Last year, I wrote about the importance of a contemporary and modern approach to financial planning that is very applicable for mid-life professionals who are in the midst of career change.
Whether they have been impacted by job loss, transitioning toward new career pursuits, and/or considering leaving the working world altogether, I have advocated for a more personalized and strategic form of personal financial planning that uses “cash flow” planning as a primary cornerstone for both short and long-term decision-making.
Plan Now for Shifting Cash Flow Later
Through my experience in serving these individuals for many years, I have learned that a rigorous analysis of long-term income and spending often reveals changing cash flows over time and that understanding these shifting patterns can provide an extremely powerful framework for short and long-term financial decision-making.
Recently, I was very gratified to come across objective and independent research that confirms the importance of analyzing these cash flows and spending patterns for those in mid-life who are in transition and thinking about their financial future. The research is also very applicable to seniors and those who have already left the workforce.
Dr. Zahra Ebrahimi, a research associate with the Employee Benefit Research Institute, recently completed a study (see citation at the end of this article) which demonstrated that people’s spending patterns change during their retirement years and that understanding these patterns over the decades ahead is a key element in effective retirement planning. In short, when it comes to retirement spending, “one size does not fit all.”
The research paper, based on data from the University of Michigan Health and Retirement Study, found that there are variations in spending for those in mid-life and older households, due to a broad range of factors. It is notable coming from EBRI, which is a tax-exempt and non-partisan research organization that does not engage in lobbying or sales of consulting services. In short, this organization looks at data, conducts research, and has no “axe to grind!”
What the Research Says About Planning for Cash Flow Changes
These changing patterns, according to the research, provide important insights about saving and investing for retirement, and also help in designing effective retirement withdrawal strategies. The EBRI research makes a great deal of sense to me, based on my experience working with mid-life professionals who have been consistent savers and investors during most of their lives.
For example, income streams such as Social Security, pensions, and/or mandatory retirement account withdrawals kick in at different times. Similarly, certain expenses like Medicare premiums (which are tied to your income) also begin on certain dates based on government rules and may increase substantially over time.
Other expenses (such as a home mortgage) may diminish or go away entirely. Understanding these shifting cash flows for your own situation has important implications for a range of long-term financial planning issues.
Seeing and visualizing the income streams and expenses over many years provides an amazingly effective framework for approaching a range of strategic decisions across the financial spectrum, including income tax planning, withdrawal rates from investment accounts, asset allocation decisions, estate planning, long term care planning, and more.
Moving Past a Traditional Financial Planning Approach
I have long advocated for this more robust approach to financial planning for mid-life professionals, and especially for those experiencing career change. Traditional financial planning approaches often do not evaluate such cash flows in a comprehensive fashion.
I wrote about the shortcomings of these approaches last year. These methods tend to rely on more conventional “rules of thumb” that are outdated and not useful, especially for mid-life professionals who have spent a lifetime saving and investing wisely.
One of those old financial planning truisms is called the “4% rule”, which says that you can withdraw 4% of your portfolio during the first year of retirement, with annual adjustments for inflation thereafter. I have never believed that the 4% rule provides a useful approach to retirement planning.
The cash flow studies that I have conducted for scores of clients over years show that withdrawal rates can change significantly over the course of a lifetime and that the 4% rule is too rigid and unrealistic. For example, in the years after you stop working, you may have higher withdrawal rates, due to increased discretionary spending on travel and/or other activities. Then, in subsequent years, you may spend or withdraw much less money from your retirement savings.
In addition, many people have multiple retirement accounts with differing tax rules. Over time, spending withdrawals can vary significantly from these accounts due to IRS rules and other tax related considerations. This is another reason why assuming a consistent withdrawal rate may not be practical since withdrawal patterns may likely not be the same for all accounts. In short, while a breakthrough in its day, the 4% rule is no longer relevant in my opinion.
Interestingly, in a recent media interview, Dr. Ebrahimi, the research paper’s author, said that following the 4% rule may not be wise advice for many seniors with shifting spending priorities, (as reported in the December 30, 2020 issue of Barron’s, the weekly financial and investment newspaper). Based on my professional experience, I could not agree more!
Almost universally, my experience has shown that successful mid-life professionals do not seek out generic financial advice, nor do they benefit from hearing financial platitudes such as the 4% rule or being told to save more and spend less. Instead, they want to gain clear insights about how they can thoughtfully approach decisions about a future that will most certainly be different than their past.
Comprehensive financial planning based on thorough cash flow analysis may provide an important foundation for moving into that future with confidence. As always, please contact my office if I can help you thoughtfully approach these matters.
Citation: Zahra Ebrahimi, “Older Americans’ Spending Profiles: One Size Does Not Fit All,” EBRI Issue Brief, no. 520 (December 10, 2020).