When we meet our clients, some of the most common questions we are asked are:
- When can I afford to retire and how much can I spend?
- How much do I need to save to meet my desired lifestyle in retirement?
- What level of return do I need to meet my desired lifestyle in retirement?
- How much risk do I need to take with my investments?
- Can I afford a large capital expense such as a new car, or make gifts to family?
- Can I meet my goals if my investments don’t perform as well as expected?
- How would my family cope if I am unable to work, or if I die prematurely?
Having a financial plan can provide you with the answers to these questions. Cash flow modelling is an important part of our financial planning for clients. It helps us to answer many of these concerns by allowing us to forecast your current and future financial situation.
When creating a financial plan, we will firstly establish your lifetime goals. We will then assess your current situation and determine how close you are to achieving your goals based on aspects such as your income, expenditure, assets and liabilities.
After this, the next step is to develop and implement a plan to establish what action you need to take. The plan can then be used to help make well informed financial decisions. As your situation evolves over time, the plan will be monitored and reviewed and adjusted where necessary.
When the cash flow is run, there are typically two scenarios:
1) You have a surplus of assets. This means you can meet your financial goals and opens opportunities to discuss the potential for:
- Retiring early
- Enhancing your lifestyle by increasing expenditure.
- Making gifts to family
- Reducing inheritance tax liabilities
- Reducing unnecessary risk associated with your investments.
2) You have a shortfall of assets. This means your financial circumstances are not sufficient to meet your future aspirations. The advantage of having a plan will highlight potential shortfalls or threats to your situation and put you in an informed position well in advance. This means you can do something about it at an early stage and remain in control of your financial future. It opens opportunities to discuss:
- Your desired retirement age
- How much you need to save to achieve your goals
- The level of return you require to meet your goals
- Assessing the level of risk you are taking with your invested assets.
- If there is the potential to downsize or other methods of releasing capital
- Reducing expenditure in retirement.
Example – Income Shortfall in Retirement
The following chart shows a forecast of a client’s cash flow over their lifetime. Each bar represents one year. Where they are coloured blue, it means there is enough income or liquid assets to draw upon to meet the client’s income need for the year. The need is represented by the black line running along the chart. Where bars are coloured red, there is a shortfall. In other words, there is not enough income or liquid assets to meet the income need for that year.
In the following example, the client has a shortfall at age 89. Before retirement, there is an excess income which is not being used.
Using the cashflow software, we are able to see what might happen if the excess income is used to fund a stocks and share ISA each tax year. The results are as follows;
The chart above shows that the shortfall has now been filled. This indicates that by investing the excess income in an ISA, the client has a much better chance of achieving their retirement objectives and being able to meet all planned expenses until age 100.
Example – Pensions and Tax planning
The cashflow system can also help to identify future tax liabilities. In the following example, the client faces a Lifetime Allowance Tax (LTA) charge at age 75 due to the value of their pensions. This is demonstrated by the large spike at age 75. In this example, the LTA charge is in excess of £150,000.
The following scenario demonstrates what could happen if the client takes a phased retirement approach. They decide to draw a higher level of income from their pensions in the earlier years of retirement when they are likely to be more active and have a greater need for the money.
This scenario shows that through careful planning, the LTA charge can be eliminated.
In addition, the projection shows that the client can afford to take the additional income and spend more in retirement and there is still no shortfall in the plan.
In summary, having a financial plan can help you stay in control of your financial future by giving a clearer picture of what it might look like. It ensures you have the right provisions in place now, to enable you to make big decisions at the right time, to ensure you can meet your lifetime goals without your money running out.