Simplify Budgeting With The Cash Flow Analysis

The Cash Flow Analysis And Its Two Separate Levels

Published in Blog |

Let’s just put it out there – almost no one, including advisors, enjoys going through the process of putting together a full budget. Budgets can end up being inaccurate as well as time-consuming, and they often provide little actual value to the consumer. However, you still need to know your client’s cash flow as you construct a retirement income plan for them. How do you obtain that information without going through the labor-intensive budgeting exercise? Introducing the Cash Flow Analysis, a methodology that cuts through some of the budget process “clutter” and gets to the important numbers you need in order to get started.

There are two separate levels of the Cash Flow Analysis: the Income Gap Assessment for pre-retirees and retirees, and The Budgeter for younger, currently working individuals, or individuals who need more data analysis around their income and expenses. Let’s look at each one:

The Income Gap Assessment

The purpose of this exercise is to determine the “gap” between the net income a client is currently living on while working and the fixed income sources they will have after retirement.

It is based on a consumption methodology of budgeting and will provide an accurate amount that they will need to draw off of their liquid investible assets once they retire. This assessment is particularly valuable and efficient for clients and prospects who are less than 10 years from retirement. There are four fairly simple sections to complete in order to figure out the “gap.”

Simplify Budgeting With The Cash Flow Analysis

Current Amount Deposited Into Checking (Net Income After Taxes)

The first section, the current net amount deposited into checking, includes the net salary, wages and other sources of income pre-retirement which the client is using for living expenses. It is important to base this number on the net income deposited into the client’s checking account, not their gross pay. Net pay already factors out tax withholding, retirement contributions, and/or any employee benefits, such as health insurance, that would be paid through withholdings. What we are looking for is the net amount that the client has available to spend on an annual basis.

After we get to this annual number, we ask the client if one of three things is happening:

  • They are breaking even, consuming all their net income;
  • They are managing to save some money, consuming less than their net income; or,
  • They are losing money, going into debt.

If the answer is #1 or #2, the income gap assessment is a viable tool to determine the income gap your client may have in retirement. Simply ask the client, “If we were able to replace the same amount of net income you are spending now when you retire, would that meet your retirement goals?” This will serve as a basis for their total income needed in retirement.

If they chose #3 and are losing money every month, you may need to pivot to a detailed budget and determine if this client or prospect fits into your parameters of an “ideal client” with whom you wish to work.

Fixed Income In Retirement

This second section focuses on the client’s income post-retirement. The two primary sources listed here would be Social Security and/or pensions income. For Social Security optimization, clients may delay one or both of their benefits, leaving a larger income gap for a short period of time. In these cases, you might want to do multiple income gap assessments for the different time periods in order to get an accurate picture of their income gap/ excess cash flows throughout retirement. You could also do one income gap assessment as if all fixed income sources were activated, and then determine the amount of assets you would need to set aside in order to cover the bridge needed to make up for the delayed income. For example, a married couple turning 66 decides to delay one of their two Social Security benefits until age 70, which will produce a benefit of $30,000 per year for that client at age 70. We would create the income gap assessment as if the client were 70 years old and with full Social Security benefits in effect, and then segment somewhere between $120k – $150k of assets in our client’s Soon Bucket to bridge the Social Security delay.


Simplify Budgeting With The Cash Flow Analysis


Anything that might affect retirement income should be listed here. You can list both increased and decreased expenses that will occur in retirement in this section. For example, a mortgage might be paid off, resulting in a decrease in expenses. Conversely, an uptick in travel expenses might occur, resulting in an increase there. The client may have to allow for additional income taxes in retirement, which can be identified by creating a tax pro forma of their withdrawal strategy.

Once the Income Gap Assessment has been completed, you will be able to determine the client’s retirement income gap (or income surplus) by using the following formula:

Simplify Budgeting With The Cash Flow Analysis

Total Income Gap/Surplus

Once you have this final number, you’ll know if the client has an annual income surplus or an income gap for their retirement. If there is an income surplus, they will have excess cash flow in retirement. You can generally see this with clients who are lucky enough to have large pensions. Knowing this will allow you to help them get even more strategic with their plans, perhaps with additional life insurance, asset based long-term care or tax-efficient managed accounts. If the client has an income gap, we recommend that you ask them how much of that income gap they will want guaranteed in their financial plan. This will create an educational opportunity for you to show them different ways to guarantee their income in retirement.

The Budgeter

The Budgeter exercise is for younger clients who are more than 10 years away from retirement and still in the “accumulation” phase of life, or pre-retirees/retirees that need more detailed budgeting information mapped out as part of their cash flow analysis. The result will give the client an idea of their monthly cash flow surplus/deficit while in their working years to figure out approximately how much they have available to invest. For a retiree, it shows the same monthly surplus/deficit the client will have based on their income needs and fixed income sources.

Simplify Budgeting With The Cash Flow Analysis

The Budgeter also has four sections:

  1. Income
    Like the Income Gap Assessment, this section of The Budgeter lists everything that the client is bringing home net-after-tax. This includes normal salary, bonuses, commissions, Social Security, and pension income. You then add in the pay frequency to annualize the income number.
  2. Tax Adjustments
    This is where any necessary tax adjustments should be listed. These can be based on the client’s prior year tax return or even current year projections. (As a side note, if they are getting a refund, they are withholding too much and that could be adjusted moving forward.) Refunds should be entered as a positive value on the sheet, while taxes owed should be listed as a negative value.
  3. Expenses
    In another departure from the Income Gap Assessment, The Budgeter delves into the client’s monthly expenses. While not a full-blown budget exercise, it does track some main categories, like mortgage/rent, property tax, auto payments, childcare, etc. This will help you get a more accurate picture of where the client is spending their money and help them adjust their spending habits, if necessary.
  4. Totaling
    Once you total all these categories, you’ll have a good idea about your client’s or prospect’s monthly and annual cash flow surplus or deficit. If there is a surplus, your client has the opportunity to create a systematic savings plan for retirement – which could lead to further sales opportunities. If there is a deficit, they are spending more than they make, and they will need to put a budget in place to start cutting back on that extra cash outlay.

When you sit down with a prospect or client and go through either one of these exercises, you accomplish several things:

  • Your client or prospect has peace of mind knowing that they don’t have to change their lifestyle in retirement.
  • You can quickly get to the number the client will need to draw from their liquid investable assets to meet their retirement needs.
  • You uncover opportunities for additional client education and sales.

While there will always be cases where you need to do a full budget analysis with a prospect or client, utilizing these tools is a quick and easy way to arrive at a net consumable, spendable income, followed by an accurate net amount that they will need to draw from their assets in retirement. Knowing these numbers will assist you in designing a suitable plan for your client, who will sleep better at night knowing that you are working to help them achieve their retirement goals.

While you’re on the go, listen to our podcast for more insight on the Cash Flow Analysis.

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