Accountants are of course familiar with cashflow modelling in a professional setting, but have you considered it to forecast your own future finances?
Its accuracy can give you the confidence to make wide-ranging financial decisions such as choosing when to retire or how much you can afford to give to children, but what I find is that my accountant clients often overlook it when it comes to personal finances. Instead, they choose to map out their future finances on a homemade spreadsheet.
Some of these spreadsheets are excellent but they simply don’t have the accuracy of professional cashflow modelling. However sophisticated they are, they’re unlikely to take into account all the variables that can have a significant impact on future finances. Most of them don’t include inflation or tax rates, let alone Benefit Crystallisation Event 5A on the pension lifetime allowance. Because of this, I find that homemade spreadsheets often don’t give people the confidence to make decisions. This can lead them to err on the side of caution and compromise when really, they are in a position to make much bolder decisions.
In contrast, cashflow modelling has a huge number of calculations and formulae ‘under the bonnet’ so can forecast future finances with accuracy. It provides data and personalised charts but just as importantly, it also creates an agenda for a family conversation. You have the relevant facts and figures to make important decisions. The example scenario below demonstrates this.
An example scenario
Julie and John want to understand if they have enough money for Julie to retire shortly rather than waiting a year. Julie is 62 and earns more than £150,000 working as an accountant. John, who is almost 62 is just about to retire as a teacher. He earns £48,000. He has recently received an inheritance of £320,000 from his mother and because his health is quite fragile, they are keen to enjoy time together as soon as they can.
Cashflow modelling is designed to give clarity in exactly these circumstances.
They have accumulated pensions of £500,000, ISAs of £250,000 each and both expect to get a full State pension at 66. John will receive a teacher’s final salary pension and Julie has a small annuity.
Julie’s mother is still alive and, at a conservative estimate, she expects to inherit £180,000.
I have broken down their retirement into three stages to work out their expenses.
Phase 1 – during the active retirement I have ear-marked £92,500 p.a. into their 80s.
Phase 2 – their expenditure then drops to £65,000 p.a. as they become less active.
Phase 3 – during their last five years, I have increased their expenditure to £100,000 p.a. to allow for care costs. When working out life expectancy, I use Cohort +5, which is the average life expectancy of someone their age plus five years.
Costs such as house maintenance and new cars are also included.
Can Julie retire?
Their money runs out at the age of 88. They still have their State pensions, teacher’s pension and annuity together with a house worth £1m.
John is not comfortable with this scenario as his mother died at 91.
Julie resolved to stay working for another 18 months but when we modelled this, it didn’t make much of a difference. They ran out of money at 91.
Julie and John had planned to downsize to release £100,000 from their home at 75 but they now wanted to look at the impact of releasing £300,000.
Julie also reconsidered her choice of cars, deciding that she’d rather retire earlier than drive a smart car for the next 20 to 30 years. She chose to look at the impact of reducing the cost of replacing her car from £40,000 every four years down to £20,000.
We also looked at increasing the growth rate assumptions for their investments. They were very conservative and we built the first two scenarios on an assumed growth rate of 2% after costs. Following risk profiling, they were comfortable to take on slightly more risk, so we increased assumed growth to 3% p.a.
With these changes, cashflow modelling showed that they would still have £295,000 at 95 plus a house worth £700,000.
This wasn’t their original plan but it created a way for Julie to retire immediately, and the accuracy of the forecasting gave them the confidence to follow it through.
Of course, we will review the plan with them and make changes if necessary, but it is often the case that because we have used sensible and conservative assumptions, clients find they are actually ahead of the game as time goes on, which increases their confidence.
Talk to Tilney
If you would like further information on planning for your retirement, we offer free consultations which you can book online or by calling 020 7189 2400.
If you would like to book your place on Tilney’s upcoming webinar ‘How much do I need to retire’, you can do so here.
The value of an investment may go down as well as up, and you may get back less than you originally invested.
This article does not constitute personal advice. If you are unsure as to any course of action, please talk to an adviser.
Issued by Tilney Financial Planning Limited. Authorised and regulated by the Financial Conduct Authority.
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