances will change. It’s important for you and your financial planner to be flexible and, if necessary, reevaluate the terms of the letter of engagement.

More from U.S. News

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What Is a Letter of Engagement for Financial Planning? originally appeared on usnews.com

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