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Retirement Daily
Planning for Your Golden Years: Don't Let Traditional Methods Limit Your Retirement
By Retirement Daily Guest Contributor,
28 days ago
By Lisa Featherngill and Melissa Linn
The golden years should be enjoyable, relaxing and stress free. As individuals approach retirement, they want to understand if they are financially ready, and traditional methods of funding retirement have resulted in some retirees looking for work late in life. Some retirees have adjusted their lifestyle based on reduced means, but there is a more effective approach for forecasting retirement income and expenses that can help retirees more realistically plan for the unexpected.
Traditional Approaches to Managing Retirement Income
The endowment model aims to liquidate a portion of the investment portfolio every year to support expenses over and above anticipated sources of income in retirement – this approach is like the 4% rule. The 4% rule assumes you can withdraw 4% of a portfolio in the first year of retirement and then adjust the amount by the rate of inflation in future years without depleting assets during retirement. The endowment method tries to provide a consistent income stream during retirement but runs the risk of a significant asset decline, resulting in principal depletion.
Retirement Income Strategy:
The retirement income strategy aims to produce sufficient investment income to cover retirement income shortfalls through asset allocation. This strategy can lead to a portfolio heavily invested in fixed income, sacrificing portfolio growth. In years where fixed income does not perform as expected, there is an income shortfall while missing growth opportunities. Unexpected expenses can lead to the liquidation of fixed income investments earlier than originally anticipated, resulting in a reduction of income generated by the portfolio and retirees reducing their lifestyle or looking for supplemental income.
A New Approach to Managing Retirement Income
The modern approach to retirement income planning begins with setting income and expense assumptions, targeting a long-term asset allocation, and testing these assumptions with Monte Carlo simulation (MCS). MCS uses statistical analysis to model the probability of different investment results over a period of time. This process runs hundreds, if not thousands, of trials to understand best and worst-case scenarios. The number of trials is limited by the software program used.
The result of the analysis allows for a portfolio to be positioned with long-term objectives and risk factors in mind. If the portfolio underperforms in the early years of retirement, the expense level and/or the portfolio allocation may need to be revisited. The MCS should be re-run, at a minimum, every three years to determine if the portfolio is performing as intended. The balance sheet should be updated annually and compared to the projections to determine if the retiree is on track financially. Cash flow should also be reviewed annually to ensure there are no significant changes in the assumptions.
This approach provides a more precise picture of annual cash flows and allows the client and advisers to anticipate liquidity needs. As a result, sufficient funds can be maintained in money market or other liquid vehicles to provide short term cash flow needs, while continuing to invest the balance of the portfolio to support longer term needs. MCS also identifies early enough if a retiree has fallen off the predicted path, providing the opportunity to course correct and avoid a less-than-ideal retirement experience in the later years.
A CPA/Personal Financial Specialist's Role
The tools to perform this type of analysis are typically available to CPA financial planners and Personal Financial Specialist (PFS) credential holders, who can help with retirement projection, tax management, asset allocation and the many decisions facing retirees. These credentialed individuals understand the analytical decisions as well as the non-analytical choices that need to be made to have the retirement experience that the client desires.
Planning for retirement is a journey that should be started well in advance of the target date. Integrating Monte Carlo Simulation and expense awareness can give retirees peace of mind during their retirement journey. In addition, retirees can monitor legacy goals for heirs, pursue dreams they didn’t know were attainable or explore fulfilling post-retirement income and activities. Involve a CPA/PFS early in the journey to maximize the opportunity for success!
About the authors: Lisa Featherngill and Melissa Linn
Lisa Featherngill is the national director of Wealth Planning at Comerica Bank. She has also spent 25 years at Wells Fargo/Wachovia/First Union and 11 years at Arthur Andersen in Washington, D.C. Lisa is a member of the AICPA’s Advanced Estate Planning Committee for the AICPA ENGAGE Conference.
Melissa Linn is a senior wealth planning strategist at Comerica Bank. She has also worked for Wells Fargo/Wachovia, Deloitte, and Stancil & Co. Melissa is a member of the AICPA PFP Executive Committee and PFP Conference Planning Committee.
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