As a corporate treasurer, you will be familiar with cash-flow modelling in a professional setting, but have you considered using it to forecast your future finances? The accuracy it provides can help you make important financial decisions with real confidence. For example, it can help you understand if you are in a position to retire in the next few years, how much you could afford to pass on to your children now without compromising your own future lifestyle, or whether the time is right to buy that home in France.
It is often the case that while those in professions such as yours are usually meticulous planners – and certainly rarely need encouragement to plan for the future – cash-flow modelling is often overlooked when it comes to personal finances. Instead, there is a tendency to rely on homemade spreadsheets to work out what future finances could look like.
While homemade spreadsheets are often excellent, they are unlikely to take into account the many variables that can change the outlook for future finances, so can never match the accuracy of professional cash-flow modelling. As an example, most spreadsheets don’t include inflation or tax rates, and are even less likely to consider the impact of Benefit Crystallisation Event 5A on the pension lifetime allowance. This matters because it is accuracy that gives you the confidence to make decisions. Without accuracy, people naturally err on the side of caution and this can mean compromising when it comes to your future.
The first step in any cash-flow model is to collect information about your finances, for example, your income, outgoings, pensions and investments. The financial planner running your cash-flow model will then analyse this information along with your future goals and income requirements to forecast if you are on track, have more than enough money or are likely to fall short. This is done interactively and it is possible to try out different scenarios, for example, looking at the impact of taking a different level of risk with your investments or choosing to retire earlier. It is also possible to show the impact of events such as a market crash.
Cash-flow modelling usually leads to fascinating conversations as people visualise their future, work through trade-offs and realise what is important to them. The case study below brings this to life.
The clients Tara and Adam want to understand if they have enough money for Tara to retire shortly rather than waiting a year. Tara is 62 and earns more than £150,000. Adam, 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 father and because his health is quite fragile, they are keen to enjoy time together as soon as they can.
Cash-flow modelling is designed to give clarity in exactly these circumstances.
Their finances They have accumulated pensions of £700,000, ISAs of £310,000 and both expect to get a full State Pension at 66. Adam will receive a teacher’s final salary pension and Tara has a small annuity.
Tara’s mother is still alive and, at a conservative estimate, she expects to inherit £180,000.
Their expenses Their retirement is broken down into the following three stages to work out their expenses:
Phase 1 – during the active retirement into their 80s, £80,000 p.a. is earmarked.
Phase 2 – their expenditure then drops to £60,000 p.a. as they become less active.
Phase 3 – during their last five years, their expenditure is increased to £100,000 p.a. to allow for care costs. When working out life expectancy, Cohort +5 is used, which is the average life expectancy of someone their age plus five years.
Costs such as house maintenance and new cars are also included.
Scenario 1: Their money runs out at the age of 89. They still have their State Pensions, teacher’s pension and annuity together with a house worth £690,000. Adam is not comfortable with this scenario, as his mother died at 91.
Scenario 2: Tara stays working for another year but, when modelled, this doesn’t make much difference. They ran out of money at 90.
Scenario 3: Tara and Adam had planned to downsize to release £100,000 from their home at 75, but they now wanted to look at the impact of releasing £200,000.
Tara also reconsidered her choice of cars, deciding that she’d rather retire earlier than drive a luxury 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.
The growth rate assumptions for their investments were also looked at. They were very conservative, so the first two scenarios were built on an assumed growth rate of 2% after costs. Following risk profiling, they were comfortable to take on slightly more risk leading to an assumed growth rate of 3% p.a.
With these changes, cash-flow modelling showed that they would still have £200,000 at 93 plus a house worth £600,000.
This wasn’t their original plan, but it created a way for Tara to retire immediately, and the accuracy of the forecasting gave them the confidence to follow it through.
Martin Holden is a financial planning partner at Tilney
If you would like to speak to a financial planning expert, Tilney offers initial no-obligation consultations, which you can book online or by calling 020 7189 2400.
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.
