Picture this: You’re five years into retirement, having drinks with your friends on a sunny patio, and everyone is sharing how worried they are about paying for an upcoming cruise, funding their children’s education or making ends meet if Social Security payments don’t keep pace with inflation. Conversely, you sip your margarita happily, knowing you don’t have to worry about running out of money.
How is that possible? Cash flow analysis.
While it’s impossible to predict the future, a cash flow analysis helps you plan for several “what if” scenarios and can help increase your financial security in retirement. It may sound like a complicated financial process, but it’s a simple tool that can make a world of difference in your financial success.
Cash Flow Analysis Basics
Simply put, a cash flow analysis compares your estimated retirement income to your expenses to determine if you have enough money to pay for your needs. When we create a financial roadmap for a client, we run the plan through our cash flow analysis software. The system takes all of their retirement income into consideration — estimated Social Security benefits, 401(k) and IRA withdrawals, rental income, annuity payments — and plots that data out, according to when each of those payments kick in. For example, it’ll show Social Security payments starting at age 67 and required minimum distributions beginning at age 73.
Then, the system compares that to your estimated expenses and taxes and applies several risk factors, including inflation and market volatility. We often start by building the most obvious scenario first. For example, retiring at age 65, withdrawing 4% of your savings annually and applying average market returns and inflation rates.
Then, we run the plan through several “what if” scenarios: What happens if inflation spikes five years into retirement? How long will your money last if you need long-term care starting at age 75? What would happen if the market crashes the year before you plan to retire? Would moving more money to a non-qualified account help your nest egg last longer? What happens if one spouse passes away prematurely?
Running all of these hypothetical scenarios — we call this “stress testing” — can help expose potential weaknesses in your plan. For example, you might find out a Roth conversion could save you thousands of dollars in taxes or you may need to increase your retirement contributions because your nest egg is only predicted to last until age 75.
On the other hand, stress testing your plan can help bring peace of mind, knowing you are set up to withstand potential challenges. We’ve worked with several individuals who were afraid to retire, but a cash flow analysis proved their nest eggs were enough to cover their needs.
In short, cash flow analysis can help you make more well-informed decisions about your finances — from deciding when to retire or claim Social Security benefits to picking the right amount of investment risk or withdrawal strategy. Our software helps you see exactly how each of these decisions could potentially impact your retirement.
How Much is “Enough?”
When we talk about cash flow analysis with clients, they often want to know how much money is enough to live a comfortable retirement. That answer is different for everyone because your unique goals will impact your income needs.
Someone who wants to simply pay the bills each month and maybe take one or two trips a year will need much less income than a couple who hopes to winter in Spain and fund their grandchildren’s college education. Communicate your retirement goals with your financial advisor to ensure any major expenses are accounted for when running a cash flow analysis.
When Should I Use Cash Flow Analysis?
The earlier you can start planning for retirement and run your plan through cash flow analysis software, the better. If there are issues, you want to ensure there is plenty of time to fix those before you retire. We also recommend stress testing your plan regularly, especially when any major life events happen, such as inheriting a large sum of money, losing your job or finding out you’re expecting triplets. Rerunning your plan with these new scenarios in mind will help ensure you’re still on track to be successful.
It’s important to know that a cash flow analysis cannot be done well on your own. You might be able to find a free online tool or compare your income and expenses on an Excel spreadsheet, but these often lack the ability to apply variables like market volatility, inflation and taxes — all of which can have a significant impact on your long-term success. Our planning software allows us to stress test your plan against hundreds of scenarios to help you make informed decisions about your money.
If you want to learn more about how we use cash flow analysis software to help you proactively plan for your golden years, reach out to schedule a meeting with our team. It’s our goal to help you become the friend at the table who never has to worry about running out of money. Cheers!